Harvard Management Co., a pioneer of the market-topping “endowment model,” opened the reporting season for the scholastic fiscal year ended June 30 with a decent, if underwhelming, 11% investment gain, while touting the progress it had made in making its portfolio more liquid and flexible.
That return, 160 basis points above the policy benchmark for Harvard University's league-topping $27.4 billion endowment fund, trailed a plain vanilla 60% stock/40% fixed income portfolio by a similar margin.
For the prior 12-month period, which included the brunt of the market meltdown sparked by the Sept. 15, 2008, bankruptcy of Lehman Brothers Holdings, the fund plunged 27.3%.
The university's Sept. 9 announcement of its latest fiscal results touted the year's “strong positive returns,” while noting HMC's focus on “liquidity, capital commitments and risk management” during the past two years.
What that post-crisis focus on liquidity and flexibility will mean for the outsized returns endowments such as Harvard's enjoyed from hefty allocations to illiquid alternative asset classes for the decade or two before the wheels came off the financial bus from mid-2007 is an open question.
Jane Mendillo, president and CEO of Harvard Management, didn't respond to questions on the potential impact on Harvard's alternatives-heavy portfolio. Likewise, other HMC board members — including Robert S. Kaplan, Jay O. Light and Peter A. Nadosy — couldn't be reached for comment.
In an interview, John Y. Campbell, professor and chairman of Harvard's economics department and an HMC board member, said a range of factors — including moves to enhance liquidity, greater caution about leverage in any form and a continued pickup in flows into alternative asset classes — could weigh on future returns, although the impact is hard to predict.
Even so, the endowment model — defined as broad diversification across a range of non-standard asset classes — would “continue to make very good sense” even if the scale of outperformance over more traditional investing were to moderate somewhat, he said.
Endowment watchers say liquidity remains an important topic for endowment executives, but there's no evidence yet of a sea change in asset allocation.
According to Deirdre Nectow, managing director of new business development for Boston-based investment consultant Cambridge Associates, a leading adviser to endowments, if cash and fixed-income holdings are taken as a proxy for liquidity, then changes over the past few years appear more evolutionary than revolutionary.
The Cambridge data, which covers endowments with more than $1 billion in assets, show cash allocations for endowments rising to 3.5% as of Dec. 31, 2009, from 2.7% the year before and 1.8% as of December 2007 — a positive increase, although the decline in equity markets contributed to the gain, she said. Allocations to U.S. investment-grade fixed income, meanwhile, have held fairly steady — at 8.8% as of December 2009, 8.9% the year before and 8.5% as of Dec. 31, 2007, she noted, adding that those numbers don't suggest a “radical re-do of asset allocations.”
In an interview, William Jarvis, a managing director and head of research at the Wilton, Conn.-based CommonFund Institute, likewise said he's seen no evidence of wholesale asset allocation shifts by endowments following the recent financial crisis.
Still, all are struggling to come to grips with the collapse of the belief that they “could always behave as if liquidity is free,” he noted. Endowment boards now are looking to make sure they have “truly liquid assets” to cover anywhere from one to two years of expected draw downs from the institutions they serve, he said, adding it's difficult to pinpoint what the impact on investment returns could be.
Harvard's Mr. Campbell said bull market returns endowments enjoyed in recent decades led universities to rely on them for an increasingly larger share of their operating budgets — a situation, which in the light of recent market turmoil, is forcing them now to recalibrate how much risk they can tolerate in their investment strategies. And that calculus has to be done on a school-by-school basis, he said, noting that endowment money covers more than 50% of the arts and sciences budget.
According to HMC's latest announcement, the endowment contributes 35% of Harvard's operating budget — more than double the level of two decades before.
Citing recent statements by Harvard officials, Cynthia Steer, managing director and chief research strategist at Rogerscasey Inc., Darien, Conn., said Harvard appears to be taking a “holistic” view in managing the risk-return balance for its various endowment funds, depending on the extent to which the respective parts of the university rely on those funds for their operating budgets. Those efforts could make Harvard a market leader, not for its asset allocation as in years past, but for its risk posture, she predicted.
In the Harvard announcement, Ms. Mendillo noted that every major asset category except “real assets” — the endowment's 14% allocation to commodities plus its 9% allocation to real estate — delivered positive returns that outperformed their benchmarks.
Among other major universities, Columbia is the only one to announce its results so far, reporting a 17% gain, following a 16.1% loss the year before. The university doesn't break out its asset allocation.