Monday, July 6, 2009

Take the Millions and Run

Recent valuations of nonprofit and foundation endowment funds have come out and it is not a pretty sight. "The five largest single-university endowments - Harvard, Yale, Stanford, Princeton, and the Massachusetts Institute of Technology - expect to finish the year with 25- to 30-percent losses," reported the Wall Street Journal. Also unlovely is the lack of focus on the much-vaunted money managers whose compensation for the last few years was tied to driving the bubble. Let’s watch for their signature gifts back to the funds they managed, shall we? No one else is.

And everything was going so well! Our poster child was Harvard University. "The Harvard endowment soared from $4.8 billion in 1990 to $36.9 billion as of June 30, 2008, and in the last half-decade or so, the men and women who run Harvard seemed to have convinced themselves that the university's fund would grow at double-digit rates for, well, eternity," writes Vanity Fair.

Just two short years ago, was singing paeans to Harvard University's endowment fund CEO Mohamed El-Erian. He had rescued HMC (Harvard Management Corporation) from the gaping hole left in 2005 by the departure of Jack Meyer and nearly three dozen staff, and ballooned the fund to $34.9 billion when he suddenly resigned and returned to PIMCO. "El-Erian's return last year (23 percent) beat Harvard's five-year average of 18.4 percent and the 12.3 percent average over the same period for endowments and foundations with more than $1 billion in assets, according to Wilshire Associates," effused "We will miss his leadership," lamented James F. Rothenberg, treasurer of Harvard University and chairman of the fund's board; "In 18 short months, HMC has completed the transition and rebuilding phase and established conditions for sustaining superior returns over time."

Cut to June 23, 2009 in Bloomberg: "Harvard University, the richest and oldest U.S. institution of higher education, will cut about 275 staff positions in response to its endowment's sinking value… Harvard President Drew Faust has tightened spending controls, frozen salaries and offered employees early retirement as the school estimates its endowment will fall 30 percent for the fiscal year that ends this month."

Previously, President, Drew Gilpin Faust, had issued an open letter on Feb. 18 declaring that the school was "facing the worst economic crisis since the Great Depression."

Vanity Fair's Nina Munk asked a hedge fund manager "who counts Harvard among his investors…to look at Harvard's finances now and assess the extent to which its endowment will be able to keep pace with its immovable costs. The hedge fund manager's conclusion: "They are completely fucked."

My financial advisor, Martin Weil (a former arts executive director), who had tried several times to explain to me over the last few years why university endowment funds were earning vastly more than our puny savings could generate, writes: "I find the story of El-Erian, who left PIMCO in 2006 to take over the reins of HMC, abruptly returning to PIMCO without any comment whatsoever in 2007, to be one of the most under-discussed stories in all of this."

While at Harvard, El-Erian and his number two person made $6.5 million and $6 million very quickly. Then El-Erian was suddenly gone. Is no one protesting? Are millions per year not related to billions lost?

Why is it so hard to hang on to ancient lessons? Hand over your money to someone to "invest" and give them the incentive of a dizzyingly high reward to the extent that they out-do the market, and they'll probably gamble with it (or worse, as we've seen). As we all know, the only consistent winner in a gambling establishment is the House.



The Oram Group, Inc. (c) 2008 said...

Great post Marilyn.

Martin said...

Actually Marilyn, I have no way of knowing whether El-Erian is behind the debacle at HMC. Personally I suspect he got there, saw a disaster looming and bailed before it went bad. These sorts of losses are not arrived at overnight unless one is in Vegas.

There is a true tragedy of alignment in all of this that mirrors that at major publicly-held companies. CEOs et al are highly incentivized to incur risks with other people's money, risks that are generally a long time in playing out. When the chickens come home to roost (have I used too many metaphors yet?), the decision makers do not share the pain equally with the "other people," and perhaps have even left with their bonuses intact.

I do have some faith that the market and the providers of capital (we investors) will learn from this disastrous misalignment of interests and put in place better incentive structures to reduce this problem this in the future.