Thursday, January 26, 2017

Harvard's Endowment Adopts Yale's Model?

Alvin Powell of the Harvard Gazette reports, Course change for Harvard Management Company:
Explaining that challenging investment times demand “we adapt to succeed,” the new head of the Harvard Management Company (HMC) announced sweeping internal changes today, including a major shift in investment strategy, workforce reductions, and a compensation system tied to the overall performance of the University’s endowment.

N.P. Narvekar, who took over as HMC’s president and chief executive officer on Dec. 5, immediately began executing his reorganization, announcing four new senior hires: Rick Slocum as chief investment officer, and Vir Dholabhai, Adam Goldstein, and Charlie Savaria as managing directors.

“Major change is never easy and will require an extended period of time to bear fruit,” Narvekar said in a letter announcing the moves. “Transitioning away from practices that have been ingrained in HMC’s culture for decades will no doubt be challenging at times. But we must evolve to be successful, and we must withstand the associated growing pains to achieve our goals.”

Founded in 1974, HMC has overseen the dramatic growth in the University’s endowment that has made it, at $35.7 billion, the largest in higher education. Made up of more than 13,000 funds, many of them restricted to particular purposes, the endowment is intended to provide financial stability year to year for the University. In the last fiscal year, which ended on June 30, endowment funds provided $1.7 billion, more than a third of the University’s $4.8 billion budget. Such endowment income supports Harvard’s academic programs, science and medical research, and student financial aid programs, which allow the University to admit qualified students regardless of their ability to pay.

During the 1990s and early 2000s, returns on Harvard’s endowment regularly outstripped those of other institutions, making HMC a model for endowment management. Since the market crash of 2008, however, endowment performance has been up and down. Last year, endowment returns fell 2 percent, dropping the value below the $36.9 billion high-water mark reached in the 2008 fiscal year.

Narvekar has decided to shift from the policy of using both in-house and external fund managers that had made HMC’s approach to investing unique. In recent years, he said in his letter, competition has intensified for both talent and ideas, making it tougher to both find and retain top managers and exploit “rapidly changing opportunities.”

In what he called “important but very difficult decisions,” Narvekar announced that the in-house hedge fund teams would be leaving HMC by July, and the internal direct real estate investment team would leave by the end of the calendar year. The natural resources portfolio, meanwhile, will remain internally managed. Altogether, he said, the changes will trim HMC’s 230-person staff roughly in half.

“It is exceptionally difficult to see such a large number of our colleagues leave the firm, and we will be very supportive of these individuals in their transition,” Narvekar said. “We are grateful for their committed service to Harvard and wish them the very best in their future endeavors.”

The changes are in step with an overall strategy shift that will move away from what Narvekar called a silo investing approach, wherein managers focus on specific types of investments — whether stocks, bonds, real estate, or natural resources — to one in which everyone’s primary goal is overall health and growth for the endowment.

The problem with the silo approach, Narvekar said, is that it can create both gaps and duplication in the overall portfolio.

“This model has also created an overemphasis on individual asset class benchmarks that I believe does not lead to the best investment thinking for a major endowment,” Narvekar added.

Narvekar sees his incoming “generalist model,” which is employed at some other universities, as fostering a “partnership culture” in which the entire team debates investing opportunities within and across asset classes.

Narvekar, who previously oversaw the endowment at Columbia University, said he would encourage managers to be open-minded and creative as they move forward, adding that the generalist model is flexible enough that, under the proper circumstances, it could again allow for hiring in-house managers down the road.

“While I don’t expect a large portion of the portfolio to be managed internally as a practical matter … nothing is out of bounds in the future,” he said.

Narvekar expects a five-year transition period for the changes to be fully implemented, and although he warned that investment performance will likely be “challenged” this year, by the end of the calendar year organizational changes should have taken hold and HMC will look and act differently.

In effect, HMC’s compensation structure will move away from a system where managers are compensated based on how their siloed investments perform relative to benchmarks. The new system, to be implemented by July, will be based on the endowment’s overall performance.

In a press release, Narvekar said he has known the four executives brought aboard to implement the changes for much of his career. Three of them — Dholabhai, Goldstein, and Savaria — have earlier experience at the Columbia Investment Management Co. where Narvekar was CEO. The fourth, Slocum, who starts as chief investment officer in March, comes to Harvard from the Johnson Company, a New York City-based investment firm. He has worked at the Robert Wood Johnson Foundation and the University of Pennsylvania.

In addition to his experience at Columbia, Dholabhai, who starts on Monday, was most recently the senior risk manager for APG Asset Management US. Goldstein, who starts on Feb. 6, comes directly from Columbia, where he was managing director of investments. Savaria, who also starts on Monday, co-managed P1 Capital.

“I am pleased to welcome four senior investors to HMC who bring substantial investment expertise and deep insight into building and working in a generalist investment model and partnership culture,” Narvekar said. “I have known these individuals both personally and professionally for the majority of my career, and I value their insights and perspectives.”
The last time I discussed Harvard's 'lazy, fat, stupid' endowment was back in October where I drilled down to examine criticism of another dismal year of performance and 'mind blowing' compensation.

HMC's new president, N.P. Narvekar, wasted no time in setting a new course for Harvard's endowment fund. In essence, he's basically admitting that Yale's endowment model which relies primarily on external managers is a better model and he's also putting an end to insane compensation tied to individual asset class performance.

Narvekar is absolutely right: “The problem with the silo approach is that it can create both gaps and duplication in the overall portfolio. This model has also created an overemphasis on individual asset class benchmarks that I believe does not lead to the best investment thinking for a major endowment.”

I don't believe in the silo approach either. I've seen first-hand its destructive effects at large Canadian pension funds and I do believe the bulk of compensation at any large investment fund should be tied to overall investment results (provided all the asset class benchmarks accurately reflect all the risks of the underlying portfolio).

At the end of the day, whether you work at Harvard Management Company, Yale, Princeton, or Ontario Teachers' Pension Plan, the Caisse, CPPIB, it's overall fund performance that counts and senior managers have to allocate risk across public and private markets to attain their objective.

Now, US endowment funds are different from large Canadian pensions, they have a shorter investment horizon and their objective is to maximize risk-adjusted returns to more than cover inflation-adjusted expenses at their universities, not to match assets with long-dated liabilities.

Still, Narvekar and his senior executives now have to allocate risk across public an private market external managers. And while this might sound easy, in an low interest rate era where elite hedge funds are struggling to deliver returns and shafting clients with pass-through and other fees, it's becoming increasingly harder to allocate risk to external managers who have proper alignment of interests.

What about private equity? Harvard and Yale have the advantage of being premiere endowment funds which have developed long-term relationships with some of the very best VC and PE funds in the world but even there, returns are coming down, times are treacherous and there are increasing concerns of misalignment of interests.

And as Ron Mock recently stated at Davos, you've got to "dig five times harder" to find deals that make sense over the long run to bring in a decent spread over the S&P 500.

All this to say that I don't envy Narvekar and his senior managers who will join him at HMC. I'm sure they are getting compensated extremely well but they have a very tough job shifting the Harvard Endowment titanic from one direction to a completely different one and it will take at least three to five years before we can gauge whether they're heading in the right direction.

What else worries me? A lot of cheerleaders on Wall Street cheering the Dow surpassing the 20,000 mark, buying this nonsense that global deflation is dead, inflation is coming back with a vengeance and bonds are dead. Absolute and total rubbish!

When I read hedge funds are positioned for a rebound in the oil market and they're increasing their bearish bets on US Treasuries, risking a wipeout, I'm flabbergasted at just how stupid smart money has become. Go read my outlook 2017 on the reflation chimera and see why one senior Canadian pension fund manager agrees with me that it's not the beginning of the end for US long bonds.

In fact, my advice for Mr. Narvekar and his senior team is to be snapping up US Treasuries on any rise in long bond yields as they shift out of their internal hedge funds and to be very careful picking their external hedge funds and private equity funds (I'd love to be a fly on the wall in those meetings!).

Below, Bloomberg reports on why Harvard's new fund manager is copying Yale, farming out money, ending on this sobering note: 
Mark Williams, a Boston University executive-in residence who specializes in risk management, said the moves mark the end of a long, painful realization that its strategy was failing, a capitulation he considered “long overdue."

Williams said the move will mark an opportunity for outside managers eager to oversee funds for such a prestigious client: "It’s going to be a bonanza for those money shops.”
That's what worries me, a bunch of hedge funds and other asset managers lining up at Harvard's door begging for an allocation, looking for more fees. But I trust Narvekar and his senior team will weed out a lot of them. For the rest of you, pay attention to what is going on at Harvard, it might be part of your future plans.

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