Harvard Endowment: Worse time to get into the job

Imagine getting into a job you think its your dream all the while and it turns out that you need to do alot of clean up. I think this is what this lady is feeling right now:

Harvard may be the nations wealthiest university, but it is short on cash.

The school relies on its endowment to generate a third of the money for its operations, and the endowment is on the verge of posting its biggest loss in 40 years. With much of its money tied up for the long term, it is scrambling to meet some obligations.

Harvard has frozen salaries for faculty and nonunion staff members, and offered early retirement to 1,600 employees. The divinity school has warned it may not be able to cover tuition for all its students with need, the school of arts and sciences is cutting its billion-dollar budget roughly 10 percent, and the university president said this week than the unprecedented drop in the endowment was causing it to delay its planned expansion, starting with a $1 billion science center, into the Allston neighborhood of Boston.

The school has even added to its debt by issuing $1.5 billion in new bonds, its largest such offering ever.

Turning the ship around turns heavily on Jane Mendillo, who took over the Harvard endowment on July 1 which in hindsight looks like the worst possible moment to step into a job once held by some legendary investors. The endowment, the largest of any university in the nation, has shrunk by at least $8 billion, to $29 billion, since she arrived.

Undoubtedly, Ms. Mendillo inherited a complex portfolio, with many investments involving leveraged bets on equities and commodities that are difficult to unwind. Within days of her arrival, oil prices peaked and, with other commodities, began a precipitous fall. Stock prices commenced a sharp decline. Then came the cash calls on her portfolio.

In an interview, she recalled the Sunday in September when she learned Lehman Brothers would file for bankruptcy a night she was celebrating her 50th birthday as the beginning of her 12-hour workdays. Clearly, that was a big turning point, she said, adding that her longer-term strategic goals were overrun by urgent needs, like raising cash.

There were some things that I knew were going to happen and be challenges, said Ms. Mendillo, who speaks softly, choosing her words carefully. There were others that I dont think anybody could have foreseen.

One she might not have anticipated was the intense pressure caused by the Allston expansion, according to one person with knowledge of the endowment. Several years ago, the university had envisioned an ambitious capital expansion program stretching for more than a decade. Lawrence H. Summers, then Harvards president, had raised the possibility of locking in interest rates that appeared to be at historic lows, a plan the university adopted, said several people familiar with the endowment.

All went well at first. But in the second half of last year, interest rates plummeted, and Harvard turned to the endowment to meet hefty collateral calls, which could rise to $1 billion if rates remain weak, according to a person with knowledge of the university. According to a statement Friday from James R. Rothenberg, treasurer of the university, Harvard has taken a series of steps to reduce the risk associated with the transaction.

The endowment was squeezed partly because it had invested more than its assets, a leveraging strategy that can magnify results, both good and bad. It also had invested heavily in private equity and related deals, which not only lock up existing cash but require investors to put up more capital over time.

To free up cash, Ms. Mendillo has had to make some unpleasant choices, selling $1 billion in equities, including some in hedge funds with outstanding performances. A source familiar with the endowment identified Convexity Capital, run by one of her predecessors, Jack Meyer, as well as Baupost Group, led by Seth Klarman. Neither would comment for this article. Though she would not confirm relationships with specific managers, Ms. Mendillo said, We have taken money from a lot of funds as the size of the portfolio has changed.

She also sought to sell some of the endowments large private equity positions, to little avail.

Harvard, like other universities, has pushed into alternative investments, including private equity, which now constitute 13 percent of its total assets. In good times these investments return money as deals are completed. Now the returns have dried up, yet the commitments for new money remain, causing perhaps her greatest headache.

The university needs cash, and we have investments that need capital, Ms. Mendillo said.

She has raised the equivalent of 3 percent of assets for a cash reserve. For a long time, Harvard had a negative 5 position, she said. That means that 105 percent of the assets are invested at most times.

Her critics say that Ms. Mendillos overall investment strategy is unclear and that while the crisis erupted faster and with more magnitude than could have been predicted, she could have moved more quickly to manage the risk. Supporters counter that her predecessors essentially left her hamstrung with a portfolio that was illiquid, and give her high marks on investing acumen.

She does not beat you over the head with her knowledge, although it is clear that it is there, said Andrew K. Golden, who oversees the endowment at Princeton.

Harvard has said its overall endowment portfolio declined 22 percent from July through October and that it could end the fiscal year in June down 30 percent. That performance is in line with the average for university endowments, though some have done better. Yales endowment was off 13.4 percent in the comparable four-month period, while Princetons was down 11 percent, and both have projected a total 25 percent drop for the fiscal year.

Like Harvard, many schools are responding by taking on more debt. Princeton sold $1 billion in bonds recently, its first taxable offering since 1994.

Before landing on the hot seat, Ms. Mendillo ran the much smaller endowment of Wellesley College. But she honed her investing style earlier at Harvard. After graduating from Yale and its school of management, she was an equity analyst and a consultant. David Swensen, a friend who manages Yales fund, advised her to work for Mr. Meyer if she wanted to learn portfolio management. She started covering steel and insurance industries, because that was what was left over and stayed 15 years.

Mr. Meyer racked up a stellar record running the endowment, putting Harvards returns second only to Yales. But complaints about the size of managers pay packages, relative to the academics pay, ultimately prompted Mr. Meyer and many of his acolytes to leave in 2005.

A period of relative instability ensued. Harvard hired Mohamed El-Erian, who stayed just two years before returning to a top post with Pacific Investment Management Company. Before and after Mr. El-Erians stint, the endowment relied on board members as interim managers.

Though the Harvard endowment posted a strong 8.6 percent gain in the year before Ms. Mendillo arrived, David A. Salem, who heads the Investment Fund for Foundations, says he believes that Mr. El-Erian did the school a disservice by hiring people to implement certain strategies and then jumping ship.

Mr. El-Erian declined to comment for this article.

Mr. Salem, who knows Ms. Mendillo from the board of the investment fund, also said that Mr. El-Erian appeared to have left Harvard with an extremely illiquid portfolio, a situation complicated when a permanent replacement was not named for seven months after his departure.

According to two people familiar with Harvards strategy, the endowment had entered into swap agreements under which it paid short-term interest rates and received the returns on stock and commodities indexes. Those indexes declined sharply in the third quarter last year, and Harvard had to come up with collateral just as it was forced to meet other cash needs.

Though she has let go about 25 percent of her staff, or roughly 50 people, as the portfolio shrinks, Ms. Mendillo seems intent on keeping 30 percent of the assets under internal management.

She is also trying to manage expectations.

I am preparing the Harvard portfolio for the next one to three years for returns that will not be as attractive as what we expected on average, she said.