PENNY WISE AND POUND FOOLISH

AN IMPORTANT INVESTING LESSON FROM HARVARD

October 19, 2016

On September 23, 2016, Barry Ritholtz wrote a very interesting article for Bloomberg entitled “Harvard Does a Trade You Should Never Make”.

Regular readers will know that our philosophy at HG Partners is, and has always been this:  focus on the end result, net of fees, not on the fees themselves.  While it is hardly surprising that “do it yourself:” investors think that they are smarter than professional money managers, it was a little surprising to see that this misguided focus on investment fees and expenses, to the exclusion of a concentration on net returns, is not limited to “small” investors.  Harvard has made the same myopic (and very expensive) mistake.  Here is the story.

The Harvard Management Co., which now oversees Harvard University’s endowment and other investments recently released its 2016 Annual Report.  In the latest reporting year, the return on investment was negative 2 percent.  Put into dollar terms, the fund lost about $2 billion.  In the article, Ritholtz notes that “anybody can have a bad year” – that is certainly true in any occupation.  But he points out that the reason for that bad year is really the issue.

The performance of Harvard’s endowment fund was once one of the best in the world.  Ritholz notes that “a combination of academic hubris and political correctness led to a series of terrible – and expensive – decisions.”  So, what exactly happened here?

It seems to have all started about a dozen years ago, when a number of notable alums and major donors began a movement threatening to withhold future gifts unless Harvard cut the compensation for the money managers responsible for the fund.  At the time they were delivering above benchmark returns.  Over time, the school caved into the wishes of the alums and also the majority of the faculty with respect to management compensation.  As a result, Harvard replaced one of the best performing money management teams in the world.  The performance of the fund has never recovered.

Years of reliable and above-average returns, and stability of the team disappeared overnight.  The in-house management team is now in the process of finding it’s fourth CEO in a decade.  So much for stability.  And interestingly, even after the purge of the “overpaid” managers, Harvard still has the highest paid investment management team of any university.

Part pf the problem has been a significant focus on hedge funds, where over the last several years performance in general has been weak, and fees very high. But the performance of the equity component of the fund has been very sub-par, underperforming it’s benchmark by 400 basis points.

The lesson here really is not that complicated.  Investment management that outperforms benchmarks on a fairly consistent basis is an uncommon thing.  When that situation is upset because of interference (for all the wrong reasons) such as happened at Harvard, it is hardly surprising that returns suffer.  The old adage of “if it ain’t broke, don’t fix it” comes to mind.

So, here’s what has happened:  the school saved about $50 million in money manager compensation.  Yes, that is a lot of money.  On the other hand, it would appear that billions have been lost (again, $2 billion in the last reporting period alone) by hiring less-capable managers.  “It almost doesn’t need saying that this is a trade you should never make,” concludes Ritholtz.
Howard Goodman
President, HG Partners Limited
Director, Private Client Group &
Senior Financial Advisor,
HollisWealth Advisory Services Inc.

This article was prepared solely by Howard Goodman who is a registered representative of HollisWealth Advisory Services Inc. (a member of the Mutual Fund Dealers Association of Canada and the MFDA Investor Protection Corporation).  The views and opinions, including any recommendations, expressed in this article are those of Howard Goodman alone and they are not those of HollisWealth Advisory Services Inc.

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