Harvard Endowment Aces a Brutal Year

Gain of 7% to 9% Outshines Classmates;
Commodities, Treasurys Are Smart Picks

By CRAIG KARMIN and GREGORY ZUCKERMAN
August 7, 2008; Page C1

Score another win for the Crimson.

With endowments and pension funds struggling in a down market, Harvard University's endowment notched a strong gain for the fiscal year ending in June, up 7% to 9%, according to people familiar with the returns.

The endowment, worth $35 billion at the close of the 2007 fiscal year, was boosted by investments in commodities, Treasurys and some strong hedge-fund performers. It was below the endowment's average annual return rate of 15% over the previous decade.

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Harvard University students walk through campus in February 2006.

But during a year when the subprime crisis and plunging stock markets caused many institutional investors to deliver their worst performance in six years, those returns still put it at the top of its class.

"That would be easily the best performer among the foundations and endowments that we track," says Craig Tome, of Chicago's Northern Trust, which collects endowment and pension-fund performance data.

Mr. Tome noted that Harvard's returns would top any of the nearly ninety endowments and foundations that Northern Trust follows. The group -- with an average of $1 billion in assets -- lost an average of 3.1% last fiscal year, and only one in five notched positive returns. The performance was even worse for public and corporate pension funds, which lost 4.3% and 5.1%, respectively, according to Northern Trust.

It will be another month before Harvard releases the final results, which it guards carefully and is still tabulating.

The endowment's positive returns came at a time when Harvard Management Co., the company that runs the endowment, has been in flux. Mohamed El-Erian stepped down as head of HMC in December to return to California investment firm Pacific Investment Management Co., or Pimco, a unit of Allianz SE.

Robert Kaplan, a former Goldman Sachs vice chairman, served alongside Mr. El-Erian as interim chief executive from October. He was succeeded on July 1 by Jane Mendillo, Wellesley College's former chief investment officer.

The managers took some strong positions over the past year. In particular, the fund began the fiscal year with 17% of its assets invested in commodities, a portion of which was in timber or farmland, according to an HMC document. That's an unusually large position in commodities for an institutional investor. A spokesman wouldn't say what the fund's position is now; in July, commodities slumped after months of record gains.

Harvard's performance offers a vote of confidence in its investment model, which includes use of both outside and on-staff managers. Most endowments place all their money with outside managers.

It has not all been easy for the endowment. One of Harvard's outside investments was in Sowood Capital Management, a hedge fund founded by former Harvard endowment manager Jeffrey Larson. Harvard invested $500 million in Mr. Larson's hedge fund when it launched in 2004, and by February 2007, the position was $975 million, according to documents reviewed by The Wall Street Journal. The endowment lost about half that amount after Sowood suffered losses and sold its portfolio to Chicago-based hedge fund Citadel Investment Group.

Those losses were countered by outsize gains from some of the endowment's other hedge-fund investments.

For example, Convexity Capital, a $10 billion fund run by Jack Meyer, Harvard's former top investment manager, outperformed through option-related trades that tend to do well when volatility rises in the market. Mr. Meyer also scored gains anticipating the subprime-debt market implosion of the past year.

Harvard made an initial $500 million investment in Convexity in February 2006.

Another Harvard investment that racked up even more profits from the credit crisis: Seth Klarman's Baupost Group, a Boston-based investment firm that rose more than 52% last year, in part by buying credit-default swaps, or insurance protection, on residential mortgage-backed securities and corporate bonds.

Compensation for Harvard's staff managers has been controversial. With the endowment's success, staff managers' paychecks have soared, sometimes into millions of dollars a year -- far more than the school's Nobel laureates or its deans get. Critics have argued that the university should outsource more of its asset management to save costs.

But the past year's performance suggests that Harvard's hybrid model -- from an investment perspective, at least -- remains effective.

The endowment's staff pursued a strategy of shielding the fund from market downturns by purchasing credit-default swaps that helped protect it from wild market swings. Harvard also had a larger position than many endowments in plain-vanilla Treasury debt, which outperformed the stock market.