11 Percent Investment Return Boosts Value of Endowment to $27.4 Billion
Harvard’s endowment was valued at $27.4 billion as of June 30, the end of fiscal year 2010—up 5.4 percent from $26.0 billion at the end of fiscal 2009—according to the annual report released by Harvard Management Company (HMC). During the fiscal year just ended, HMC recorded an investment return of 11.0 percent on endowment and related assets, a gain of perhaps $2.85 billion using a back-of-the-envelope calculation. This was a welcome improvement from the negative 27.3 percent investment return during the financial market upheavals in fiscal 2009, when the endowment’s value declined by the daunting sum of nearly $11 billion. The difference between the rate of investment return and the growth in the absolute value of the endowment reflects the distribution of endowment funds to support University operations (approximately $1.56 billion in fiscal 2010, down from $1.66 billion in fiscal 2009 and $1.63 billion in fiscal 2008), offset by endowment gifts received during the year. Exact figures will be reported in the University’s annual financial report, to be published in early October.
The arithmetic—gross endowment gains, less distributions, plus gifts, equals net endowment growth—is important. HMC’s fiscal 2010 investment return handily exceeded its long-term goal of 8.25 percent annual gains. After distributions in support of University spending (the endowment now provides about 35 percent of operating revenues), this return, plus gifts, enabled the endowment to grow at about half the rate of the investment return. That is, reassuringly, above the current low rate of inflation: it represents real growth. But it implies a very extended period of recovery after the $11-billion decline in fiscal 2009. For context, HMC’s annualized rate of return for the past five years is now 4.7 percent, and 7.0 percent for the past 10 years. Those figures reflect not only the fiscal 2009 drop, but also the extraordinarily favorable rates of return (23.0 percent in fiscal 2007, 16.7 percent in fiscal 2006, 19.2 percent in fiscal 2005) realized during some earlier years in the decade. It is this longer-term performance that shapes the Corporation’s budget decisions—significantly including the rate of distribution from the endowment.
On a relative basis, HMC’s performance (after all investment-management fees and HMC operating expenses) was better than the 9.4 percent return calculated using market benchmarks for the assets in the “policy portfolio.” (That is what HMC calls its model for allocating assets among categories such as equities, fixed-income instruments, real estate, and so on.) In fiscal 2009, HMC’s performance trailed its market benchmarks by 2.1 percentage points. In both years, the University’s portfolio—which is highly diversified, and geared toward long-term appreciation—fared less well than a popular measure of large endowment funds, the Trust Universe Comparison Service. Median performance for the TUCS in fiscal 2010 was a 13.3 percent investment return, 2.3 percentage points above the HMC results. The difference reflects dissimilar asset allocations: TUCS funds are about half invested in public equities (versus one-third for HMC’s policy portfolio), with only a few percent invested in real assets (typically almost one-quarter of HMC’s allocation—and this year, the only segment of its holdings where, overall, HMC recorded negative returns).
By asset class, using the categories introduced in its reporting last year, HMC’s fiscal 2010 performance (with comparison to the benchmark) was:
Public equities 15.8 percent (0.6 percent better)
Private equity 16.2 percent (2.9 percent better)
Absolute return 15.2 percent (2.9 percent better)
Real assets -2.7 percent (2.0 percent better)
Fixed income 8.5 percent (1.3 percent better)
Total endowment 11.0 percent (1.6 percent better)
Within these categories, according to the report by Jane L. Mendillo, HMC’s president and chief executive officer, investments in U.S. equities returned 17.1 percent and those in developed-market international equities 12.9 percent—both comfortably ahead of benchmark returns. Investments in emerging-market equities returned 17.6 percent, below benchmark returns. (Each of these three public-equity classes is assigned an 11 percent weight in the policy portfolio, summing to one-third of typical endowment holdings.)
Private-equity investments account for another 13 percent of the policy portfolio. Although Mendillo indicated that the policy-portfolio weightings for fiscal 2011 will be unchanged, her report indicates a more nuanced view of this asset class. “Private equity bears a mention of its own,” she wrote. “Harvard has benefited from being an early participant in the private equity arena, and we have a strong team in this area and many important relationships with a number of the best private equity and venture capital investors in the world. However, the field of private equity has become more and more crowded—with capital, with managers, and with investors—over the last decade. Our expectations…are that returns will be more muted going forward.” Accordingly, although HMC expects to maintain “a meaningful level of exposure to this asset class over the long term,” those investments will be more concentrated, entrusted to a smaller roster of “our highest conviction [investment] managers.”
Returns on high-yield investments (reported within the “absolute return” category, 18 percent of the policy-portfolio allocation) were 19.6 percent, somewhat below benchmark results. That implies that hedge-fund managers’ results—the larger part of absolute-return investments—exceeded their benchmark, but Mendillo’s report does not provide a figure.
Real assets (23 percent of the policy portfolio, consisting of real estate—9 percent—plus commodities and natural resources, such as timber and agricultural land) produced investment losses, reflecting the continued weakness in commercial real estate—a segment where HMC’s results trailed market benchmarks. Natural resources investments yielded a “relatively low” nominal return, Mendillo wrote, but above-market results; and commodities returns were apparently around zero.
Fixed-income returns (11 percent of policy-portfolio assets, excluding high-yield bonds, as noted above) were driven by above-market results in HMC’s internally managed funds, Mendillo wrote. Her report did not categorize returns by domestic, foreign, and inflation-indexed bond investments.
Finally, the policy portfolio now allocates 2 percent of total assets to cash. (In prior years, HMC borrowed up to 5 percent of its total holdings, using leverage to boost returns; this cash-negative strategy was obviously unhelpful when financial markets declined sharply.) In a year with positive investment returns but near-zero interest rates on cash instruments, such an allocation would have had the effect of depressing HMC’s overall results slightly. But the fund managers have the opportunity to deviate from the policy portfolio to some degree, and it is not clear from Mendillo’s report whether the cash holdings were in fact committed to investments.
Investment Initiatives and Outlook
In categorizing the year, Mendillo called it “a successful one for the Harvard endowment” and for HMC. She cited the value added in returns that exceeded market benchmarks; improvements in the organization through hiring of new skilled personnel; and changes that “more closely aligned HMC with the University,” after the harrowing months in late 2008 and early 2009 when long-term investments were out of synch with Harvard’s urgent need for liquid resources. She cited “the much improved flexibility of the portfolio we are managing today,” the result of “attend[ing] closely over the last two years to liquidity, capital commitments, and risk management.”
Notably, Mendillo reported that uncalled capital commitments—contractual obligations to provide funding in the future to real-estate and private-equity investment managers—had been reduced to $6.5 billion at the end of fiscal 2010, down from $8 billion a year earlier, and by nearly a half from the $11 billion at the end of fiscal 2008. These reductions apparently reflect fulfilled obligations plus sales of interests in investment partnerships, maturing investments, and renegotiation of contractual terms with investment managers. (There have also been hints in recent months that private-equity managers have been able to realize some of their gains and resume making cash distributions to their investors, a sign of some return to normalcy in that market, and obviously a critical indicator of health for investors in such assets.)
Looking ahead, Mendillo wrote that depressed conditions in the real-estate market have so reduced values that this is now “one of the areas we find most interesting in terms of current and future opportunities.” With new real-estate talent in house, HMC will look beyond limited partnerships to other forms of investment—presumably joint ventures and direct relationships—in this area. She similarly pointed to further commitments in natural resources and in commodities, building on existing strong disciplines and, throughout HMC, on the opportunity to hire skilled investment managers as the financial industry worldwide continues to restructure.
As Mendillo suggested last year, HMC is likely to increase the portion of funds managed internally, by HMC staff: she again cited the advantages of control over assets, insights into market conditions, and lower expenses compared to using outside firms.
More generally, she reaffirmed Harvard’s commitment to the “endowment model” associated with Yale, HMC, and other institutions in recent decades: relying on highly diversified portfolios, with significant investments in untraditional and relatively less liquid asset classes where sophisticated investors can realize long-term advantages compared to conventional stock and bond holdings. “Has the ‘endowment model’ run its course?” she wrote. “Our answer to that question is No.”