Harvard favours emerging markets and absolute returns over fixed income

Harvard Management Company (HMC), which manages the $32 billion Harvard endowment, has made significant alterations to its policy portfolio, including increasing allocations to emerging market equities and the externally-managed absolute returns program, while slashing fixed income allocations.

The policy portfolio has been changed for 2012 following rigorous internal debate, led by Emil Dabora, who holds a Harvard PhD in Corporate Finance Econometrics, and a team of risk analytics investment professionals.

Some of the more significant changes since 1995 are the increase in emerging market equities to 12 per cent, and the allocation to absolute returns, moving to 16 per cent of the fund (see table below).

Meanwhile, the allocations to private equity, real estate and domestic bonds have been reduced since 2005.

The absolute return portfolio, which returned 11.6 per cent for the year to June 30 – beating the hedge fund industry return by about 200 basis points – has been restructured over the past few years, according to HMC chief executive Jane Mendillo’s (pictured) summary in the endowment report this September.

“We are now happier with the mix of managers and strategies it contains: a variety of approaches to generating value ranging from purely opportunistic to long/short to unusual investments such as royalty streams,” she says.

“When public equity markets do not do as well as they did this past fiscal year, we expect this segment of our portfolio to continue to produce stable risk-adjusted returns over the economic cycle.”

Overall the HMC has a plan to increase the internally managed assets and will continue to make internal appointments.

“We still plan to expand our internal team, consistent with our goal of judiciously shifting assets from external managers back to our internal platform over the next several years,” says Mendillo.

“Given the benefits of our hybrid model, including the alignment of interests, cost efficiency, and greater transparency we gain, it makes good sense for Harvard to allocate a larger proportion of the total portfolio to internal management in the coming years.

“Even as we add to internally managed assets, our externally managed portfolio will continue to be important for the investment activities that we either cannot or prefer not to pursue from the internal side. It also gives us tremendous geographic reach and breadth.”

In the past year the HMC has created a new internal group focusing on credit markets, and made a recent in-house addition with expertise in Chinese equities.

Additions were also made to active commodities trading, and real estate teams.

The Harvard endowment returned 120 basis points above its benchmark for the fiscal year 2011, with domestic equities the outperformer, returning 34.6 per cent, versus the benchmark of 31.9 per cent.

Outside of public equities, private equity (26.2 per cent), public commodities (26.9 per cent) and foreign bonds (21.7 per cent) all performed well.

Its real assets portfolio also returned 18.8 per cent for the year. It makes up about 10 per cent of the endowment, which has invested in timberland since the 1990s.

China has been a focus for HMC during the year. In December, it hosted a “China Day” at the university, with academics speaking to HMC fund managers about the role of China in Harvard’s investment portfolio.

“Our goal is to continue to develop and evolve our investment edge in China as the country and its markets gain even greater prominence and influence across the global investment landscape,” says Mendillo.

Over five years the endowment has returned 1.2 per cent above the benchmark; for 10 years, 2.7 per cent above; and over 20 years, 3.1 per cent above the policy portfolio.

The Harvard Policy Portfolio

Asset class                              1995    2005    2012

Domestic Equities                   38%     15%     12%

Foreign Equities                       15        10        12

Emerging Markets                   5          5          12

Private Equities                        12        13        12

Absolute Return                       0          12       16

Commodities                            6          13        14

Real Estate                                7          10        9

Domestic Bonds                      15        11         4

Foreign Bonds                         5          5          3

High Yield                                2          5          2

Inflation-Indexed Bonds      0          6          4

Cash                                         -5         -5         0

TOTAL                                   100%   100%   100%