The Harvard-Yale Endowment Rivalry
Not all professional investors noticed last year when the Yale Bulldogs beat the Harvard Crimson 24-3 at the 134th annual Harvard-Yale Game. On the whole, investors are far more interested in the results of Harvard and Yale’s off-the-field rivalry over endowment performance.
The competition was most intense in the years during which Jack Meyer led Harvard’s endowment and David Swensen led Yale’s. Over the 10 years before Meyer left Harvard in 2005, Yale returned 17.4% per year and Harvard returned 16.1% per year, far outpacing the median college endowment’s return of 9.4% per year. This extraordinary outperformance led to the widespread adoption of the so-called endowment model.
But while Yale’s endowment has continued to outperform, Harvard’s endowment has fallen behind in the annual competition. In fact, over the past decade, Harvard’s endowment has underperformed a passive 70% equity, 30% bond portfolio (using the MSCI All Country World Index for equities and the Vanguard Total Bond fund for bonds).
Figure 1: 10-Year Trailing Returns from 6/30/2017
Source: Harvard, Yale, CapitalIQ
Much has been written about the brilliance of Yale’s David Swensen and the strategies that have led to Yale’s outperformance. But less has been written about Harvard and the lessons for those that pursue endowment-style investing.
We did a deep dive into Harvard’s endowment results to discern where and how Harvard went off course after Jack Meyer left. Harvard doesn’t report all the underlying details in a consistent way each year, leaving us the difficult task of assembling a puzzle with a few missing pieces.
But we don’t need all the details to see what is blindingly obvious: Harvard’s woes over the past decade mostly result from one very large bet that went wrong. In the mid 2000s, the endowment decided to significantly increase exposure to commodities. In 2000, the policy portfolio was 6% commodities. By 2008, the target allocation was 17%. The endowment had $5.7B in commodities in June of 2008.
The CIO at the time, Mohamed El-Erian, laid out the logic for this bet in his 2008 book, When Markets Collide. A former academic deemed a “Global Guru” by Fortune, El-Erian argued that markets of yesterday (US and other developed markets) were colliding with the markets of tomorrow (emerging economies), and that the emerging economies would grow much faster, driving higher inflation and, most importantly, higher commodity prices.
This was excellent as a description of the five years leading up to 2008. From 2003 to 2008, emerging market equities soared, returning 29% annualized. Commodities returned 30% annualized. The S&P 500 returned a mere 7% annualized.
Figure 2: Value of $100 Invested in Emerging Market Equities, Commodities, and US Equities 2003–2008
Source: CapitalIQ
But El-Erian’s thesis was remarkably bad as a forecast. Over the next decade, commodities lost 6% per year, emerging market equities returned 2% per year, and the S&P 500 returned 10% per year.
Figure 3: Value of $100 Invested in Emerging Market Equities, Commodities, and US Equities 2008–2018
Source: CapitalIQ
Harvard’s 17% bet on commodities, predicated on the “markets of tomorrow” theme, resulted in significant losses for the endowment and returns that lagged passive stock/bond benchmarks.
The endowment model as a whole is predicated on just this type of decision: large allocations to alternative asset classes that are less liquid, more esoteric, and have higher fees than traditional stocks and bonds. When that model works, as it has at Yale, the results can be spectacular. But when the model doesn't work, investors can end up trapped in illiquid and under-performing asset classes with returns lagging passive benchmarks.