The Sorry Tale of the Harvard Endowment

Forbes and the NYT ran curiously similar pieces on the Harvard endowment over the weekend, and the message I get from them is that it's in serious trouble. The new boss, Jane Mendillo, arrived seven full months after the old boss, Mohamed El-Erian, left -- and it seems as though nothing good or sensible transpired in the interim, although it's not entirely clear whose fault that is.

El-Erian certainly catches some flak:

Though the Harvard endowment posted a strong 8.6 percent gain in the year before Ms. Mendillo arrived, David A. Salem, who heads the Investment Fund for Foundations, says he believes that Mr. El-Erian did the school a disservice by hiring people to implement certain strategies and then "jumping ship."
Mr. Salem, who knows Ms. Mendillo from the board of the investment fund, also said that Mr. El-Erian appeared to have left Harvard with an extremely illiquid portfolio, a situation complicated when a permanent replacement was not named for seven months after his departure.

El-Erian is the kind of money manager who has a very active and hands-on investment strategy. He's constantly on top of his positions, and when they get too risky, he's quick to hedge:

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.

After El-Erian left, it seems that his riskier investments were simply held on to, while his hedges were allowed to expire. And a similar thing was happening with positions put on by Larry Summers:

A few years ago, as Harvard was preparing to issue billions of dollars of debt to finance an ambitious building expansion, the university entered into interest rate swaps to lock in seemingly low interest rates. The swaps were huge, with a notional value of $3.7 billion on June 30, 2005...
The university could have easily gotten out of the swaps after Summers left Harvard in 2006. But it did not. Near the end of 2008, Libor rates plummeted, forcing the university to post collateral.

Once again, all of this made sense at the time. Summers was very worried about America's twin deficits, and the risk of a sharp spike in interest rates; the likes of Nouriel Roubini shared those concerns. Locking in low interest rates seemed like a good idea. But after Summers left and the housing bubble burst, it became clear to Summers, Roubini, and others that the big rate shock they should be worried about was to the downside, not the upside. Unfortunately, Summers had left Harvard by then -- and so had El-Erian -- and it seems that no one felt empowered to unwind the swaps (an action which could have been taken at very low cost).

The picture one gets of the Harvard endowment right now is that it's suffering from a major liquidity crunch: it just doesn't have the cash on hand that it needs. In that respect it stands in stark contrast to Yale, where David Swensen seems quite unworried about his liquidity situation.

Once again, the culprit would seem to be legacy positions from the era of Summers and El-Erian: positions which might well have made perfect sense as part of an actively-managed portfolio which was run by people who were fully aware at all times of potential liquidity needs, but which certainly didn't make sense as part of a portfolio which became much more passively managed upon El-Erian's departure, with no one really in charge of making sure that the endowment was able to make good on all its obligations.

It's hard to know how any of this can be avoided. El-Erian can't be faulted for making decisions on the basis of his staying at Harvard on a permanent basis -- after all, he was hired on just such a basis. Such decisions can't, by their nature, be easily unwound, which means that he necessarily ended up bequeathing to his successor a portfolio which would have been very difficult to understand and to hedge. El-Erian might well have been able to do it, because he constructed the portfolio in the first place. But it's not clear that anybody else could.

So did El-Erian's decision to move back to California from Boston cause billions of dollars in losses for the Harvard endowment? And is there any way for an endowment to hedge against that kind of personnel risk? If El-Erian had been at the Harvard Management Company a bit longer, perhaps he could have endowed it with more of an institutional knowledge base. As it is, he stayed just long enough to implement a large-scale strategy, but not long enough to allow the office to be able to run it without him. And now Mendillo is left to try to pick up the pieces as best she can.

Comments

[TheSnail:]

Ha Ha Ha. Let's put the former fools back in who got us into this intractable mess.

Not much of solution your proposing their Einstein.

Feb 23 05:42 PM

[Roger Knights:]

Ve Ri
Nas
Ti

Feb 23 06:09 PM

[Crocodilian:]

"It's hard to know how any of this can be avoided."

----------------------...

By penalizing illiquid and opaque transactions. So much of our troubles have occurred when exotic bets have been lumped in with investments. There's nothing wrong with exotic bets --in certain circumstances they can be helpful-- but they need to be identified, segregated, reserved against, and have an explicit wind-down scenario and cost, at the time they are acquired.

This story could equally easily have been written about AIG "we put these positions on, but we never really figured out how/when/how much it will cost" to get out of them.

Feb 23 06:30 PM

[venividivici:]

Sounds like poetic justice to me. Harvard ;trained MBA's have played a major role in creating this financial catastrophe. George Bush got an MBA from Harvard but always admitted that economacks was not his strong suit. In fact the only thing he knew was that "the foundations of the US economy are sound" and he repeated that again and again until it was obvious to all but the brain dead that that was patently untrue.
Getting people with an Harvard background to run your financial affairs is a recipe for bankrupcy as Harvard may soon discover.

Feb 23 07:03 PM

[Whippet:]

Thanks, Felix- this is the first SA article in a while that gave me a good smile and laugh. To think the same idiot that made the Crimson bleed is now 2nd in command to a tax cheat reporting to a fellow Harvard snob is less amusing (especially considering the only living man to have actually led us OUT of a mess of this magnitude is standing in the hallway...)
When will the American people finally see the hypocrisy?

Feb 23 07:57 PM

[EMS:]

I think it would be funny if they become insolvent and need to sel off their items...so much pomposity there.

Feb 23 08:23 PM

[Duude:]

I think perhaps one is expecting a little too much out of a money manager if they are to be blamed for a long 7 month delay in finding a permanent replacement. The financial markets change very quickly as all could agree. Harvard had a fiduciary responsibility to be more attentive. Surely, they would have a temporary fix if El-Erian was to suddenly get hit by a bus. But, they were given a headsup for a certain short period of time that he was moving on, and they did nothing. Seven months down the road they find a permanent replacement? That's ridiculous! That's on the school. They failed.

Feb 23 09:13 PM

[Harry Tuttle:]

How could this be avoided? by correctly accounting for liquidity risk.

You are welcome.

Feb 23 09:15 PM

[mr freddo:]

I fully agree with Duude. Harvard had ample warning of El-Erian's departure and should have been right on top of this. They should have had a strategy to unwind the complicated hedges.

But Harvard shouldn't feel so bad. Aside from the liquidity issue, Harvard now shares something with the rest of us....losses across our portfolios causing difficulty in meeting our current and future obligations.

Feb 23 10:45 PM

[jse17:]

Yes, it is difficult being a wingnut ATPIT!


On Feb 23 05:31 PM NITRAM wrote:

> When you screw up and lose billions of dollars for Harvard, you become
> a perfect member of whats his names team. Larry Summers lost billions
> for Harvard, and our socialistic wannabe president picks him. Summers
> says we dont need Paul Volker, I can screw up again with no help.Summers
> like the want to be, screws up then leaves town. If anyone can name
> one competant person in the present DISADMINISTRATION WHO IS CAPABLE,
> PLEASE LET ME KNOW.

Feb 23 11:01 PM

[ur2smrt4me:]

El-Erian didn't just forget the nature of these investments after he left did he? Did he think of picking up the phone and clueing the new team in that they should not just sit on this stuff? Am I missing something?

Feb 24 12:22 AM

[Mr. Ed, Jr.:]

I was also thinking maybe someone should have picked up a phone. After all, the Harvard endowment was $37 billion (now apparently 26b-28b ?)

The NYT article states that during the 7 month interim, "board members" ran the fund. That is rather vague, and apparently the NYT does not have details.

A big piece of information is missing-- what happened (or didn't happen ) during the 7 month interim ? Who are the board members, and what are their qualifications ? Was it a committee of board members, or did they take turns ? And, of course, are board members allowed to pick up a phone ?

One more question...Is this the same place where we get "our best and brightest" ?




On Feb 24 12:22 AM ur2smrt4me wrote:

> El-Erian didn't just forget the nature of these investments after
> he left did he? Did he think of picking up the phone and clueing
> the new team in that they should not just sit on this stuff? Am I
> missing something?

Feb 24 01:24 AM

[monday1929:]

Perhaps Harvard (and the Pension Gaurantee Fund of the US Govt. which doubled down on "exotic" investments in an effort to erase an 11 Billion dollar deficit) should not Gamble.
The new Head said, as the elite always does when it fails, that "no one could have seen this coming". Well, many who understand the history of MANIAS did see this coming.
Did Robert Rubin attend Harvard? His confident incompetence suggests he did.

Feb 25 05:11 PM