For a long while, Harvard's daring investment style was the envy of the endowment world. It made light bets in plain old stocks and bonds and went hell-for-leather into exotic and illiquid holdings: commodities, timberland, hedge funds, emerging-market equities and private equity partnerships. The risky strategy paid off with market-beating results as long as the market was going up. But risk brings pain in a market crash. Although the full extent of the damage won't be known until Harvard releases the endowment numbers for June 30, 2009, the university is already working on the assumption that the portfolio will be down 30%, or $11 billion.
The strain of market turmoil is visible in staff turnover at the management company, which axed 25% of its staff recently and is on its fifth chief in four years. Mendillo, 50, came to Harvard last July after running Wellesley's small endowment. She declines to comment. But how much blame she should get is unclear; the big bets on derivatives and exotic holdings were in place before she got there. The bad bet on interest rates--a swap in which Harvard was paying a high fixed-interest rate and collecting a low short-term rate--goes back to a mandate from former Harvard President Lawrence Summers.
Jack R. Meyer, 64, a revered money manager who headed Harvard's endowment until 2005, offers a few guarded comments. "The liquidity thing most concerns me--that should not have happened," he says. Though he wasn't there at the time, Meyer says Harvard Management bought the commodity and foreign stock derivatives as a way to get exposure to those asset classes while freeing up cash to put to work elsewhere. The strategy, he says, "drained liquidity" from the endowment in recent months. "Many endowments stretched too far, and I think Harvard did as well," he says.
The endowment will remain stretched. Harvard has been counting on it to fund more than a third of its $3.5 billion operating budget. Assuming the fiscal year ends with around a $24 billion endowment value, the university will be drawing down half again as high a percentage of its assets as it did in 2004, the last time the endowment was around that size.
That can't go on forever. The strain on liquidity will continue, as the private equity partnerships compel Harvard to meet billions in capital calls in future years. Why not just unload those partnerships along with the liabilities that stick to them? Because no one wants to buy them. Private equity stakes like Harvard's are selling at 40% to 60% discounts in various markets. "Endowments will be shocked at the valuations of their [private equity] portfolios," says Stewart Massey, an endowment consultant at Massey Quick. "It's going to be an absolute bloodbath."
Harvard's woes are in some ways no different from those at other universities or in the market generally (the S&P 500 is down 37% since last July 1). "A loss in these kinds of markets is inevitable," says Michael Eisenson, a former HMC staffer who now runs private equity firm Charlesbank. The average endowment is down 23% in the five months through November, according to a university trade group.