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Harvard Whacked

Harvard's losses are probably greater than advertised.

Harvard Management Co., which runs the world's largest endowment fund, has had until recently an incredible record. Over the past six years, it succeeded in more than doubling the notional value of Harvard's endowment to $36.9 billion in fiscal 2008 (which ended on June 30) even after paying for about one-third of Harvard's operating expenses. So its recent loss of $8.1 billion from July 1 to Oct. 31, 2008, came as a stunning blow. Yet this huge loss, as staggering as it sounds, might be only the tip of the iceberg of illiquid investments. According to a source close to the Harvard Management Co.,the damage, if the fund's illiquid investments are realistically appraised, may be closer to $18 billion—or more than twice the amount previously reported.

Harvard's asset allocation? 

  • 18% hedge funds
  • 13% private equity
  • 11% emerging market equities
  • 11% foreign developed market equities
  • 11% US equities
  • 9% real estate
  • 9% timber and other agricultural land
  • 8% oil and gas
  • 5% inflation-indexed bonds
  • 4% US bonds
  • 2% foreign bonds
  • 2% high-yield, i.e. "junk" bonds
  • -3% cash

Cash was the best performing asset in the fourth quarter.

By my estimation, about half of Harvard's assets are in illiquid assets.  Sales of illiquid assets have collapsed.

One major player in the private equity business tells me that Harvard had tried this fall to sell its private equity stakes at 30 percent to 35 percent discounts but could find no buyers even at those prices. It's also possible that Harvard will have to meet "capital calls" on its private equity investments that would sap even more capital.

Endowments, pension plans, insurance companies and other large pools of institutional capital invest along asset allocation guidelines.  Asset allocations guidelines implicitly assume liquidity will always be available, i.e. an investor will be able to sell assets when needed to pay liabilities.  Liquidity is assumed in all financial models, including asset allocation models.  However, as Harvard - and the whole world for that matter - is discovering, liquidity is not always available.  That is a problem if you need liquid funds for expenses.

Many endowments and pension plans tried to emulate the success of Harvard and Yale by moving into illiquid assets.  They have found that illiquidity is a cost, and the risks of such investments were under-stated when they were putting together their investment plans.

My guess is that many of those same funds will move out of illiquid assets back into boring old stocks and bonds over the next several years.

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