Thursday, December 4, 2008 10 comments ++[ CLICK TO COMMENT ]++

Harvard endowment fund posts -22% loss in 4 months

This is not a good sign for pension funds but it looks like the Harvard endowment fund has posted losses of about -22% in 4 months (up to October.) This is without alternative assets such as private equity holdings and real estate holdings being factored in. One should also note that the market has declined since then.

Harvard University’s endowment decreased 22 percent, or $8 billion, in the first four months of fiscal 2009, putting the fund on course to have its worst performance in at least four decades.

...The worst annual return that Harvard, in Cambridge, Massachusetts, has recorded in at least 40 years was a loss of 12.2 percent in 1974.

The 22 percent decline, excluding adjustments for real estate and private equity, outperformed the Standard & Poor’s 500 Index of stocks, which fell 24 percent during the same period with dividends included.

I generally don't care what the smart money is doing but we need to be concerned about some of these funds because they invest some of our assets. For instance, even though I'm cynical and expect almost nothing from my Canada Pension Plan contributions, it is still something that many people depend on. Similarly, the last thing we need are universities needing to be bailed out because they made disastrous investment decisions.

There has been a push over the last decade for pension funds, endowment funds, charities, and so forth, to "diversify" into riskier assets such as hedge funds, private equity, commodities, and emerging markets. Funds such as the Harvard fund has been at the forefront and will likely get out with the least losses. But we have a whole hoard of imitators who followed these funds and may be facing massive losses. Assets such as private equity and hedge funds have lock-up periods and gates that will spread losses over a long period of time so one can never know what the actual losses are.

One of the themes running on this blog, or at least in my head, is the question of who will bear the brunt of the losses. It would be unfortunate if pension funds and endowment funds end up with the losses. I would prefer if private investors took the losses but this is a free market and if these highly paid portfolio managers are making mistakes the market rightly punishes them.

Finally, we should keep in mind some of these losses may simply be quotational losses but I don't have an optimistic picture for the institutional funds since they invested in toxic assets that only smart money can: hedge funds, private equity, various commodity schemes and real estate. When it's all said and done, the aforementioned assets (except real estate) will likely post greater losses than broad market stocks or bonds.


10 Response to Harvard endowment fund posts -22% loss in 4 months

December 4, 2008 at 5:21 PM

Canadian Pension Plan? Why are you skeptical about it?

From my perspective, it seems that it is run better than our Social Security Administration, which doesn't really 'invest' any money-George Bush tried to get us the chance to do that, but took a lot of flack over it (surprise, surprise).

December 5, 2008 at 10:04 AM

I am skeptical about these pension plans in general. Some of our plans are well run but I am still concerned for a couple of of reasons.

I am not a huge fan of pension funds investing a lot of money in volatile assets like stocks or commodities, not to mention private equity or hedge funds. I think a portion should be allocated to those assets but it is preferable for them to be run conservatively, as it seems to have been the case in middle of the last century. Unlike private investors, who can simply hold positions deeply underwater if fundamentals are still strong, these funds often have to liquidate assets to meet payment requirements. In such a case, holding wildly volatile assets seems questionable.

First of all, they overpromise their future returns. This is a problem that Warren Buffett has warned about corporations in general. Many pension, university, corporate, etc, funds project rosy future returns. Unfortunately, this results in projects being undertaken that really should not be. In the case of pension funds, this generally means potentially increasing benefits or loosening benefits, instead of being strict and trying to keep employee benefits stable.

The other problem is that these funds have, in a herdlike fashion, tried to follow popular strategies which actually seem risky to me. I mean, why does almost every fund seem to have positions in private equity. If it weren't for this excess capital, private equity wouldn't have hit the same bubble valuations. Similarly, the trend towards investing sizeable sums with hedge funds seems questionable to me (but I am a critic of hedge funds in general due to their high compensation schemes.) Investing in commodities, which was really popular with institutional investors, is also questionable in my eyes. Admittedly I've been bearish on commodities but even if I was somewhat bullish, I would have to admit that these institutional funds distort the prices of some commodities.

December 5, 2008 at 10:20 AM

That makes a great deal of sense. On a moral level, I really like your argument about how they seem to chase bubbles... I wonder if in 400 years we will look back at this situation and think "wow, the Dutch Tulip Bubble was pretty absurd, but this real estate bubble was invested in and given the good graces of the state!"

Have there been any real efforts to reform the system in Canada?

December 5, 2008 at 11:15 AM

The current bubble may end up being a global bubble. Such a thing has not happened in the past to this degree. So the wealth destruction we will witness are immense. But it is not clear what the reality is.

For instance, we all talk about the real estate bubble, but if commodities were also in a bubble (we still don't know if it was a bubble) there was even more bizarre investments made in that field. The real estate bubble would seem "rational" compared to institutional investors hoarding (physical) commodities without any intention of using the commodity. The billions invested in (physical) commodity indexes would seem bizarre in 100 years... but it's not clear if commodities are in a bubble...

As for Canada, I don't follow the institutional or government scene much. I'm more left-leaning than most of the blog readers. I may quote Jim Grant, since he is brilliant, but don't agree with half his suggestions :) My impression is that the Canadian situation has mostly been the status quo for years. Ever since the federal government balanced the budget in the late 90's, there isn't much financial pressure on the pension funds and such. The provincial and municipal governments are not in good shape but hopefully they will fix things within the decade (after the current recession.) So the pressures really lie with the provincial and municipal governments.

Canada is more socialized so some of the obligations are built into the system, if you will. However, I do feel that our healthcare costs are growing too fast for my liking and we need to stabilize that. If countries--almost any of the developed ones--don't control their healthcare costs, they are going to face massive problems in the future. There will also be a war between the young (my generation) and the old (baby boomers.) To me, it makes little sense that healthcare costs are growing much faster than the GDP. Yes, the retiring baby boomers mean that growth will be higher but not to this degree.

One of the problems in the US is the weird situation where the federal government is taking out the "surplus" from the Social Security account for its own budget needs. Clinton's budget wouldn't have been balanced in 2000(?) if the govt didn't use the surplus for its own needs. I would argue that the problem in the US is the high spending by the government rather than any problems with social security or any of those programs. The healthcare programs (medicare etc) may still be a problem in the US but it's not clear what the "right" solution is.

December 5, 2008 at 1:47 PM

You are dead on with the spending problem that we have here in the US. We always have people campaign on balancing budgets, but they never do-the political situation here really sucks. Really, it ultimately extends itself into a monetary policy... but that is a completely different issue.

Social Security and Medicare here are growing at an astronomical rate. Once my parents retire, it is really gonna suck since there will be more retirees than just about anyone else. I don't really see how to keep spending down without cutting into the entitlement programs we have. B

Here is a question that I will throw your way. Why would it be so strange in 100 years that we hoard commodities? Granted, they may have been overvalued, but they are a means of production. Silver has a great number of uses in industry, as well as platinum, zinc, copper, oil, nat gas and the like. They are all things that make us live better-as a means of production.

Granted, we have been living well since we had a bunch of earning that were caused by excessive leverage that ultimately came from real estate. With more money to buy stuff with, stuff could go up in price.

I would guess that there was a bubble that encompassed just about everything, but arose from the underlying bubble in real estate.


December 5, 2008 at 2:48 PM

In my opinion investment is about gaining assets that will generate a continuous stream of payments, this bolstering your income, over time. Buying a house to live in is thus an investment since having a place to live is a payment stream in kind. Stocks and bonds are investments as they create a claim in part of a continous payment stream.

Buying commodities can then never be an investment since commodities generate no income. Buying something only because you hope a bigger fool will turn up is speculation pure and simple. That kint of behavior got us tulip madness, California real estate and, oh commodities. Buying commodities to "invest" is blind speculation and nothing good will ever come of it.


What's with this supposed left-wingery of yours? In a recent thread you seemed to largely agree on a liberal-conservative low tax, small government, personal freedom agenda. I haven't seen you defend any lefty causes here either, so why claim to be on the left?

December 6, 2008 at 9:46 PM


ContrarianDutch essentially provided the bearish argument for commodities. I share similar views but I think commodities can be worth investing as a pure macro bet.

It may be possible that all assets, including commodities, were in a bubble. The fact that many junior mining firms are on the verge of bankruptcy--these were firms that were stars and had market caps of several billion--implies that there was a bubble. These are stocks, rather than the physical commodities, but the outcome is somewhat similar. Even if the commodities were not in a bubble, it goes to show how volatile and impossible to predict these commodity markets are.

The main reason value investors do not like commodities is the reason that ContrarianDutch provided. Namely, commodities do not generate any income. For instance, it is quite reasonable for commodities to stay at the current price for the next 20 years. I'm not predicting that but just arguing that it would not be out of the ordinary for that to happen (in contrast, it would be highly unusual if bonds or stocks (assuming not overpriced) to stay the same.) Then what? What will your return be in that case?

Having said that, a commodity can go up. Ignoring bogus bubbles, they will only go up if there is a supply & demand imbalance. If you strongly believe there is an imbalance then you can bet on them. Even Warren Buffett, who avoids commodities and commodity businesses like the plague invested in silver in the early 2000's. But the problem in my eyes is that there is too much hype about commodities right now and even if fundamentals are somewhat favourable, it's not clear if prices already factor that in.

For instance, oil at $50 looks cheap when compared to $140 a few months ago. But if you think about the fact that it has gone up almost 5x (from $12(?) in 1998 to $50) from its low, how certain are we that the market isn't pricing in the future fundamentals. The growth in the world economy clearly does not account for the 5x increase. Neither does total world oil demand; nor did supply drop significantly. So I would argue that the market is pricing in future demand (from China, India and others) as well. What if actual oil price was, say, $30 and $20 was from high growth in emerging markets. If you buy oil at $50 then your future returns on this investment will be poor. Even if fundamentals are somewhat strong, they will just catch up to price. In the mean time, you are earning zero income.

Having said all that, I only see one reason commodities may go up in 20 or 30 years. That has to do with scarcity. There is a powerful argument Jeremy Grantham makes in one of his commentaries where he speculates that commodities may become precious. If that happens, commodities may be higher in 50 years than now. But in the history of humanity, commodities in general have never become scarce. Or more precisely, when one becomes scarce, another substitute takes over (so you don't see the massive price prices that scarcity would imply.)

December 6, 2008 at 10:00 PM

ContrarianDutch: "What's with this supposed left-wingery of yours? In a recent thread you seemed to largely agree on a liberal-conservative low tax, small government, personal freedom agenda. I haven't seen you defend any lefty causes here either, so why claim to be on the left?"

I have always considered myself to be on the left. I don't vote for right-wing parties because I don't vote for social conservatives. However, I am not as much of a socialist as most of the left happens to be right now (a misguided view in my opinion.)

Anyway, I'm left-leaning because I'm more in favour of government intervention than most on the right or even most centrists. I'm also neutral and often positive on social programs undertaken by government (the right generally considers these programs wasteful and useless.) For example, I would be in favour of government spending money on, say, social programs to combat crime than on police. I would be ok with the government spending money on arts or tourism or something.

As for taxes, I'm not really in favour of low taxes. I'm actually ok with high taxes. What I always argue is that the government should not be doing things it has no business getting involved in (eg. airlines, housing, etc.) Perhaps this implies a lower tax because a smaller government would mean lower taxes. However, I personally don't care about the tax policy per se. I'm more concerned with waste by government. This is probably similar to other liberals like Warren Buffett, who has no problem paying high taxes but is probably as capitalist and against govt running businesses as anyone out there.

As for freedoms, I think your view of the left and liberals in general is different from my impression. I would argue that the left is far more in favour of freedoms than the right. There are some exceptions where certain causes take precedence for some misguided reason (eg. gun control or hate speech.) But look around the world. The liberals are the ones that are skeptical and fighting for freedom of the speech, or for human rights, or whatever. I'm not saying it is only the left but it is far more in favour of freedoms.

December 8, 2008 at 11:30 AM

I wasn't trying to make an argument either way for commodity prices as an investment- you're right, they don't produce cash like companies can... Just saying that I don't trust the government enough to manage our currency, so, I figure they should back it in something tangible (which coincidentally is something that we at least use to em better our lives).

The best inflation hedge in the world is KO @ at cheap price relative to value.

Also, Something about liberal here, in the US, that is crazy (and kinda goes against their rights principles) is that they don't seem to view money as a form of speech. Due to election laws, we are extremely restricted on what we can say/purchase on TV during an election cycle. It is kinda bogus.

December 8, 2008 at 2:12 PM

The biggest problem in the US political system is the two-party dominance. Admittedly there is nothing stopping other parties from gaining influence but in practice it's next to impossible.

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