BOSTON -- Harvard Management Co. has reduced its allocation to private equity by three percentage points because it could not fully invest millions of dollars it had available for the asset class.
Harvard Management invests for Harvard University's $14.4 billion endowment. Its inability to find enough venture capital investments hurt overall investment performance in fiscal 1999.
The company is a limited partner in all of the best venture funds, but the demand is so great each investor is limited to an average of no more than $20 million. "As a result, we invested several hundred million dollars less than we had available for venture cap, and not getting to our allocation hurt us," said Jack Meyer, president of Harvard Management.
Boston-based HMC's solution has been to scale back the private equity allocation to 12% from 15%, "to give us a shot at reaching our benchmark," Mr. Meyer said.
The endowment's benchmark is Cambridge Associates' broad index of private equity returns, which was 57.2% in the fiscal year ended June 30. Harvard Management's private equity returned 29.2% in the period.
"The new allocation reflects our invested position," Mr. Meyer said. He would not say how much money Harvard has invested in private equity.
Harvard Management also revamped other areas of its investment policy to beef up returns. It has:
* created a new 4% allocation to inflation-indexed bonds, giving it real returns so it no longer will use leverage to invest in other asset classes. (Harvard has had a negative 5% position in cash, assuming the real return on cash was 2%. The model would short cash and spread it over other categories. But with inflation-linked bonds, the model is reset every six months like Treasury bills, which would give a 3.5% to 4% return, Mr. Meyer said. Harvard eliminated its negative 5% in cash and went long with inflation-linked bonds.)
* raised its allocation to cash to zero from minus 5%.
* cut its allocation to domestic equities to 24% of assets from 32%; and
* increased commitments to absolute-return, commodities and high-yield strategies slightly to make the portfolio more diversified.
After posting sterling returns of 20% and higher for four years running, the endowment's investment returns lagged in fiscal 1999, yielding 12.2% after expenses. While this exceeded the median performance of comparable funds by one percentage point and bettered the rate of inflation by more than 10%, the results nevertheless trailed Harvard's "policy portfolio" by 6.7 percentage points.
Harvard's new policy portfolio, which became effective July 1, is now allocated as follows: domestic equities, 24%; foreign equities, 15%; emerging markets equities, 9%; private equity, 12%; absolute return, 6%; high yield, 3%; commodities, 6%; real estate, 7%; domestic bonds, 10%; foreign bonds, 4%; and inflation-indexed bonds, 4%.
The endowment was hurt by an underweighting in venture capital when prices of initial public offerings of Internet-related stocks surged, reaping mega-gains of 100% for some venture funds. "It's a difficult issue. We're trying hard to get a significant allocation," Mr. Meyer said.
Real estate also was problematic. The portfolio earned 6.6%, while the NCREIF Property index returned 17.1% for the fiscal year. Mr. Meyer called the benchmark "unrealistic" because real estate financing collapsed at the end of 1998, depressing property values. These haven't yet shown up in the NCREIF index, because appraisers don't move as fast as the market. "They tend to wait before marking properties up or down, while Harvard will mark the changes up or down right away," he said.
Harvard's real estate investments returned 44% in 1998. Mr. Meyer predicted the index will reflect lower values going forward. "We're not changing benchmarks. We'll just sit and wait for this one to correct itself in a year or two."
The large domestic and foreign equity and fixed-income portfolios, which together account for more than half of the endowment, all exceeded their benchmarks. But emerging markets, absolute-return funds and commodities underperformed. Harvard Management officials fault external managers who since have been changed. He would not name the managers.
The shift to more external management is in part the result of the departure in the past few years of three of Harvard Management's portfolio managers, who left to form separate companies. They continue to manage assets for HMC, but on an external basis.
Most recently, Timothy Peterson, who ran the high-yield portfolio, resigned to start Regiment Capital Advisors LLC, Boston, which will continue to manage $220 million in a high-yield strategy for the endowment. Other ex-Harvard managers who now run Harvard endowment money on an external basis are John Jacobson, who formed Highfields Capital Management, Boston, which is managing $500 million in domestic equities for Harvard Management, and Michael Eisenson, who formed Charlesbank Capital Partners LLC, Boston, which is managing $1.4 billion in direct private equity and real estate investments for the endowment.
As a result, two-thirds of Harvard's assets are now being managed internally, down 21 percentage points from an estimated 87% that was previously managed internally.
Mr. Meyer said he has no plans for additional cuts in internal management.