Following the near-record 33.6 percent investment return on endowment assets in fiscal year 2021, and the inevitable adjustment in fiscal 2022—when financial markets took account of the pandemic stimulus and rising inflation, and the endowment yielded a negative 1.8 percent return on investments (in line with most peers)—what is in prospect when Harvard Management Company (HMC) reports on the year ended June 30, 2023, sometime this autumn?
It is never appropriate to project one institution’s results too closely on another’s: investment objectives, strategies, and execution all vary, sometimes significantly. But there are a few early indications about the kind of year it was for large institutional investors overseeing perpetual endowments or long-term funds for pension plans.
Evidence from West and East
The mammoth California Public Employees’ Retirement System (CalPERS, with $463 billion in assets as of June 30) in July reported a preliminary net investment return of 5.8 percent for the year—a solid improvement from the fiscal 2022 return of negative 6.1 percent. The major contributor in fiscal 2023 was public equity investments (stocks): 45 percent of assets, returning 14.1 percent. Fixed-income assets (bonds), the second-largest category of assets, had a zero rate of return, presumably as rising interest rates depressed the value of the holdings, offsetting interest earnings. And of great interest when thinking about HMC’s portfolio, the CalPERS private-equity assets and real assets (real estate)—both reported as of March 31—produced losses: negative 2.3 percent and negative 3.1 percent, respectively (in each case, lesser losses than the CalPERS market benchmark for that category of holdings).
The smaller but historically excellent University of Virginia Investment Management Company (UVIMCO, $13.6 billion in endowment-like funds, and fiscal 2021 and 2022 returns of 49 percent and negative 4.7 percent, respectively) just reported a 2 percent return for fiscal 2023. That compares with its policy portfolio, or model, returns of 12.3 percent. During the year, public equities, 27 percent of the asset pool, earned a return of 8.2 percent—well below double-digit returns on world, U.S., and European stocks because, UVIMCO explained, it was overexposed to weaker emerging markets, especially in China. (The report also seems to suggest that UVIMCO’s fund managers were perhaps surprised, like many institutional investors, by the outsized returns for the large capitalization high-technology companies, the enthusiasm for artificial intelligence, and related Wall Street themes: “[O]ur developed market managers were not able to fully capture the strong gains seen in the domestic equity market”). Private-equity assets, 26.3 percent of the total, produced a negative 5.3 percent return. Other equity assets produced single-digit returns, and the fixed-income portfolio generated a negative 2.9 percent return.
UVIMCO’s language about its public stock performance is significant. The very largest, most highly diversified university endowments—Harvard, Yale, Princeton, Stanford—tend to favor private equities over publicly traded assets (see Harvard allocation below). In a year when private-equity performance has lagged, overall results may well be dampened for such endowments compared to the investment returns of smaller, less diversified endowments—precisely because such smaller funds are more weighted toward public equities, which had a very good year. As the Wilshire investment advisory firm’s Trust Universe Comparison Service reports, “Large plans underperformed small across all plan types for the one year, due mostly to smaller allocations to public equities.” For Wilshire’s purposes, a large plan has assets exceeding $1 billion, so that covers a wide range of asset pools; but in the service’s foundations and endowments category, large plans realized a median gross investment return of slightly less than 8 percent, versus slightly less than 10 percent for small plans.
Harvard’s Prospects
As reported, the University and HMC stopped disclosing the endowment’s asset allocation last year. But like UVIMCO, which devotes 75 percent of its assets to equity investments, Harvard’s endowment is overwhelmingly focused on equities. In fiscal 2021, 81 percent of HMC assets were equity-linked: 14 percent in public securities, 33 percent hedge funds, and 34 percent private equities.
For several years, HMC has been expanding its private-equity holdings, and they likely remain among the endowment’s largest asset categories—if not the largest—today. But private equities are private, and the valuations attributed to holdings by their managers are an art form, rather than the real prices established daily in the highly liquid markets for publicly held stocks. As CEO N. P. Narvekar noted last year, the positive valuations then given private assets, at a time when public securities had depreciated sharply “may indicate that private managers have not yet marked their portfolios to reflect general market conditions. This phenomenon does make us cautious about forward-looking returns in private portfolios.” In other words, given the widely dissimilar results for public and private equities, the relatively favorable data released for fiscal 2022, he warned, may represent embedded future risks.
Rising interest rates, like those in the United States and Europe since early 2022, depress the valuation of such investments—particularly immature companies hoping for future growth and profits, and leveraged enterprises with lots of debt. Combine that harsh reality with the cooling of irrational passions after the early stages of the pandemic, and the investment outcome can be daunting. Instacart, the grocery-delivery firm, reportedly was privately valued at $39 billion in 2021; at its initial public offering on September 19, investors decided the firm was worth about $10 billion. Any investor who carried an ownership position at that earlier value in its 2021 financial statements and maintained the stake would have an uncomfortable adjustment to make today.
Speaking in general terms, Narvekar observed last year that “the end of the current calendar year [2022] might present meaningful adjustments to these valuations, as investment managers audit their portfolios.” In other words, reported performance for such assets during endowments’ fiscal 2023 might be considerably less bubbly. Or, during the next few years, returns for these asset classes may well trail their strong results in the recent past, and might lag a recovery in public securities when economic and financial-market conditions improve (as has proven to be the case in fiscal 2023). “This circumstance is not unique to Harvard,” Narvekar wrote then, as “other institutional investors with large private portfolios will almost certainly face the same dynamic.”
Point taken. Witness the CalPERS and UVIMCO private-equity losses in fiscal 2023: possibly a harbinger of vulnerability for HMC’s fiscal 2023 performance, given the magnitude of its private-equity assets.
In other respects, HMC may be more favorably positioned. Narvekar has rigorously pruned Harvard’s real-estate and commodities holdings. The carnage in the commercial real-estate market (underused office buildings, empty storefronts and malls, and daunting increases in debt costs) should have a relatively small impact on the University’s endowment, compared to those of many peers. The same judgment applied to bonds, where Harvard saw relatively limited return potential and limited its commitments.
In all likelihood, the results HMC reports for fiscal 2023 will therefore turn on the performance of the public-equity and hedge-fund holdings—perhaps half of endowment assets. There, performance will be affected by such factors as the domestic versus international distribution of stocks (and the impact on the latter of the dollar’s strength and the size of emerging-markets holdings), long versus short stock strategies, and other factors—none of which will be visible to outside observers. In his comments on fiscal 2022, Narvekar wrote that although managers responsible for investing HMC’s equity-related assets produced performance that “had been unusually strong over the past four fiscal years, FY 22 was not a strong benchmark relative year.” (He then reiterated the importance of focusing on longer-term performance, over five-year periods—or the even longer duration of an entire economic and investment cycle, his preferred metric.)
Given what has already been reported about lagging private-equity results, the performance of those other equity investments is the key to HMC’s fiscal 2023 absolute and relative returns. No one would reasonably expect another grand-slam year like fiscal 2021. Putting the negative fiscal 2022 results in the past would be real progress. Absent a substantial penalty from real estate and negligible bond returns, HMC might be looking at a relatively modest positive rate of return on investments for the year: a base hit on which to build in the new fiscal year now well underway.
