Overhauling the Endowment

Stephen Blyth
Photograph by Stephanie Mitchell/Harvard Public Affairs and Communications

When Harvard Management Company (HMC) president and CEO Stephen Blyth reported on endowment investment returns last fall, he bluntly described declining performance; laid out a new mission statement and investment goals; detailed a new asset-allocation model; and sketched changes in operations and compensation. In November, he invited Harvard Magazine to HMC’s offices to discuss these changes in depth. Blyth directly addressed an altered investment environment that is reducing returns; University constraints in the wake of the 2008-2009 financial crisis that limited investing options; and other aspects of HMC’s execution that affected endowment performance. He also reviewed the cultural changes under way that aim to put HMC on a post-crisis footing, in pursuit of better investment results. The full transcript of the conversation is available here. Highlights follow.

On the investing environment: HMC’s “10-year rolling average real return declined from the double digits to just over between 5 percent and 6 percent annually. That is highly related to the fact that interest rates have declined dramatically…Ten-year, essentially risk-free real rates have declined from 4.5 percent to 0.6 percent….In order to generate 5 percent real return 10 years ago, you could just buy mostly TIPS [inflation-adjusted bonds] and then take a little bit of risk. Today, you need TIPS plus 4 percent of real return” from taking risk.

On the University’s constraints, and their effect on endowment investments: At a town hall meeting with his staff last winter, Blyth said, “[L]et’s recognize that Harvard had a tough war, had a very difficult financial crisis, and its liquidity position was worse than other comparable institutions for a number of reasons….”

He subsequently amplified: “[I]t was absolutely appropriate in early 2009 to say to people, do not do this investment that could lose this amount of money because…that would be very damaging to the overall position of the University….If I’m an investor at HMC in 2009/2010…, even if there’s an opportunity, I need to make sure that it does not show up on the downside if something goes bad, so that means a sizing issue. I need to do it on a smaller scale. As a direct result, it’s not going to show up on the upside if things go well. So, there’s a conviction-to-scale mismatch.…

“[W]e were doing trades in 50 or 100 lots for a $30-billion endowment and others were doing 100 to 200 lots for a $20-billion endowment….Say we wanted to do a one-percent investment in a high-conviction manager or asset, we were doing a quarter- to half-percent investments where others were doing one- to one-and-a-quarter-percent investments, so that is something that we need to shift.”

On changing HMC’s culture: “[T]he first thing I did here…was set the new narrative for HMC. I viewed it as…not drawing a line under the financial crisis, but at least starting a new paragraph or new chapter.” Having recognized prior constraints, he continued, “Let’s just…realize that our job is to improve investment performance.

“Interestingly, there was a sense of relief from the organization that that was just said publicly internally. This is the new path. This is about moving from recovering…to competing.”

On relationships with external investment managers: “HMC retrenched significantly and in a number of ways. It was unable to give capital to subsequent funds from high-conviction managers….We sold certain interests at a discount, as is well documented. As a result, the relationships with private-equity managers as a particular case were affected following the financial crisis.…

“But the relationships that we have with the top-tier private-equity managers and venture-capital managers are just incredibly valuable. Those are assets that need to be managed and looked after in the same way we would look after financial assets. That’s an area that I personally, the executive team, the private-equity team are highly focused on—developing those relationships back to a place where they are valuable assets.”

On a more flexible asset-allocation model: “[I]f we’re explicitly saying we have this flexibility, all these portfolios are permissible, it allows us now to incorporate the best-ideas concept. I think that’s something that is going to be additive….We’ll no longer be having, ‘This does not fit in my bucket’ or ‘My bucket is full; I can’t fit any more in.’ Things that are just suboptimal from an investment perspective…are no longer in play.”

On reorganizing to foster investment decisions: “We have changed the investment-management structure at HMC in an important way. We’ve essentially taken out a layer of investment management.…I was head of public markets….[with] public equities, public credit, public commodities, and public fixed income reporting to me. The debate across that second layer and what was then a third layer was…suboptimal. When I became CEO, I didn’t replace myself.…and I’m not replacing the head of alternative assets [who retired].…[A]s CEO, I dropped down to sit on top of the investment committee, which is now the portfolio-management heads. That means the discussion is less vertical and more horizontal just by construct. That changes the decision-making process significantly.”

On HMC’s hybrid model of investing assets internally and externally: “I have no target….There’s no, ‘We want to get this amount internally’ or ‘We want to get this amount externally.’ …We just want to make sure we have the best investors in everything we’re doing. If we have an external manager who’s not good enough, we’re going to redeem. If we have an internal portfolio-management team that is not good enough, we will have to upgrade.”

For background coverage, see “Endowment Gain—and Gaps,” November-December 2015, page 22, and “Harvard Endowment Rises to $37.6 Billion on 5.8 Percent Investment Return.”

Read more articles by John S. Rosenberg

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