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Harvard
University's admission that it lost $8 billion from its
$36 billion endowment fund, as staggering as it sounds,
may grossly underestimate the true magnitude of the loss
between from July 1 through Oct. 31 2008. According to a
source close the Harvard Management Corporation (HMC), which
runs the fund for Harvard, the loss is closer to $18 billion
if the losses on the fund’s illiquid investment are
realistically appraised.
To be sure, the highly-talented and highly incentivized–
MBAs at HMC did exceedingly well for Harvard during the
early years of the new millennium. From 2000 to 2008, they
more than quadrupled the notional value of Harvard’s
wealth through a strategy that involved shifting the lion’s
share of Harvard’s money from American stocks, bonds
and cash to to highly esoteric investment which were not
only illiquid but whose imputed value often could not be
easily determined by outside parties. So, by the time the
bubble burst in the fall of 2008, less than a fifth of Harvard’s
endowment fund was invested in exchange-listed stocks and
bonds. Where was the rest of Harvard’s money? Nearly
28% of Harvard Endowment fund was in what the fund manager’s
called “real assets,” a category comprised of
timber forest and arable land in remote areas, commercial
real estate participators, and huge stockpiles of oil and
other physical commodities. Such “real assets”
plunged in value, if they could be sold, much more severely
than the stock market averages. Oil, for example, one of
the fund’s largest investment, lost about two-thirds
of its value. Another huge chunk of the endowment was in
private equity placements and hedge funds which imposed
restrictions on withdrawals. In the case of so-called “gated”
hedge funds, some of which suffered enormous losses, Harvard
could only extract its investment by selling its participation
at a steep discount to a “secondary” hedge fund.
Another 11 percent of Harvard’s money had been sunk
in volatile emerging markets. Here the investments took
a double hit: First, the local stock markets collapsed in
most of these countries, with, for example, Russian stocks,
losing 80%, of their value. Second, on top of these losses.
the local currencies lost much of their value against the
dollar, with the Brazilian Real, for example losing 40%
of its value. Given the true cost of getting its money out
of this financial exotica, my knowledgeable source finds
the claim by Harvard’s money managers that the fund
only lost 22 percent not only “purely pollyannaish”
but self-serving (they got increased bonuses for 2008).
But while Harvard’s money managers may chose to look
through rose color glasses at the value of their portfolio
, Harvard University, which relies on the interest from
its endowment fund for one-third its budget, needs to be
more realistic. As its President, Drew Faust, noted in letter
to the Harvard faculty, “We need to be prepared to
absorb unprecedented endowment losses and plan for a period
of greater financial constrain.”
The collateral damage goes far beyond the ivy-covered walls
of Harvard. Money managers at other non-profit institutions,
no doubt inspired by the dazzling success of the Harvard
Management Corporation in rapidly multiplying the notional
value of its endowment fund adopted similar strategies,
including plunging their funds into the murky get-rich-fast
universe of illiquid investments. Consider, for example,
the adventures of CalPERS, the giant pension fund of the
California Public Employees’ Retirement System, I
which heavily invested in the same sort of “real assets”
as Harvard. Leveraging its own funds with borrowed money,
it bought so much undeveloped real acreage, that by 2008
it became the largest private land owner in America, and
as the real estate bubble expanded, it marked up the notional
value of its portfolio accordingly. Then came the subprime
debacle, and the real estate bubble imploded, leaving Calpers
with unsalable land and, because of its borrowed funds,
a 103% loss. Together with other losses in hedge fund and
conventional investments, Calpers found that it had lost
nearly 40% of the value of its entire pension fund. In Calpers’s
case, it had little choice other than to realistically report
its enormous losses since it had pension obligations that
now might require raising money from local governments in
California. Other nonprofit funds with more leeway, such
as Harvard, have yet to fully come to grips with the problematic
value of their illiquid investments.
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