As the investment returns from Harvard’s endowment continue to lag behind those of Yale and other Ivy League schools, Harvard is altering the way in which the university invests its money.
In a Sept. 22 letter to Harvard alumni, Stephen Blyth, president and CEO of the Harvard Management Company, unveiled a new process, called “flexible indeterminate factor-based asset allocation,” that gives Harvard more flexibility when investing its $37.6 billion endowment. But several professors and outside experts interviewed by the News said they did not fully understand the new model, and they expressed doubt that Harvard will be able to catch up to Yale’s investment returns, despite the new approach.
“I don’t imagine that [Harvard] is going to catch up,” School of Management professor Roger Ibbotson said. “I would bet on Yale.”
According to an Oct. 4 article in the Financial Times, FIFAA is Blyth’s way of closing the gap with Yale, which has consistently outperformed Harvard’s returns since the 2008 financial crisis. But Yale is not the only school with stronger returns than Harvard: although not all schools have reported their gains yet, available numbers show Harvard trailing several of its peers. For fiscal year 2015, Harvard’s return on its endowment was 5.8 percent. In comparison, Yale’s return was 11.5 percent, Dartmouth’s was 8.3 and Stanford’s was 7.0.
After several years of low returns, the former head of the Harvard Management Company, Jane Mendillo, stepped down last year and handed the reins to Blyth in an attempt to bring Harvard back in line with its peers. In the September letter — his first major policy statement since he took on the role — Blyth explained that FIFAA is intended to create an investment process that better quantifies the idea of risk. While most schools, including Yale, account for risk by looking at the standard deviation within a given market, Harvard will now look at risk through the lens of five new factors: global equities, U.S. Treasuries, high-yield credit, inflation and currency. This method will give Harvard a greater sensitivity to macroeconomic variables when deciding where to invest, Ibbotson said.
But economics professors are skeptical of whether Harvard will ever be able to match Yale’s returns numbers. Furthermore, three of three professors interviewed said they do not fully understand the intricacies of the FIFAA approach based on publicly available information — a result that may be intentional, Ibbotson said, citing the tendency of schools like Yale and Harvard to reveal as little information about their investment plans as possible.
Professors noted that although computers can anticipate how much asset classes — an area of stocks or bonds that behave similarly in the marketplace — will fluctuate each year, no prediction is perfect. Good investment returns are also the result of luck, and changing Harvard’s portfolio may not accomplish much, Ibbotson said.
“People think it’s all skill, but a big piece of it is luck,” Ibbotson said. “You don’t know which asset classes will do the best.”
But some investment strategies, like those at Yale, as well as MIT and Princeton, where some of Yale Chief Investment Officer David Swensen’s protégées have adopted similar investment models, have consistently yielded large returns. Swensen’s strategy for Yale’s endowment — dubbed the “Yale model” by financial newspapers — involves buying private equity, natural resources and real estate to diversify Yale’s portfolio and reduce risk. Many schools including Harvard have imitated the Yale model, but not all have succeeded to the same extent as Yale, William Jarvis ’77, managing director of the Commonfund Institute, an institutional investment firm, said.
Additionally, because Yale adopted this investment strategy before its peer institutions, the University has more negotiating power and can make better deals, Ibbotson said.
“There’s nothing a firm would rather do than take Yale as an investor. It’s a tremendous certification,” he said. “Yale’s got more prestige at this than Harvard.”
Economists interviewed by the News said they do not know precisely how the five-factor approach will affect Harvard’s investments in the immediate future, but noted that Harvard may want to invest more money in assets that have yielded the highest returns. The breakdown of Harvard’s 2015 investment returns show that the largest returns were from real estate and private equity, which earned Harvard returns of 19.4 percent and 11.8 percent, respectively. Part of Blyth’s FIFAA method allows Harvard to invest more money in precisely these two markets.
Beyond introducing the new five-factor model, Blyth’s report adds four new asset classes to Harvard’s portfolio. In addition to the eight asset classes that Harvard used last year, the university is extending its investment ranges and adding domestic bonds, foreign bonds, inflation-linked bonds and “high yield” assets.
“The ranges provide us with appropriate flexibility to execute a variety of investment opportunities and strategies as they arise,” Blyth wrote in his letter.
Ibbotson said Blyth’s opaque language in describing FIFAA is likely a way for him to create his own agenda at Harvard and invest in new markets without being questioned. Investment offices at schools like Yale and Harvard rarely reveal their plans, he added.
“[Blyth’s] not going to publicly announce what he’s really doing,” Ibbotson said.
Yale’s endowment is currently $25.6 billion.