Harvard decides to go different way on investing

Harvard Management Co. is reversing its decades-old investment approach, an acknowledgement of the need to cut costs that also is expected to put the bulk of its $34.5 billion endowment in play.

Nirmal P. “Narv” Narvekar, HMC's new president and CEO, is conducting a massive overhaul of the company, which includes halving its staff, eliminating its internal hedge fund teams and fundamentally changing the way it manages the investments of the Cambridge, Mass.-based university's endowment.

“The shift represents a meaningful pool of assets suddenly up for grabs for third-party investment managers,” said Nathan Flanders, managing director, non-bank financial institutions at Fitch Ratings. Inc., New York.

Mr. Narvekar, who declined to be interviewed, did not provide details in a Jan. 25 letter to the Harvard community on how and where the money will be invested.

Tim Barron, chief investment officer at Segal Marco Advisors, Chicago, agreed that Harvard is likely to have a number of asset managers “beating a path” to the school. “It's a marquee name that any asset manager would want on their client list,” Mr. Barron said. “But the magnitude of that is unclear.”

In his letter, written roughly two months after taking on the leadership role at Boston-based HMC, Mr. Narvekar sought to explain his vision for the company, and its move away from the investment style originally put in place in the 1990s by former CEO Jack Meyer. “The investment landscape has evolved significantly, requiring us to adapt two aspects of HMC's organizational and investment models in order to maximize performance over the long term,” he wrote.

The first aspect is the endowment's “hybrid model” of investing, in which HMC relies on a large internal staff to manage public equities and debt plus external managers to participate in private capital and real assets. The second aspect is a “siloed” asset management approach in which team members act as specialists in specific asset classes or strategies.

As part of the restructuring, the endowment's management company will reduce the size of its 230-person staff by about half by Dec. 31, he said. It also will shift from the specialized investment strategy to a more general model in which all members of the investment team will take ownership of the entire portfolio. HMC also plans to outsource management of most of its assets, Mr. Narvekar noted in the letter.

Although the management team could still manage some assets, Mr. Narvekar said he doesn't “expect a large portion of the portfolio to be managed internally” going forward.

Also as part of the restructuring, remaining hedge fund teams will depart by June 30 and the direct real estate investment team will spin out and become an external manager by Dec. 31.

The natural resources portfolio will continue to be managed internally for the time being.

Mr. Narvekar said in his letter that he expects this new investment plan to take five years to be implemented.

“It just shows the Yale model wins. Harvard threw in the towel,” said Charles A. Skorina, founder of San Francisco-based executive search firm Charles A. Skorina & Co., which specializes in the hiring of chief investment officers. Mr. Skorina called this overhaul “a smart move” that's “long overdue.”

Brian Caldwell, lead endowment investment consultant in the Atlanta office of consulting firm Willis Towers Watson PLC, agreed in a separate phone interview that the move made sense for the endowment.

“As these portfolios become more complex and have higher governance burdens, I don't think it's unusual (for CEOs and CIOs) to take a step back and look and their structure and ask, "Does this add value?'” said Mr. Caldwell.

Cost and resources are the main drivers of the change, Mr. Narvekar wrote in the letter. Harvard can no longer afford to pay Wall Street-level salaries — especially if the endowment isn't producing stellar returns.

“In the past, HMC's approach of investing in internally managed portfolios generated superior returns,” Mr. Narvekar wrote. “In recent years, however, the tremendous flow of capital to external managers has created a great deal of competition for talent, making it more difficult to attract and retain the necessary investment expertise.”

Nicholas Tsafos, a partner at audit, tax and accounting firm EisnerAmper LLP, New York, agreed. “When you look at the best and brightest in hedge funds out there, how is Harvard going to pay for that talent? The industry is paying a lot better than the endowments and the pension plans,” he said.

In addition to cost, it appears as though Mr. Narvekar is making the shift because the current model hasn't been working. In the "90s, Mr. Meyer implemented a unique investment model that, for a while, generated strong returns, which justified the competitive salaries and large staff within HMC. But over time, those returns stopped being so competitive.

Harvard University's endowment returned -2% on investments for the fiscal year ended June 30, below the 1% return of Harvard's benchmark policy portfolio. Its 10-year return was 5.7% vs. 4.8% for its benchmark, and for the 20 years, 10.4%, vs. 7.7% for its benchmark.

In the NACUBO-Commonfund Study of Endowments, Harvard still ranks No. 1 in terms of endowment size, but the one-year asset decline was the largest among the five biggest endowments and the fourth-worst among the 25 largest endowments.

As the returns became less impressive, Mr. Meyer's successors, Mohamed El-Erian and Jane Mendillo, gradually worked to implement the hybrid approach Harvard's endowment now employs.

“It was a unique structure that carried certain implications of what it could achieve,” said William F. Jarvis, managing director and head of research at the Commonfund Institute in Wilton, Conn. “If you hired top-level professionals and gave them mandates and they performed well and (Harvard) compensated (the professionals) well, the net results would be superior for Harvard. But that doesn't seem to be demonstrated by the historical record.”