Harvard's Endowment Gets Hit By A Black Swan

Harvard University,along with Yale has been a pioneer in using "alternative" asset classes in their portfolios: private equity, hedge funds, venture capital and commodities. In fact the allocation to to publicly traded securities at Harvard is 33% According to the most recent annual report available from the Yale Endowment, the allocation to Bonds is 4% domestic equities 11% and foreign equities 14%, th rest went to alternatives and these numbers have been fairly stable for years.

This strategy has been widely emulated by other university endowments and pension funds (as in the case of the state of Pennsylvania described in yesterday's post). It seems that the riskiness of these strategies has hit with a venegance, not only in terms of large losses but also because these asset classes which were touted as having low correlation with each other and with traditional asset classes (stocks an bonds). As many in the financial markets have discovered in the past months, nothing goes up in a down market except correlation. In the case of the alternative asset classes almost all were dependent on leverage and/or access to easy credit and as the crisis has intensified these asset classes have suffered even more than the more liquid unleveraged positions in stocks and bonds. The WSJ reports that the Harvard Endowment has reported losses of 22% in the last 4 months and in fact even that number may be understated.


Harvard's Endowment Drops 22% in 4 Months


By JOHN HECHINGER and CRAIG KARMIN Wall Street Journal
Harvard University's endowment suffered investment losses of at least 22% in the first four months of the school's fiscal year, (as you will see below the number is actually far higher on a mark to marke basis) the latest evidence of the financial woes facing higher education.

The Harvard endowment, the biggest of any university, stood at $36.9 billion as of June 30, meaning the loss amounts to about $8 billion. That's more than the entire endowments of all but six colleges, according to the latest official tally.
Other university endowments also are suffering, and many states are cutting public funding of higher education. Colleges are instituting hiring freezes, planning enrollment cuts and discussing steep tuition increases, intensifying worries about the impact of the recession and financial crisis on college access.

(As noted other universities moved from more conservative investment strategies to portfolios similar to those at Harvard and Yale. Not surprisingly the results have not been pretty as of late:)

The University of Virginia Investment Management Co. said it lost nearly $1 billion, or 18%, of its endowment over the four-month period, reducing it to $4.2 billion. In Vermont, Middlebury College says its endowment fell 14.4%, to $724 million. In Iowa, Grinnell College's endowment dropped 25%, to $1.2 billion. In Massachusetts, Amherst College says its endowment, $1.7 billion as of June 30, also fell by 25%.
The letter from the office of the Harvard President shows things may be far worse than the 22% loss.
The Harvard letter said the 22% loss, from July 1 through October 31, understates the actual decline in the endowment because it doesn't reflect certain assets, including private equity and real estate, whose declines couldn't yet be estimated. Currently, endowment income funds 35% of Harvard's $3.5 billion budget.
The letter said Harvard is planning for a 30% decline for the fiscal year ending in June 2009. That would eclipse the loss of 12.2% in 1974, the worst over the last 40 years.
Harvard's loss marks a sharp reversal from the endowment's formerly chart-topping performance. Harvard and Yale University -- which hasn't disclosed its endowment's recent performance -- pioneered an investment approach that de-emphasized U.S. stocks and bonds and placed large sums in more exotic and illiquid investments, including timberland, real estate and private-equity funds. That strategy, which was widely copied, helped the schools avoid significant losses after the technology boom ended in 2000.
But the current market has been far less favorable, partly because both Harvard and Yale have relatively small holdings of bonds, such as U.S. Treasurys, one of the few assets that have performed well. Harvard began its fiscal year with a target of having 33% invested in publicly traded shares, split among U.S. stocks, which have dropped 24% in the four months through October, and international stocks, which have fared worse.
Other investments, such as commodities, which were a boon to Harvard in past years, have turned negative in recent weeks. Harvard has sought to sell off about $1.5 billion in investments with private-equity firms, which typically use their assets to fund corporate takeovers, according to people familiar with the situation. That would be one of the largest sales ever of a private-equity stake. But its private-equity partnerships received bids of only around 50 cents on the dollar, according to other people familiar with the matter.
Daniel Jick, chief executive officer at Boston-based HighVista Strategies, which handles money for some endowments, says that in some prior years, investments such as real estate and private equity have helped buffer endowments against losses on stocks. "But this time, they are not providing as much help as expected," he says.


The nyt reports on the endowment losses here,

Here is the text of the Harvard letter. Note that their strategy. Note that to meet cashflow needs Harvard intends to tap the credit markets with new borrowings.

the Office of the President

Financial Update

To: Council of Deans
From: Drew Faust and Ed Forst
Cambridge, Mass.
December 2, 2008

As we navigate our way through these turbulent economic times, we are writing with some further information on the University’s endowment performance and an update on our broader financial strategy for the time ahead. We look forward to our continued work with the Council of Deans as we address these challenges together.
Endowment Update

As has been reported, the value of the University’s endowment was $36.9 billion on June 30, 2008, the end of the last fiscal year. Since then, the severe turmoil in the world’s financial markets has affected all major asset classes in which the endowment is invested.

While historically Harvard has reported investment returns only at the end of the fiscal year, in the current extraordinary circumstances we believe it is critical that our efforts to plan responsibly be informed by a more widely shared understanding of what we expect.

Harvard Management Company, using standard industry practices for valuing assets, has calculated investment losses of approximately 22 percent from July 1 through October 31. Yet even that sobering figure is unlikely to capture the full extent of actual losses for this period, because it does not reflect fully updated valuations in certain externally managed asset classes, most notably private equity and real estate. HMC expects that as we receive more comprehensive valuations in these asset classes from our external managers, the endowment will realize further declines in value. With those considerations in mind, and in view of the uncertain outlook ahead

, we continue to plan for a scenario in which our endowment is down 30 percent in value for the year.

To put a loss of that size in historical context, over the last at least forty years, Harvard’s worst single-year endowment return was a negative 12.2 percent in 1974, and at that time our endowment stood at less than $1 billion and funded a much less significant proportion of University operations. Since that time, there have been only three years of negative performance, with returns ranging from -0.5 percent to -3 percent. We will of course hope to do better this year than we are now planning, but we need to plan with a clear-eyed view of the reality that confronts us, as best we can gauge it.

Income distributed from the endowment now funds roughly 35 percent of the University’s overall operating budget, and some of our Schools rely on endowment income to cover more than 50 percent of their expenses. The prospect of significant endowment losses therefore has major implications for our budgets and planning, especially since our other principal revenue streams also stand to be challenged by the economic crisis. The implications will differ in degree from school to school and department to department. But all of us will need not merely to contemplate changes at the margins, but to take a more fundamental look at how to align our spending with revenues that will be significantly reduced from what we had imagined just a few months ago.
Financial Strategy

In so fluid and unpredictable a financial environment, it is particularly important to maximize our flexibility and minimize risk so that we can respond to changing circumstances. Toward that end, we are planning to take advantage of Harvard’s strong credit ratings to increase the University’s flexible cash resources in the near term.

The major rating agencies, Moody’s and Standard & Poor’s, rate Harvard as Aaa/AAA – the highest credit ratings available. With the benefit of those ratings, we are planning to issue a substantial amount of new taxable fixed-rate debt. This will help us sustain flexibility and momentum in addressing our academic and research priorities, including financial aid, as we work to absorb the impact of anticipated losses in revenue. We also intend to convert a substantial amount of existing short-term tax-exempt debt into bonds with longer maturities, so we can reduce our exposure to volatility in the credit markets and provide a measure of greater predictability in a time of extraordinary flux. These moves will strengthen our capacity to fund ongoing operations and critical academic and research priorities.

(while this strategy seems perfectly reasonable under current circumstances, it will be interesting to see how successful the Harvard bond offering will be, With ten year treasuries under 3% it could prove to be a very savvy move for harvard to lengthen the maturities of their debt if they are able to borrow at reasonably low spreads over treasuries. In fact it may prove to be the best move Harvard will ever make in the financial markets.)

The letter concludes:

Given our planning assumption about endowment losses and our desire to buffer the near-term impact to a reasonable extent, we also expect that we will be spending a higher percentage of the endowment next year than we have in the recent past.
Budgets and Planning

While the steps outlined above will help, they do not obviate the need to reduce expenses, beginning this fiscal year. To ensure that we are in the best position to respond to this new set of financial realities, we are working with each School to focus on a range of capital and operating budget-reduction scenarios. This approach will enable each School to make choices among its strategic objectives in the context of reduced budgets, yet preserve our collective, institutional flexibility to make adjustments as conditions evolve. We are reconsidering the scale and pace of planned capital projects, including the University’s development in Allston, and are taking a hard look at hiring, staffing levels and compensation to consider how we can reduce overall spending while at the same time invest in the academic programs that are vital to Harvard today and will propel us forward tomorrow.
University-wide Coordination and Communication

We are grateful to you, and your colleagues, for all you have been doing to analyze and understand our changed financial landscape and to share ideas about how best to chart our forward course. Especially at times like these, each of us can learn from one another's insights and approaches, and all of us stand to benefit from seeing local challenges in a broader institutional context. In addition, our new financial realities call on us to consider more intently whether certain activities we have tended to pursue separately might better be pursued cooperatively – as we seek not just to assure our financial well-being but to continue our momentum in creating more fruitful connections among different parts of the University.

Many of you have been in touch with your School communities, through some combination of letters and meetings, to give people your perspectives on how the economic crisis bears on your own School’s activities. Please let us know how we can be most useful to you in those continuing efforts. Meanwhile, we intend to post this memorandum to the Web, so that people throughout the Harvard community will know more about our present situation and some of the steps being taken to address it.

In closing, we want to express our appreciation for the diligence and spirit of partnership with which you and your staff, as well as those who work with us in the University’s central administration, are approaching these tasks.

As for Yale's Endowment the Chief Investment Officer David Swensen has an interview in the current issue of Worth Magazine( I couldn't find in outline)in whic he states he wont know the year to date losses on the endowment and won't have a number for Yale's performance till June 30 the fiscal year end. Right now he has "no idea" what many of their assets in illiquid mkts are worth. He also indicated now doubts about Yale's overall strategy.