The Harvard Endowment: A Legacy of Growth and Controversy

The Harvard endowment, standing at $53.1 billion as of 2023, is the largest university endowment globally and a force in the investment world. It influences well beyond academia and Cambridge-Massachusetts, shaping financial markets and sparking debate about wealth accumulation, allocation, and social impact.

However, recent years have presented a set of challenges and uncertainties that demand careful introspection and strategic adjustments to ensure the endowment's continued support of Harvard University's mission and aspirations in a potentially more resource-constrained future.

This article explores the Harvard Endowment's complex dynamics, its recent performance, the strategies that have propelled its success, the trials and tribulations it currently faces, and the lessons to be gleaned from its impressive journey.

The Genesis of Harvard's Endowment

The Harvard Endowment's roots can be traced back to 1636 when the university was founded, making it one of the oldest educational institutions in the United States. However, it wasn't until the mid-19th century that Harvard actively engaged in fundraising through formal, strategic efforts. The initial focus of these efforts was to supplement state funding for Harvard University's operations and bolster its financial foundation. However, it was David Swensen, who took the ownership of the endowment in 1985, who ushered in the transformative era of modern endowment management.

Swensen's approach changed the way academic endowments were managed, not just at Harvard, but across the country. The "Yale Model," as it became known, placed significant emphasis on diversification and risk-adjusted returns. Swensen emphasized that the purpose of the endowment was to maintain the long-term purchasing power of the University and the distribution practices that stem from that long-term outlook, warranting the aggressive investments that soon became a signature aspect of the Yale Model.  Moving beyond traditional asset allocations heavy in public equities and bonds, Swensen advocated for investments in alternative asset classes like private equity, real estate, and hedge funds. As of June 2023, Harvard’s has high exposure to hedge funds (31%) and private equity (39%).

Swensen also prioritized strategic alignment with skilled external managers who shared Harvard's long-term investment horizon. This emphasis on skilled managers and the importance of their selection was critical. Harvard couldn't have had success with its strategies without establishing a strong foundation through the selection of individuals who understood and shared the University's philosophy.

Performance and Recent Dynamics

With a market value exceeding $50 billion, the Harvard Endowment has seen impressive growth, averaging nearly 12% growth per year since Swensen's tenure began. During its peak performance years, from 2009 to 2014, the endowment was up 50% from $26bn in market value to $39bn. 

As of fiscal year 2023, the Harvard Endowment's value has declined in two straight years. The returns for FY2022 and FY2023 were -1.8% and 2.9% respectively. Notably, the endowment has significantly underperformed the UC system which saw 14.7% returns for FY2023, and likely has to do with Harvard's higher private equity/hedge fund and lower public equity allocations.

Like many institutions, Harvard's endowment faces several challenges:

• Inflationary Pressures and Rising Costs: The increased costs of running a top-tier institution require careful cost management to offset operating margin fluctuations.

• Federal Research Funding Uncertainty: Fluctuations in funding from agencies like the National Institutes of Health make forward-looking budget planning difficult.

• Tax Reform Impacts: Harvard's endowment is subject to the 1.4% tax implemented by the 2017 Tax Cuts and Jobs Act.

Harvard's Distribution Practices and Risk

Consistent with most other endowments, the Harvard Endowment operates under the expectation that the principal of the endowment funds will not be touched by distributions and will continue to grow over time, to the point that the initial investment will be significantly smaller than its future value after decades of growth. However, with recent underperformance, HMC has been having internal conversations about appropriate risk management practices going forward.

Currently, the Harvard Endowment has the largest proportion of endowment funds of top 6 universities going towards private equity, while also operating at a lower risk level than peers. Additionally, a significant portion of its assets have been invested into "hard-to-value" or liquid investments that take significantly longer to mature. Thus, recent years of underperformance, specifically fiscal years 2022 and 2023 could very well be masking a potential undervaluation in the endowment.

Public Perception, Politics, and Governance

The endowment system has been widely scrutinized, particularly with regards to the political influence its asset allocation could present. Additionally, protestors have called for schools to be more transparent about its holdings with many also calling for Harvard, Yale, and other private endowments to divest from holdings in fossil fuels. Criticism also revolves around the lower percentage of spending compared to endowment size (around 5%) and conflicts of interest stemming from powerful financiers influence on investment decisions and funding.

This growing public pressure has been acknowledged by many of the institutions' executives. Many universities have also attempted to appease critics by incorporating "ESG" or "sustainable investing" principles into asset management practices to maintain some form of public approval while being able to allocate investments in areas that could also benefit the universities by being among the first institutions to invest in innovative projects that tackle climate change.

However, this doesn't deter many universities' investment teams from working with various managers who prioritize long-term risk adjusted return, not public approval. Thus, it is up to the internal investment committees in these institutions to effectively communicate and develop strategies that will not only increase the wealth of their constituents, but remain in accordance with their own ESG investing practices to reduce negative external perceptions of the endowment investments.

Conclusion

The story of the Harvard Endowment shows us the importance of adaptability, risk assessment, and visionary leadership in the fast changing world of investment and finance. From its early origins as a supplement to state funding to its current stature as one of the world's largest academic endowments, the endowment has played a pivotal role in shaping Harvard University's trajectory. While recent challenges and a changing financial landscape demand a continued reassessment of strategy, the endowment remains an important, formidable, and essential resource.

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Note: This analysis is for informational purposes only and does not constitute financial or investment advice. If you observe any errors in numbers, figures, or other information presented here, please email me at [email protected].