The world’s richest university just got richer. Harvard saw its endowment grow a healthy 23% to $34.9 billion in the 12 months that ended June 30. This growth represents some of the strongest in Harvard’s history and is its best investment performance since 2000, when the endowment swelled by an astonishing 32.2%. Harvard’s gain this year far outstripped the average fiscal 2007 performance of 17.7% turned in by 151 large institutional (non-university) funds tracked by the Trust Universe Comparison Service — as well as the 20.6% gain of the S&P 500 over the same period. Put another way, the $5.7 billion gain in Harvard’s endowment last year exceeded the total endowment of all of Oxford’s 36 colleges — accumulated since teaching began in Oxford in 1096.
In the world of university endowments, Harvard is certainly the biggest, but it might not be the best. Because Harvard released endowment figures for the 2007 fiscal year ahead of most other universities, it’s impossible to compare its results to its rivals. And in what has become the academic equivalent of a football game, insiders are betting that while Harvard’s results were very good, they probably weren’t as stellar as endowments with bigger allocations to real estate and private equity. Last year, for example, Yale earned a cool 22.3%, followed closely by Stanford (19.8%) and Harvard (19.2%).
Harvard Near the Top of the Class: The Secret Revealed
Twenty years ago, about 80% of Harvard’s endowment was invested in domestic stocks and bonds. Today its portfolio looks very different. Mohamed El-Erian, the Harvard Management company’s new president, noted that the endowment’s performance in its latest fiscal year was driven mostly by its investments in emerging markets, international stocks, and U.S. equities. The emerging markets portfolio, the best single performer, surged 44%.
It turns out that Harvard’s "secret" has been simply to diversify away from holdings in U.S. stocks and bonds. Last year, Harvard had about 17% of its assets in hedge funds; 31% in hard assets including real estate, timber and energy; 13% in private equity; 31% in foreign and domestic stocks; and 13% in fixed income. Contrast this with a typical U.S. pension fund that has 60% of its assets in U.S. stocks and 35% in U.S. bonds — and maybe 5% in foreign stocks, and you start to see how Harvard’s unconventional allocation of assets has been the key to its extraordinary results.
That’s why, as a group, the top performing university endowments have been up about 15% per year during the last decade — handily trouncing not only average pension plans (generating returns of about 8%), but also a "high risk," all-stock portfolio consisting of the S&P (producing returns of about 10%). You’d have slept better, too. While large chunks of your pension funds evaporated in the post-bubble years of 2000-2002, the top university endowments were essentially flat. Yale did not have a single down year.
Harvard Near the Top of the Class: Lessons from Yale
Yale’s David Swensen — considered the "Babe Ruth" of endowment investing — recently published a book, "Unconventional Success: A Fundamental Approach to Personal Investment," to explain how you can apply a top university endowment’s investment approach to your own portfolio. Swensen admits that Yale’s investment strategy is tough for the retail investor to replicate — especially its allocation to hedge funds and to private equity. And, Yale’s sterling reputation allows it to invest in many private equity and hedge funds that are not available to retail investors. But Swensen’s basic message rings clear: focus on the "big picture" asset allocation decisions and move your money out of U.S. stocks and bonds into global and other "alternative assets."
With the explosion in the number of global stocks and ETFs available to U.S. retail investors, you can approximate Harvard’s endowment today better than ever before. Yet Harvard’s Mohamed El-Erian notes that individuals cannot hope to duplicate the quality of Harvard’s managers, noting that "it would be like advising my son or daughter to drop out of school and play basketball with the goal of becoming the next Michael Jordan."
Harvard Near the Top of the Class: The Magic of Diversification
Indeed, diversification combined with access to top managers allows the Harvard endowment to perform magic. In July, Harvard lost about $350 million through investments with Sowood Capital Management, a hedge fund founded by Jeffrey Larson, the former manager of Harvard’s foreign stock holdings. Yet despite the 1% hit to Harvard’s endowment, Harvard’s overall endowment gained about 0.4% in July, while Standard & Poor’s 500 index lost 3.1%
How did Harvard do it? In addition to being an investor in Sowood, Harvard was also an investor in Convexity Capital Management, the giant hedge fund that makes arcane trading bets that benefit from volatility. With a strategy focused on credit default swaps and cross-currency option trades, the fund was up nearly 12% through July. The fund, started in 2006 with $6.3 billion, is run by Jack Meyer, who was Mohamed El-Erian’s predecessor at Harvard and oversaw its endowment for 15 years. The returns at Convexity, where Harvard had invested $500 million, undoubtedly helped to offset the loss on Sowood.
The bottom line? Diversification out of a standard U.S. stock and bond portfolio into global stocks and commodities is the key to your long-term investment success. As a retail investor, you may not have access to the Michael Jordan’s of the investment world. But constructing a portfolio where some parts zig while other parts zag will not only generate higher returns, but also will help to smooth the bumps on the road to big investment profits.
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