Harvard Restructuring Shows Signs of Progress

Despite not being pleased with Harvard endowment’s investment returns of 6.5% and 8.1% for the past two years respectively, Harvard Management Company CEO N.P. “Narv” Narvekar said there is “some good news” as the endowment’s five-year restructuring process is beginning to show “positive indicators of progress.”

In Harvard Management Company’s recently released annual report, Narvekar said the early efforts in the restructuring have involved rebuilding the organization’s structure and culture, constructing a generalist investment team, and establishing new investment processes. It has also recruited additional team members for the generalist and support teams, and established incentives that reward collaboration, long-term investment thinking, and calculated risk-taking.

“Culture, organizational structure, and incentives were central to the deep issues that HMC faced and are crucial to our solutions,” said Narvekar. “Most importantly, we operate as one team, not as siloed specialists. We will succeed thanks to the dedication and skill of all team members. While we still have much work to do, we are well on our way.”

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Because public equities and hedge funds are the most liquid investments in the portfolio, Narvekar said the asset classes are the areas in which the generalist investment team has had the most immediate impact. Over the past two fiscal years, both asset classes have outperformed their respective benchmarks, and on a combined basis they outperformed the blended benchmark by more than 2.25% annualized over the same period.

Narvekar regards the performance as “very good, albeit not excellent.” However, he said it he is “particularly pleased with our hedge fund performance, as it was not driven by positive equity markets.” Narvekar said that the current hedge fund portfolio, by design, has less exposure to equity markets than any such portfolio he has overseen during his 21 years of managing endowments.

“Since much of this legacy illiquid group has had unremarkable returns and has been a drag on performance,” said Narvekar, “we are all the more pleased with our impact on the more liquid portion of the portfolio.”

However, Narvekar points out that while the results have been positive so far, two full fiscal years is “far too short” to make a meaningful assessment of the true impact of the restructuring.

“As long-term investors, we think in terms of at least 10-year performance,” said Narvekar. “As we build toward that timeframe in the liquid parts of the portfolio, there will be good and bad years. What is clear is that the early results provide a positive affirmation of our approach and represent a significant step forward for HMC.”

In the report, Narvekar also discussed a new risk framework forHarvard Management Company, which he said is a critical tool in its portfolio management.

“HMC generally takes lower risk and, therefore, will likely generate lower returns than many peers over a market cycle,” said Narvekar. “During these discussions, we will determine if this approach is appropriate or not … I believe that we will conclude these discussions over the next eighteen months or so, which will help inform allocation decisions in future years.”

The portfolio’s top-performing asset class during fiscal 2019 was private equity, which returned 16%, followed by real estate, which rose 9.3% during the year. Public equity returned 5.9%, while bonds/Treasury Inflation-Protected Securities (TIPS), and hedge funds returned 5.7% and 5.5% respectively. The worst performing asset classes were natural resources, and other real assets, which lost 12.4% and 8.3% respectively.

The asset allocation for the fund is 33% in hedge funds, 26% in public equity, 20% in private equity, 8% in real estate, 6% in bonds/TIPS, 4% in natural resources, 2% in cash and other, and 2% in other real assets.

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Tags: Endowments, Harvard, Narv Narvekar, Returns, team restructuring

Private equity firms have been under fire recently from high-profile political figures over their “predatory business practices” and their subsequent influence on society. The firms are being criticized for problems such as overloading their portfolio companies with debt, price gouging practices, overcharging for ambulatory care from health care firms they own, and providing extremely poor living conditions in the private prisons they operate. Legislators have been encouraged to introduce bills that specifically target their actions and help regulators get a handle on the situation.

This negative press is having an impact on investors. A survey from Eaton Partners concluded that nearly 70% of institutional investors they canvassed are growing concerned from the recently publicized anti-private equity criticism from US lawmakers.

Sen. Elizabeth Warren recently introduced the “Stop Wall Street Looting Act of 2019” that would publicize private equity firms’ fees and returns, and institute measures that would hold them accountable for illegal activities executed by their portfolio. She also criticized private equity firms for running their privately owned prisons in subpar conditions, accusing them, among other things, of serving meals “which included not only maggots but also ‘crunchy dirt’ in potatoes,” she said in a joint statement with Rep. Alexandria Ocasio-Cortez.

Warren has likened private equity firms to vampires, “bleeding the company [they acquire] dry and walking away enriched even as the company succumbs…Costing thousands of people their jobs, putting valuable companies out of business, and hurting communities across the country.”

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The implications of the bill could have a serious impact on the return profiles of institutional investors who allocate towards private equity. Over half of institutional investors surveyed by Eaton Partners (55%) believe private equity will be the best-performing private market fund class over the next six months.

The American Investment Council recently reported that private equity has been the top-performing asset class for some of the largest public pension plans in the United States for the past seven years. The asset class generated annualized returns of 10.2% over a 10-year period in 2018, compared to an 8.5% return for public equity, and a 4.8% return for fixed income and real estate, respectively.

Eaton Partners’ survey also concluded that more than four in 10 institutional investors are allocating less direct investments in the United Kingdom, due uncertainty stemming from Brexit. Investors also reported in the survey that they are adopting a more defensive approach to portfolio allocation, in reference to the potential of an international drag on macroeconomic growth.