Endowment Value Declines 29.5% as Investment Return Is Negative 27.3%

Harvard Management Company's annual report quantifies the punishing decline in the value of the University's endowment.

Harvard Management Company (HMC) reported today that the University’s endowment was valued at $26.0 billion as of June 30—29.5 percent less than the record $36.9 billion reported for the prior fiscal year. That result reflects a negative 27.3 percent investment return on endowment assets after expenses and fees; plus capital gifts received during the year (total giving, reported on September 10, was $602 million, down just 8 percent from fiscal year 2008, but the portion directed to endowment has not yet been disclosed); minus the distribution of somewhat more than $1.6 billion from the endowment to support University operations during the year. The latter figure is surprising: it represents an increase over the funds distributed in fiscal year 2008. Details presumably will be forthcoming with the autumn publication of the University’s annual financial report—but the planned reduction in endowment distributions in the current and next fiscal years is driving cost-cutting throughout Harvard.

The endowment last approximated its current value four years ago, when it totaled $25.9 billion as of June 30, 2005.


                           An Up and Down Decade…Ends Down

 Endowment value as
of June 30 (billion)
Annual rate of return on investments
2000  19.132.2
2001  18.3(2.7)
2002  17.5(0.5)
2003  19.312.5
2004  22.621.1
2005  25.919.2
2006  29.216.7
2007  34.923.0
2008  36.9  8.6
2009  26.0(27.3)

Source: Harvard University Financial Report


The loss on endowment investments was not a surprise. As HMC president and CEO Jane L. Mendillo noted in her annual communication to the community, “Clearly, the last year was a difficult one for Harvard as it was for almost all institutional investors,” and the University had forecast a 30 percent decline as long ago as last December. (Mendillo, a former senior investment officer at HMC, returned to lead the organization on July 1, 2008, just as the markets dived; read some of her perspectives on the past year here.)

During the depths of the financial crisis and then recession last autumn and winter, in fact, there were concerns that losses in private-equity and real-estate investments might drive even deeper declines in the endowment overall. But during this past summer, some endowment managers (among them those at Princeton, Amherst, and Williams) indicated that stronger stock and bond markets in the first half of calendar year 2009 had enabled them to exceed their darkest forecasts (typically of 30 percent investment losses), and they generally raised their expectations to a negative 25 percent investment return for the year; none of them has reported final results yet. In that sense, HMC’s negative 27.3 percent return was within the forecast range, and modestly positive (by a billion dollars) compared to the University’s prior estimate.


Performance Parameters in a Bruising Year

But the result was more than bruising enough. The “policy portfolio,” the model that HMC uses to diversify its assets, returned negative 25.2 percent as measured by the investment benchmarks for each asset class—2.1 percent better than HMC’s actual performance. That margin of underperformance is not unprecedented, but it certainly is not typical of HMC’s aims. And the median large investment fund in the Trust Universe Comparison Service returned negative 18.2 percent. That still represents a very large loss, but it is a significant margin of outperformance relative to Harvard, in a year when holding conventional stock and bond portfolios proved much more rewarding than relying on the more complex assets that have given HMC decades of higher returns than other endowments (a track record that remains intact; see below).

HMC’s results this year are published in a new format, “Harvard Management Company Endowment Report: Message from the CEO”, and in one important respect are not exactly comparable to detailed results reported in prior annual letters. Thus, the performance for the year is shown in fewer, more aggregated categories than in years past or than exist in the policy portfolio (which details assets by domestic and foreign equities, emerging markets, private equities, absolute return or hedge funds, commodities, real estate, and four fixed-income classes, plus cash).

The results reported by category for the fiscal year just past show modestly lesser losses, compared to market benchmarks, in two broad classes. The first is public equities (in the past, about one-third of endowment assets). The second is “real assets”—a broad category (in the past totaling about one-quarter of investments)—including commodities; timber and agricultural land, likely a buffering influence on otherwise sharply negative results; and real estate, where commercial assets are likely still deteriorating in value.  (Mendillo’s letter did note that the “natural-resources portfolio was nearly flat” in an environment of sharply negative returns for most other growth-oriented assets.)


                                        Fiscal Year 2009 Returns

Public equities(28.3)%(28.5)%       
Private equities(31.6)(23.9)(7.7)
Absolute return(18.6)(13.2)(5.4)
Real assets(37.7)(38.5)  0.8
Fixed income(  4.1)(  3.4)(0.7)
TOTAL HMC(27.3)(25.2)(2.1)


In private equities, HMC’s results were sharply lower than market returns; the same was true for assets managed using absolute-return (hedge-fund) strategies. Fixed-income assets (in the past, about 13 percent of the total portfolio) trailed market returns slightly.

Details are not available, but in the past, HMC has said it has taken a more conservative view of the actual market values of assets managed by outside firms in categories such as real estate and private equity than have the asset managers themselves. It may have done so again in this very volatile, treacherous investing environment. If so, that could account for some of the significant underperformance logged in the private-equity investments; and could have affected the valuation of the real-estate component of the real-assets category.

In any event, Mendillo evinced continuing confidence in such investments. She noted that private-equity investments have “earned an average of 15.5 percent per year for the Harvard portfolio for the last 10 years even after a 32 percent correction in fiscal year 2009” and that the natural-resources portfolio (within real assets) “has returned 13.0 percent per year for the last 10 years.”

Mendillo’s report hinted at other factors that yielded higher investment returns. The international fixed-income team outperformed its benchmark by more than 900 basis points (hundredths of a percentage point), and the internal emerging-markets equity group exceeded market benchmarks by 370 basis points. Returns overall were bolstered by HMC’s aggregate portfolio-hedging trades and strategies—a significant element in the prior fiscal year as well (when HMC’s consolidated performance exceeded market benchmarks by 170 basis points).

Negative factors relative to the market, as measured by policy-portfolio benchmarks, included both investment factors and new concerns about liquidity. Among the former Mendillo cited, within the internally managed domestic fixed-income portfolio, “exposure to some of the less-tradable structured credit securities that were most impacted as the market imploded.” That strategy has changed, and the senior investment manager who was responsible for the assets decided to leave HMC.


Toward Enhanced Liquidity

As for liquidity concerns, she cited “recent over-sized commitments to illiquid asset classes,” a problem for an endowment now valued at $26 billion versus one worth 40-plus percent more and with expectations shaped by rapid growth earlier in the decade. As reported, at the end of fiscal year 2008, HMC had future commitments to outside investment managers totaling some $11 billion, which would, of course, worsen the “over-sized” proportion of the endowment so invested as those cash calls were made. Moreover, such managers typically impose holding periods on the investments they make, creating a second problem that Mendillo described as “a larger proportion of strategies with long holding periods” among even the liquid asset classes. Finally, she cited a “lack of ready liquidity in the portfolio to meet our obligations along with the needs of the University,” as private-equity, hedge-fund, and other asset managers slowed or stopped their distributions of funds back to HMC, and as the University faced its own credit problems last fall—necessitating sales of liquid assets at a time when HMC might have preferred not to do so.

So it is consequential that Mendillo’s report noted two significant changes:

  • First, “We have decreased our uncalled capital commitments by roughly $3 billion”—likely through a combination of sales of some investments on the secondary market; negotiations with fund managers to rein in their ambitions and the size of proposed investments to reflect current market realities; and some calls for funds made and fulfilled during the past fiscal year.
  • Second, HMC has removed leverage from its investment strategy. The policy portfolio for years called for a negative 5 percent cash position—that is, for the use of borrowing to boost investment returns. That allocation was reduced to negative 3 percent at the end of fiscal year 2008, and is now modeled as positive 2 percent: a 5-percentage-point swing in one year, and a significant change in a multibillion-dollar portfolio. (To accommodate the planned cash cushion, the policy portfolio published in Mendillo’s report reflects a 2-percentage-point reduction in absolute-return investments, and a 3-percentage-point reduction in commodities assets.)

In general, she noted, “We have made changes to…the portfolio to increase the flexibility and control we have in managing our funds while maintaining attractive return expectations.” In the investment world made new during the past year, it is clear from her report, “the risk tolerance of the University needs to be an integral factor in the decisions regarding asset allocation, flexibility, and accessibility of the investment strategies we choose,” implying a greater coordination of HMC and University financial plans and operations. At the same time, she emphasized the importance of being in a position “to explore the most attractive investment themes that we foresee emerging from the crisis we have experienced.”

A greater cash cushion will be a comforting hedge if investment markets remain choppy or turn negative again. On the other hand, if markets improve, the cash could serve as an anchor, dragging down performance. In light of that factor—and her expectation of “prolonged” slower growth in “some markets,” Mendillo cautioned about the need to be “realistic about near-term returns and about our expectations for several years to come.” (Her report did not give any interim indications of performance in the summer months, since the end of the past fiscal year, and there is no suggestion that HMC will provide such updates from now on—thus discontinuing the extraordinary guidance released during the financial crisis.)


Historical Perspective, and Investment Prospects

There is no indication that HMC is backing away from its expectation of long-term returns of 8.25 percent for a pool of assets diversified in line with the policy portfolio. In fact, including the losses just realized, HMC’s 10-year, annualized return on investments is now 8.9 percent. That figure remains significantly above conventional stock/bond portfolio performance and median large endowment returns during the same period:


                                    Historical Investment Returns

 HMC/Harvard Endowment
Policy Portfolio  Benchmark  
60/40 Stock/Bond Portfolio    
Median Large Endowment
1 year
5 years
10 years
20 years


But Mendillo noted, “For Harvard, as for almost every investor, regaining the market value lost as a result of the recent global economic crisis will take time.” (In fact, if distributions to support University operations during the next few years run near 5.5 percent to 6 percent of the endowment’s value, as they may, and investment returns are below the long-term goal, the endowment’s value could remain essentially flat, excluding any capital gifts. Given the goal of exceeding inflation over time, to maintain the endowment’s purchasing power, such results for an extended period would be worrisome.)


Strategic Changes in the Policy Portfolio and Asset Management

For the longer term, Mendillo signaled two important strategic shifts for HMC.

  • First, she characterized past changes in the policy portfolio as “incremental,” and suggested that a broader “rethinking” was under way, “to better suit current realities and lessons learned.” Thus, the decision to present detailed investment returns in fewer asset segments or classes (as shown above) may be an indication of broader changes in progress, where there would be, as she wrote, “[f]ewer distinctions among the finely tuned asset classes to encourage greater collaboration among our teams in exploring investment themes.” Those are likely, however, to include still greater concentration “in areas where HMC has unique competitive strengths,” such as active fixed-income management, natural resources, real estate, and private equity.
  • Second, she stressed the cost and especially the control advantages and feel for the market realized through internal money-management expertise (HMC personnel manage about 30 percent of the portfolio now, down from 70 percent early in the decade). As a result, without setting a specific target for internal versus external management, she wrote, “[W]e are looking to increase the share of internally managed assets under the right conditions.” Because the compensation of the five most highly paid HMC staff members, and its president, are disclosed, such a shift risks reawakening earlier disagreements about the appropriate pay for employee investment managers within the University.

In a separate note, Mendillo observed that HMC’s system of awarding bonuses for outperformance relative to market benchmarks, but reversing some of the bonuses if subsequent performance lags, had the expected result in the year just ended: “[A] substantial number of portfolio managers at HMC had portions of their bonuses earned in prior years ‘clawed back’ into the endowment.” A smaller group, presumably including those teams highlighted above, “who outperformed their markets in fiscal year 2009,” retained their past bonus awards “while earning additional performance compensation this year.”

With appropriate liquidity, new strategies, and several new people in place, Mendillo concluded, she and her colleagues have “positioned both HMC and the Harvard portfolio to be robust, steady, and, importantly, poised to benefit from growth in the world’s economies. We have reset the building blocks for a solid, innovative, and sustainable investment strategy.”

The debate over compensation will surely resume, but in one sense, the whole University community, after a chastening lesson in the behavior of financial markets, might hope that Mendillo’s guarded optimism is warranted—and that many HMC professionals are in line for significant bonuses in the years ahead.


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