Learning From The Harvard & Yale Endowments

Harvard University sits atop the academic world with a staggering $25.9 billion endowment fund, nearly twice the size of the next biggest endowment at Yale University. This war chest has accumulated over the years on the basis of donations and the stellar returns recorded by the investment management arm of the endowment, Harvard Management Company [HMC]. From 1983 through year-end 2004, HMC has realized returns of approximately 16% per year for the endowment vs. approximately 14.11% for the S&P500.

The star investment manager, Jack Meyer, managed the fund for the previous 15 years and oversaw growth in assets from $4.7 billion to $26 billion – including outperformance equal to an extra $12.2 billion over the typical large institutional fund. Last year he was ousted over a row over excessive compensation. The top six managers of HMC routinely received salary and bonus packages that totaled upwards of $70 - $100 million, and there were many vocal critics within the Harvard administration.

Meyer defended the compensation packages by arguing that they are in line with industry norms, stating “This compensation deal is a good deal for Harvard. If we had used external managers and gotten the same results, it would have cost twice as much.”

Meyer has since set a record with the largest hedge fund launch ever at $6 billion, and convinced 30 former HMC employees to join him at to the new firm. HMC has since tapped PIMCO’s emerging markets bond fund manager El-Erian to run HMC.

The average investor could never hope to compete with a staff of 30 researchers and access to the brightest minds in the business – or could he?

According to the latest updates from Harvard and Yale, the percentages they allocate to various asset classes are located in table below. While the average retail investor does not have access to private equity and hedge funds, he can invest in the remaining five asset classes through publicly traded vehicles like ETFs and mutual funds. After stripping out the hedge fund and private equity allocations, the remaining asset class allocations were normalized and then averaged between the two universities. The results are a near equal weighting across US Stocks, Foreign Stocks, Bonds, Real Estate, and Commodities:

To investigate how a portfolio of these five asset classes would have performed historically, we assign each a 20% allocation, and rebalance the portfolio yearly. The indices used for backtesting are the S&P 500, Morgan Stanley Capital Markets EAFE Index, 10 Year US Government Bonds, National Association of Real Estate Investment Trusts Index, and Goldman Sachs Commodity Index. All are total return series that are updated monthly. The portfolio is referenced as Asset Allocation [AA], and 40 basis points are deducted for management fees to invest in a representative ETF or mutual fund.

As the table above illustrates, Harvard outperforms the AA portfolio by over 300 basis points, but is also more volatile. The higher volatility and subsequent higher returns are likely due to the inclusion of private equity and hedge funds in the portfolio. On a risk-adjusted basis, the AA portfolio is fairly close to the Harvard endowment with Sharpe ratios of .86 and .99, respectively (using 4% Rf).

The S&P500 likewise unperformed the Harvard endowment, and was much more volatile. The worst drawdown for the AA portfolio was a pedestrian –11.24%, while for the S&P 500 it was a whopping –44.25%.

To account for the inherent leverage in many of the hedge funds Harvard might invest in, it is instructional to examine what results of the AA portfolio would be if leverage was applied. Including the cost of leverage at the broker call rate, the returns of the AA portfolio leveraged 1.5 times are very close to the Harvard endowment. Volatility is slightly higher than the endowment, although still less that the S&P 500 and with drawdowns half of the S&P 500.

A portfolio leveraged 2:1 would outperform the endowment on an absolute, but not risk-adjusted basis.

Comments

[Geoff Consi...:]

Nice article. This is a very nice example of the power of basic asset allocation, too.

2006 Nov 20 11:26 AM

[ryah hlkiaafs:]

Nice Article- You are missing one large portion of the HMA's success, overlays- produce alpha on every asset class. This is what propelled HMA.

2006 Nov 24 10:35 PM

[Larry Engel:]

This is a great analysis and demonstrates the simplicity with which a reasonable portfolio can be built. However, the allocation model for a multi-billion dollar endowment is likely not appropriate for an individual investor. For instance, an individual will have cash, and and individuals bond allocation will rise over time to protect retirement assets. A more instructive model based on the Harvard/Yale endowments may be that prescribed b David Swensen, who was Yale's endowment manager. He suggests 5% emerging equity, 15% large cap int'l equity, 30% large cap domestic equty, 20% real estate, and 30% bonds. While I think the analysis above is very interesting, rather than apply the MODEL used by the universities, it may be wiser to apply the EXPERTISE (through the managers themselves) used by these schools. Does anyone know if Meyer has written guidance for individuals the way Swensen has?

2006 Dec 01 01:38 AM

[Michael Zhuang:]

This is no appropriate for individual investors.

2008 Jul 18 04:51 PM

[Michael Zhuang:]

Harvard and Yale's 2008 returns were 8.6% and 2% (their calendar year ends in June). The is much better than -14.6% of the S&P 500. I studied how they were able to maintain steady and stable returns over two cycles of boom and bust in this article "All-weather portfolio: how Yale and Harvard endowments did it?" You can read the article by clicking the website link on the left.

2008 Sep 22 05:57 PM