Now that the final results for the year to June 30 2009 are in from Harvard, Yale and other prominent endowments, it is possible to take stock of the implications of the dreadful year which they have just experienced. There has of course been no shortage of schadenfreude, as will always happen when pleased with themselves institutions come up short of their own grandly stated ambitions.
In the case of Harvard, which has experienced traumatic internal ructions over the management of its endowment in recent years, and which nobody could describe as suffering from an excess of modesty, the poor results have turned a little local difficulty into a national media event. The $9bn decline in the value of its endowment in the 2008-09 year has prompted any number of prejudices to be aired and old academic scores to be settled.
Many authorities have claimed to have originated the adage that academic politics are vicious because the stakes are so low. When it comes to the performance of the endowments, however, the stakes are anything but low, as Harvard and others are discovering. Budgets have had to be slashed, hundreds of jobs have been shed and scores of ambitious new building projects halted or scrapped.
Investment losses accounted for 27.3% of the overall 29.6% fall in the value of Harvard’s endowment value in the 12 months from 30 June 2008, when the collapse of Lehman Brothers and the precipitous global financial crisis that followed were still in the future. Once the crisis hit, the performance of the endowment simply imploded, reflecting not only the stock market’s collapse, but the endowment’s above average exposure to private equity, real estate and other illiquid investments.
Over the same period the investment portfolio at Yale, presided over by the revered figure of David Swensen, lost 24.6% and the overall value of its endowment declined by 28.8%. While many other endowments with copycat investment policies suffered big losses as well during the year, not all did so badly.
In her annual report, the new CEO of the Harvard Management Company notes that the median decline in investment returns for endowments, as measured by the Trust Universe Comparison Service, was 18.2%. More galling still, an old-fashioned two asset portfolio, 60% invested in equities and 40% in bonds, would have fallen by just 13.5%, or roughly half the fall recorded by Harvard’s endowment.
In 1995, before its new policies were adopted, the Harvard endowment still had 53% in equities and 22% in bonds. By last year the quoted equity component in its policy portfolio was down to 33% and its allocation to bonds just 13%. To rub salt in the wound, its international fixed income team had an exceptional year in 2008-09, outperforming their benchmark by 9% – the pity being they had such a paltry share of the fund to manage.
Although the track record of its investment portfolio over five, ten and twenty years remains superior to its peer group, the unprecedented fall in 2008-09 has taken the value of Harvard’s endowment back to where it was five years ago. With it has gone much of its self-lauded reputation for astute financial management.
The problems would have been more manageable had not the endowment’s annual contributions to the University risen so sharply, from under $1bn per annum in 2004-05 to over $1.6bn in each of the last two years. While manageable when times were good, the annual cash drain has become unsustainable given the current much reduced starting value of the endowment and the University’s burgeoning budget.
Has the University been over-distributing the fruits of its past investment success? From the outside, it is hard to avoid that conclusion. The massive capital spending programme, begun over the last five years, many elements of which are now halted or suspended, appears to reflect an implicit belief that Harvard’s superior investment performance could continue indefinitely. Salaries have also risen sharply in the same belief.
This supreme confidence was also reflected in a willingness to borrow 5% of its portfolio value every year in anticipation of superior investment returns. Events of the past 12 months have confounded that faith. When the crisis hit last year, the vaunted diversification value of its portfolio disappeared without trace when liquidity for many of its assets, especially its holdings of private equity, dried up.
It is easy to see the collapse of the Harvard and Yale endowments as a symbol of investment hubris, as with LTCM 11 years ago. No doubt there is truth in that. Would the Harvard Management Company’s former management team have reacted any better to the developing crisis had they not been forced out in 2005 by a campaign of protest from academics resentful of the huge performance-related salaries the team was able to command? It is impossible to say.
I would not underestimate how difficult in practice it is for institutions of any kind to act decisively in anticipation of events that are foreseen but not yet certain – and harder still when everyone is telling you how brilliant you have been. Harvard has had its Minsky moment, and the reality, sadly, is that it could take several years before the University has restored its finances or its self-esteem.