Friday, October 16, 2009 0 comments ++[ CLICK TO COMMENT ]++

How not to invest: Harvard and its dubious bet on interest rates

I'm not the only one you should be using as an example of how not to invest ;) You should add Harvard University's endowment fund to that list as well. Readers may recall the numerous problems Harvard's fund faced last year so it shouldn't come as a surprise when Bloomberg reports that Harvard paid $500 million, plus another $425 million over 40 years, to cancel interest rates swaps:

Harvard paid $497.6 million during the fiscal year ended June 30 to get out of $1.1 billion of interest-rate swaps intended to hedge variable-rate debt for capital projects, the report said. The university in Cambridge, Massachusetts, said it also agreed to pay $425 million over 30 to 40 years to offset an additional $764 million in swaps.

The transactions began losing value last year as central banks slashed benchmark lending rates, forcing the university to post collateral with lenders, said Daniel Shore, Harvard’s chief financial officer. Some agreements require that the parties post collateral if there are significant changes in interest rates.

“When we went into the fall, we had some serious liquidity management issues we were dealing with and the collateral postings on the swaps was one,” Shore said in an interview today. “In evaluating our liquidity position, we wanted to get some stability and some safety.”

Harvard sold $2.5 billion in bonds, in part to pay for the swap exit, even as the school’s endowment recorded its biggest loss in 40 years, the Harvard report said.

...


Harvard has frozen employee salaries, slowed hiring, cut staff and offered other workers early retirement as part of a cost-cutting program to compensate for losses in its endowment. The fund, which dropped to $26 billion in value over the fiscal year from $36.9 billion, paid 38 percent of the school’s bills during that time, the report said.


If liquidity was a concern, Harvard probably had no choice in attempting to exit these contracts. Nevertheless, these contracts may end up being canceled at the worst possible moment. Although I am not expecting it, one shouldn't rule out the possibility of interest rates rising. If they do rise, Harvard would have done the equivalent thing to what some panicked investors do: sell near the bottom.

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