Harvard’s Endowment Outlook—Updated
Updated September 14, 2021, at 7:40 p.m.
As an early indication of just how far might be up for investment returns in the fiscal year ended. June 30, the consistently excellent University of Virginia Investment Management Company (UVIMCO; 20-year annualized rate of return of 10.6 percent) reported a 49 percent return for its long-term pool, in which its endowment is invested.
Although UVIMCO manages a much smaller pool of assets than Harvard Management Company (HMC, which oversees the University’s $41.9-billion endowment, as of June 30, 2020, and other investments), it pursues a highly diversified strategy like that used at HMC and peer higher-education endowments. Accordingly, UVIMCO’s results by asset class are of interest:
•Public equities (29.9 percent of assets) produced a one-year return of 51.4 percent.
•Private equity (26.4 percent) yielded 98.7 percent, apparently driven by venture-capital and similar holdings (the report refers to the “substantial shift to online activities, resulting in dramatically accelerated growth for many software and internet businesses”).
•Long/short equity—what HMC would call “hedge funds”—(17.0 percent of UVIMCO’s assets) produced a 33.3 percent return.
•Real assets (10 percent) yielded a 49.0 percent return (UVIMCO’s report refers to hospitality and retail real estate, and rebounding oil prices).
Fixed-income returns were negligible (1.4 percent) and UVIMCO’s credit portfolio (involving financial restructurings) realized a return of 29.9 percent.
It would be surprising if any of the very largest endowments (Harvard, Yale, Princeton, Stanford) performed at UVIMCO’s level—and as explained below, Harvard may trail the top performers among its immediate peers. But as UVIMCO’s report reveals, the recovery from the pandemic shaped historic returns for well positioned, diversified, long-term investors who have built portfolios oriented to the risks, and rewards, of owning equity.
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[The originally posted story of August 23, 2021, follows here]
Early reports for fiscal year 2021 (ended June 30) suggest very robust investment gains for endowments and pension funds. What does this imply for Harvard Management Company’s (HMC) results in investing the University’s endowment—by far the largest source of University revenues? The simple answer is of course that it is too soon to tell: HMC will report its performance for the period sometime this fall.
But the HMC team certainly was operating in an environment unusually favorable to owners of financial assets, raising the prospect of high returns last seen early in the millennium and during the recovery from the Great Recession. If so, that might produce a multibillion-dollar increase in the endowment’s value, which has risen relatively slowly during the past decade, given volatile returns and the sums distributed—now about $2 billion annually—to support academic operations. (Consult the Harvard University Fact Book for endowment value, return, and distribution data beginning in 1981.)
When the coronavirus pandemic spread around the world in early 2020, economies were shut down with unprecedented severity and speed—and financial markets declined precipitously. It is hard to remember that now, after equally unprecedented government outlays, record low interest rates, and the advent of vaccination led to swift (if still partial) economic recoveries—and eye-popping returns on investments. Even as owners of bonds endured negligible real returns with interest rates near zero, those invested in equities prospered mightily: for the year ended June 30, the Standard & Poor’s 500 stock index appreciated 41 percent, and the NASDAQ-100 index 45 percent. The Wilshire Trust Universe Comparison Service, a standard analysis of institutional investments, reported the best overall results in 35 years, with median returns of more than 33 percent for large foundations and endowments (assets of $500 million and above in its data, a very far cry from Harvard’s endowment, valued at $41.9 billion as of mid 2020). Early reports by institutional investors showed robust returns: 29.5 percent (a record) for the Massachusetts Pension Reserves Investment Management board; 21.3 percent (below its internal benchmarks) for California’s giant CalPERS fund; and so on.
Of course, each institution has its own needs, tolerance for risk, and investment strategies. A portfolio appropriate for a state pension fund might be unsuitable for an operating entity like a university. And even within a sector, the results can vary significantly, as the Massachusetts and California data suggest.
But there are interesting straws in the wind. No one expects a pool of bonds or of cash to drive performance in the current environment, and indeed, CalPERS disclosed that its fixed-income and liquid (cash) holdings yielded net rates of return of (0.1 percent) and 0.1 percent, respectively. Real assets (real estate, infrastructure, forestland, and so on) produced a 2.6 percent return through March 31: an interesting result, perhaps reflecting the fact that many classes of institutional investors’ core real-estate holdings (office buildings, hotels, retail malls) have been punished during the pandemic—even as specialized assets (warehouses that serve online retailing, pools of residential properties, or life-sciences laboratories) have appreciated amid strong demand. Commodity prices were exceptionally volatile during the past year.
So the clearly winning assets were equity-related: a year when risk was rewarded. CalPERS enjoyed a 36.3 percent rate of return on public equities (stocks)—and 43.8 percent for private-equity assets (valued as of March 31). The Massachusetts pension managers realized an even more outsized 70.5 percent return in their private-equity portfolio, according to a Boston Globe report. Such results perhaps reflect the torrid market for initial public offerings from maturing venture-capital investments, at high valuations, and sales of private-equity holdings encouraged by the economic recovery and low borrowing costs.
As of June 30, 2020—its most recent reporting date—HMC had 55.3 percent of the endowment invested in public-equity equivalents: 18.9 percent in public equities per se, and 36.4 percent in hedge funds. The latter, heterogenous category, is probably larger than HMC wants it to be longer term: as part of a sweeping change in management and strategies, the investment team has been reducing investments in real estate, natural resources, and other real assets (in the aggregate, now 11 percent of endowment investments), and planning to gradually bolster private-equity holdings (23.0 percent).
As reported last October:
[T]he team’s earlier decision to reduce real-estate commitments, and to spin out that investment team—driven by their view of market cycles, valuations, and the characteristics of such assets versus their risk and reward potential—may prove prescient for another reason. The pandemic-related carnage in the hotel, office, and retail sectors…may depress values in coming years.…[R]edeployment of investments away from this class of assets may be additive in the future.
But gaining access to preferred private-equity managers, investing funds with them, and then harvesting the results is a protracted process, at best—typically, seven to 10 years. In the interim, funds have been deployed into more liquid hedge-fund assets—and perhaps into cash: cash and equivalents represented 5.6 percent of June 2020 assets, up considerably from the prior year. (Bond holdings totaled 5.1 percent of endowment assets.)
Looking across HMC’s holdings (which may well have been redeployed significantly from mid 2020), one might project:
•minimal returns from cash and equivalents, and bonds;
•robust investment returns on domestic stocks, perhaps tempered by foreign and emerging-market equities, and on the diverse pool of hedge funds (which are designed not to be correlated with other markets, and therefore may produce performance that varies down or up from the market indexes);
•possibly, less negative results than were recorded in 2020 for remaining real-estate, natural-resources, and other real assets, where HMC has been aggressive about reducing exposure and, as necessary, realizing losses to redeploy funds and marking down values on the remaining investments; and
•continued strong performance from private equity. In light of HMC’s relatively recent commitments to this category, its returns for this year may be less stellar than those enriching longer-term, larger investors in the class. It is probable that the stratospheric venture-capital and private-equity returns being reported now originated in investments made right after the Great Recession (2008-2010) and in the few years following then—the period when HMC was most constrained in committing its funds to those classes of assets. Of course, given the break-neck speed with which companies have been formed, capitalized, taken public or acquired, and then resold or merged of late, it is possible that HMC will be a lucky beneficiary of this historic private-equity year. But more modest returns relative to those of other institutions, at the beginning of what HMC intends as a long-term private-equity strategy, would hardly be surprising.
In an environment that has lavishly rewarded equity owners, HMC’s strategic shift in that direction (78.3 percent of endowment investments, including public and private assets), and its ability to deemphasize real-estate and other real assets in a timely way, could well have produced a year of memorable absolute performance.
The Crystal Ball
If HMC’s asset allocation were unchanged from mid 2020; it earned nothing overall on its cash, fixed-income, and real assets (a down year vs. 2020 for bonds, but an improvement in the real-estate, natural-resources, and other categories); and one applied hypothetical investment returns of 20 to 30 percent to the equity holdings, it would be an easy back-of-the-envelope calculation to come up with gains for the year of roughly $7 billion to $10 billion. Reduce those gains by the funds distributed to pay Harvard’s expenses (about $2 billion) and increase them by gifts for endowment received (perhaps $0.5 billion), and the endowment’s value at the end of fiscal 2021 approaches $48 billion to $51 billion.
Were the outcome in that ballpark, there would be plenty of grist for reflection on the comparative prospects of those better and worse off when the pandemic laid bare some of the wide divisions in American society. Seen in another light, an endowment of about that size would finally, after 13 years, have gotten back to the real purchasing power in 2008, when the endowment totaled $36.9 billion just weeks before the markets collapsed and the Great Recession began: a long slog toward shoring up Harvard’s finances for the future during a period of subpar HMC performance and protracted financial constraint. And there will surely be analyses, pro and con, of the restructured HMC’s one-year performance vs. peer endowments. (The investment team rightly regards any single year as a period of time far too short to be meaningful for such assessments: HMC is aiming for superior performance over complete investment cycles, up and down—and does so, with Harvard’s needs in mind, while aiming for perhaps less portfolio risk than some peers.)
More interesting will be the reaction of the Corporation, which has held the financial reins tight, even in the wake of the $9.6-billion Harvard Campaign. Will the President and Fellows be inclined to consolidate the hard-won gains, given the recent pandemic challenges and the University’s growing dependence on endowment distributions to pay the bills? Or might they, for once, indulge in the academic equivalent of animal spirits—perhaps challenging especially loyal donors to match a one-time distribution to advance the highest-priority school and University academic initiatives?
Such speculations are, naturally, far out in front of what can be known publicly now. But they make for far more pleasant summer reveries, as professors and students return for in-person teaching and learning again, than those that darkened the semester beginning just one year ago.