So El-Erian upped HMC's exposure to emerging-market stocks, which rose from 6% of assets when Meyer left, to 11% two years later. He also used total return swaps to bet on developed world stocks and commodities on the cheap, freeing up money for other investments. Tapping former Stanford endowment staffer Mark Taborsky (an "important hire," El-Erian would later write in a book), El-Erian also took money from hedge funds he didn't like and redirected it to ones he thought were winners, putting hundreds of millions into funds in Latin America, Asia and the Middle East.
The moves looked brilliant. For the year ended June 2007, Harvard returned 23% versus 17.7% for 151 other big institutional investors (and 20.6% for the S&P 500). Fearing all markets could soon fall, El-Erian injected what he referred to as "Armageddon insurance" into HMC's portfolio for the first time by buying interest rate floors, or a wager that rates would fall, and betting, via credit default swaps, that companies could soon struggle to pay their debts.
For the following year, through June 2008, Harvard gained 8.6%, versus a 13% fall in the S&P. El-Erian's insurance accounted for much of HMC's outperformance. Hedge funds, however, were sucking up cash--HMC had increased investments in those areas to 19% from 12% a year earlier. The returns were flat. It's unclear how much of the results--good or otherwise--were El-Erian's doing. He left at the end of 2007, six months before the results came in, citing a desire to move back near his wife's family in California and return to Pimco as heir apparent to founder Bill Gross.
Since July, emerging-market shares have been a disaster, falling 50%, as measured by the MSCI Emerging Markets Index, worse than U.S. stocks. Another problem: El-Erian's insurance has been partly taken off since he left, leaving HMC vulnerable when markets plunged this fall. The total return swaps, which easily could have been terminated, were left alone. The EFG-Hermes Middle East North Africa Opportunities Fund, a hedge fund launched in September 2007 with some $200 million of HMC cash, was down 35% in 2008. El-Erian's big hire, Taborsky, left HMC in September. He's since joined El-Erian at Pimco. El-Erian and Taborsky decline to comment.
By the time Jane Mendillo walked into HMC's offices in July 2008, she figured some changes needed to be made. A former consultant who worked for years at HMC under Meyer, Mendillo got the HMC gig partly as a result of Meyer's recommendation. She had spent the last six years running the $1.6 billion Wellesley College endowment, which was completely outsourced to external managers. Her detractors say that she was ill prepared for Harvard's liquidity crisis and slow to take cognizance of the swap exposure. But they concede that the crisis came fast on the heels of her arrival.
Mendillo did move quickly to deal with the private equity portfolio. One of her first moves at HMC, which she initiated before the markets started to fall in earnest, was to sell between $1 billion to $1.5 billion of Harvard's private equity assets in one of the biggest such sales ever attempted. The high bids on such assets have recently been 60 cents on the dollar, says Cogent Capital, an investment bank that advised Harvard on the sale. Cogent says the big discounts are due to "unrealistic pricing levels at which funds continued to hold their investments" and "fantasy valuations."