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In mid-January, Mohamed El-Erian, head of the $30 billion Harvard Endowment, made a $1.6 billion bet that markets around the world were overvalued, and he sold off stocks representing 5 percent of Harvard’s total portfolio.
With the Dow Jones industrial average down about 3.5 percent since then, his hunch paid off. “We had been in a global Goldilocks world,” said the Cambridge University-trained economist who came to Harvard a year ago after seven years of running the Pacific Investment Management Company Emerging Markets Bond Fund.
“We felt that valuations were stretched and that they had gone up too quickly and we were reminded of May of 2006 where there were similar signals that people were stretching for returns,” he added. “The world has become increasingly connected, so we made the adjustments across the board.”
It is just one example of how Mr. El-Erian, 48, is setting a new course for the endowment after succeeding his highly regarded predecessor, Jack Meyer. Mr. Meyer was fond of saying that he had no clue which way the stock market would go, and generally did not change Harvard’s asset mix to try to time the market. (He preferred betting on opportunities he spotted in fixed-income securities.)
If only Mr. El-Erian just had to worry about market moves.
He and the board of the Harvard Management Company, which oversees the endowment, are also discussing the controversial issue of pay packages for top managers. And he is on a charm offensive, trying to be more visible among administrators at Harvard, an effort, in part, to make the university more comfortable with the endowment’s strategies.
Those strategies are still being refined — including just how much money Harvard should manage itself and how much it should hand over to outside managers.
Though a number of major endowments do not trade stocks in-house because of the perils of market timing, Mr. El-Erian says he believes that Harvard, which invests in an array of interrelated assets, has an edge understanding what may affect their values.
Even Mr. El-Erian’s small decisions can have an enormous impact. Last year, Harvard counted on the endowment, the largest in the nation, for roughly $1 billion, or about a third, of its annual $3 billion budget. The biggest chunk of the endowment funding goes for financial aid.
Given the intense scrutiny of Harvard’s every move, it can still seem a mystery why Mr. El-Erian made the shift in the first place. Certainly it was not for the money. Although Mr. El-Erian will not discuss it, several people who know him say he made tens of millions more at Pimco, where he oversaw $28 billion in emerging market debt.
And he is breaking a basic rule of career management — that it is better to follow someone in a job who did poorly rather than someone who did well (and Mr. Meyer did very well, earning an average return of 15.9 percent a year over his nearly 15-year tenure running the endowment).
Mr. Meyer’s performance was second only to David Swensen of Yale, who has produced annual returns of 16.3 percent over 21 years. A slender man who talks with a slight European accent, Mr. El-Erian said during a recent interview in his office overlooking Boston Harbor that he took the post because it was a new challenge that still lets him continue doing what he loves: investing, but in an academic context. And the mission is clear — to make money for Harvard and to let it think “in bold terms,” he said.
Another appeal of the job is that he does not have to see new clients or worry about capital withdrawals. The endowment is huge, comparable only in the nonprofit world to the $33 billion foundation started by Bill Gates that Warren E. Buffett has agreed to help finance. It is much bigger than Yale’s $18 billion fund.
Mr. El-Erian faces enormous pressure to deliver returns across a range of asset classes — often where he has no previous expertise. And the managers of the Harvard funds are expected to provide world-class returns, yet face criticism when their pay is compared with that of the professors and administrators.
Harvard has to disclose how much it pays its top financial managers. In fiscal 2005, Mr. Meyer earned $6 million, and two other managers earned about $17 million each.
Those figures — which had been higher in earlier years — drew sharp criticism from others at Harvard that the team was earning unseemly amounts, given academic pay levels.
Mr. Swensen, the Yale investment chief who made $1.6 million last year and does not have any in-house managers, said he was not surprised at the friction. “Paying some people $35 million where others earn $35,000 tears at the fabric of an institution,” he said.
At Harvard, the tension between the university and the endowment has come at a price. Some of its best money managers have left to start their own firms. And last year, partly out of exasperation with his critics, Mr. Meyer quit, taking roughly 30 of his 150-person staff with him to start Convexity Capital Management.
In fiscal 2006, ended June 30, Mr. El-Erian, who was at Harvard only for half the fiscal year, earned $2.3 million. For now, the new team’s compensation will continue to depend on how much money is managed in-house and what their returns are over a period of years, rather than just a single year.
Harvard will still have a significant portion of its money managed by people working for Harvard. They will continue to take home far more money than the academics — if they earn billions for Harvard. “The easiest thing would have been: let’s not rebuild the internal management team,” Mr. El-Erian said.
But he added: “Manager selection is absolutely critical, and a lot of good outside managers don’t have room anymore,” alluding to hedge funds and private equity funds that are either closed to new money or will let a new investor put in only a limited amount of capital.
Mr. El-Erian, who is married with a 3-year-old daughter, starts his day on the trading floor at 6 a.m. and spends afternoons interviewing new recruits. A challenge has been that “we cannot press a pause button on the stock market while we get our act together,” he said.
He points out that if Harvard chooses to leverage its bets, it has such a strong balance sheet that it can borrow at favorable rates. Its long-term horizon also lets it consider investments that might not pay off for years, and exposure to a panoply of asset classes can help it gain insights into economic developments.
The result may be that some managers leave, “but that means they are successful and the endowment has benefited,” Mr. El-Erian said. Mr. El-Erian seems eager to help bridge the gap between the endowment and the university. Harvard’s vice president for finance, Elizabeth Mora, said that under previous management “it was not the culture of the place to be as integrated with the university.”
“Mohamed makes it an active part of his itinerary. He came over on Friday and addressed the administrative heads of all the schools, giving a presentation on the endowment and the structure of the management company.”
His family’s background offers some insights into what has drawn him to the academic world.
Born to an Egyptian father and a French mother, Mr. El-Erian was educated in the United States, Egypt, France and Britain and got a degree in economics at Cambridge University and a doctorate at Oxford.
He recalled that his father, a law professor who joined the Egyptian diplomatic corps and spent the early 1970s in France, “insisted that we be exposed every day to a range of international newspapers that covered the entire political spectrum because it was a constant reminder that there are many ways to think about the same issue.”
Though Mr. El-Erian had hoped to become a professor, he was forced to get a job when his father unexpectedly died at the age of 60, leaving his 23-year-old son to support his mother and a 7-year-old sister.
He joined the International Monetary Fund in 1983. When he left 15 years later, he was deputy director in the Middle East department, providing emergency aid to governments and advising policy makers.
“Then Pimco came along and decided to take a gamble,” Mr. El-Erian said. “I said that I had never traded a bond in my life and Bill Gross said, ‘We can teach you that.’ ”
When he left, Mr. Gross, the chief investment officer, wrote of Mr. El-Erian in his monthly Investment Outlook note: “No one could have, or has, done it better since he crossed the threshold from the I.M.F. to Pimco.”
Mr. El-Erian turned in a compound 19 percent return for Pimco’s $3 billion emerging markets fund over nearly seven years, making it the third-best- performing fund in its sector, according to Morningstar. He oversaw an additional $25 billion in other managed accounts.
He was willing to be iconoclastic in his trading. In 1999, convinced that Argentina was running oversize deficits and the economic climate was changing, he sold $2 billion of Argentine debt, even though Argentina represented 20 percent of the J. P. Morgan benchmark fund. Mr. El-Erian’s assessment proved right two years later when Argentina suffered a $100 billion default.
Though several endowment experts and academics say privately that Mr. El-Erian’s experience may be too narrow, Harvard Management’s board said it believed that his international expertise would give the university an edge.
“The investment problem is becoming more and more global, rather than thinking about the classic U.S. asset classes,” said John Y. Campbell, a Harvard economics professor who is on the management company’s board. “Once you frame the problem that way, it is clearer why Mohamed seemed like an outstanding candidate.”
Now Mr. El-Erian wants to apply that international expertise to a broader array of markets. Last year, he hired experts in foreign exchange and from the International Monetary Fund to study the stability of various governments overseas.
“If you are interested in real estate in Brazil, for example, in addition to the best real estate opportunities, you have to have a view about the neighborhood,” he said. “There is the question of currency risk, but also the question of whether Brazil is going to stay stable.”
At least one of Harvard’s crucial external managers is cutting back the amount of the university’s money it will handle. In 1998. for example, when John Jacobson left Harvard Management to start Highfields Capital Management, a hedge fund that invests in United States equities, Harvard put $500 million with him.
By last year, that figure was $2 billion, or 20 percent of Highfields’ capital. Without the Meyer relationship and with concerns that no single investor hold such a large stake, Highfields returned $1.5 billion to Harvard last year, forcing the endowment to find new managers.
As Mr. El-Erian works to invest Harvard’s money, he joins a sector of the money management field where some endowment chiefs have become investment stars, working in a fishbowl where the competition, and pressure, are intense.
How long does he plan to stay? “I just arrived,” he responded.
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