Lesson’s From the Harvard Endowmnet

Harvard’s endowment witnessed great success until the 2008 financial crises. From 1990 to 2005, the university’s endowment increased from $4.7 billion to $22.6 billion, with 15% average annual returns from 1995 to 2005. Jack Meyer managed the Harvard Management Company during this time, following a model that downplays liquidity because liquid assets generally have lower returns. Meyer and his successor, David Swensen, added alternate assets like hedge funds, commodities, private equity, timber acreage, and real estate as opposed to more typical assets like stocks and bonds.

However, when Jane Mendillo took over the endowment in July 2008, the financial crises of 2008 quickly highlighted the endowment’s risky model. The endowment lost 27.3% in the fiscal year ending in 2009 and decreased by $11 billion. The attempt to lock down low interest rates backfired, and both alternative assets and public-equity holdings fell (private equity investments and hedge funds fell 32.6% and 18.6%, respectively, in 2009).

Mendillo has since worked to revive the endowment and announced last year that she eliminated leverage and introduced a modest cash allocation. In the most recent report, the endowment saw a return of 21.4% and showed $32 billion in assets. Mendillo stated she will also continue improving liquidity.

Harvard’s endowment can act as a cautionary tale on the unreliable nature of alternative investments (e.g., private equity and hedge funds) during bear markets.  While alternative assets can help achieve an endowment’s long-term success, they are not a risk free from of diversification. And while the 2008 financial crisis has passed, it is a serious gamble to rely on private equity and hedge funds returning to their pre-2008 performances. To prevent a Harvard endowment-like situation, advisors should not neglect near-term cash needs during asset allocation— and while diversification can help in this, it is important to remember that diversification does not prevent loss.

See Risk Bites Back: Lessons Learned From the Harvard Endowment, Financial Advisor, Jan. 25, 2012.

Special thanks to Joel Dobris (Professor of Law, UC Davis School of Law) for bringing this article to my attention.