Yale and Harvard Strike Out In A Year of Investment Turmoil
You might go to Harvard or Yale to get a top-notch education in medicine, literature, or physics, but don’t expect to sharpen your investment skills by following their lead.
The Harvard and Yale endowment funds — touted for years as being on the cutting edge of new investment practice — sustained massive losses last year after a decade of beating the stock market.
It turns out that their highly-touted “alternative” investments—which were supposed to shelter them from big declines in the stock market— turned out to be major money losers instead.
And, to add insult to injury, their mainly illiquid investments forced the endowments to hang on while prices plunged further.
The 27 percent, $11 billion loss at Harvard, and the 30 percent, $7 billion loss at Yale, have caused layoffs and budget cuts at both schools.
They also offer a textbook warning to investors on how not to invest.
Asset diversification
Yale endowment fund’s David F. Swensen and his counterparts at Harvard have long preached the virtues of holding a diversified portfolio of investment assets whose movements are not fully correlated.
So far so good: much investment research supports investors who hold a mix of bonds, different types of stocks, real estate investment trusts, and commodity-backed instruments.
Smart investors can — and do — construct diversified portfolios using those asset classes, often through mutual funds or electronically-traded funds listed on major stock exchanges.
Although such investments are subject to the vagaries of the market, they can be sold or redeemed at any time without restriction. Holding a portion of a portfolio in short-term Treasury, municipal, or corporate bonds, as well as some cash in a money fund, also provides an investor with “safe” money that can be accessed without loss even when the stock market is plunging.
Illiquid assets
But Harvard and Yale took it a step further: they wanted to super-charge their returns by using non-traditional investment vehicles, such as hedge funds, private equity investments, even direct ownership of real estate and commodities such as stands of timber.
They argued they could be patient investors because they were investing for 100 years, not 25 like the typical long-term individual investor.
Unfortunately, they found that those non-traditional investments got caught up in last year’s turmoil and slammed their doors shut to those running for the exits.
The endowments were locked into these illiquid vehicles at the same time that their publicly-traded stock holdings were dropping. Because they had such low portions of their portfolios in liquid cash or short term bonds—just 4 percent in Yale’s case—they had nowhere to draw cash to satisfy their obligations to the universities.
Borrowed money
Harvard compounded the problem by borrowing money to invest—it had a negative cash position of 5 percent.
Even worse, some of the private equity investment contracts required the endowments to keep adding money as the private equity funds plunged, forcing them to sell off stocks that were falling in order to meet those obligations.