Friday, July 24, 2009

The Harvard lesson

Vanity Fair has a new article out detailing Harvard University's financial travails. While numerous factors are responsible for its predicament what stood out to me was the role of Jack Meyer, head of Harvard Management Company which managed Harvard's endowment:
When Meyer arrived at Harvard, the endowment was in a deep rut, going nowhere. Walter Cabot, who’d run Harvard Management Company since its founding, in 1974, had survived the stock-market crash of 1987 magnificently. But afterward, weakened by a heart attack, Cabot remained cautiously on the sidelines, even as the market took off again. His time was up. Meyer, then 45, a Harvard M.B.A. and the former chief investment officer for the Rockefeller Foundation, was hired to take charge.

Meyer was a pioneer. He was daring, or reckless, depending on your point of view. Instead of abiding by the old, prosaic rule of 65/35 (whereby 65 percent of your portfolio is invested in U.S. equities and 35 percent in bonds), Meyer and his team of portfolio managers moved Harvard’s money into all sorts of things: private equity, real estate, oil, gas, fixed-income arbitrage, timberland, hedge funds, high-tech start-ups, foreign equities, credit-default swaps, interest-rate swaps, cross-currency swaps, commodities, venture-capital funds, junk bonds. As if all those exotic, illiquid investments weren’t enough to amplify the returns, Meyer added a heap of leverage. It was dizzying, Harvard’s portfolio.

The best money managers in the country dreamed of working for Meyer. “It was an intellectually charged place,” recalls a portfolio manager who worked at Harvard Management Company in the 1990s. “They were the brightest people that I have ever met,” I was told by another portfolio manager who worked under Meyer.

...For a long time, Meyer’s daring strategy worked flawlessly. Between fiscal 1990 and 2008, Harvard’s endowment boasted an average annual growth rate of 14.3 percent. That’s a spectacular performance. The Wilshire tucs index, which tracks the performance of 1,200 U.S. foundations and endowments, grew by a median annual rate of only 9.7 percent over that same time frame.
Logically Meyer should have been celebrated. By providing such incredible returns he made the Harvard community richer, providing funding for infrastructure investments, increased student aid and the hiring of more professors. Instead Meyer and his coworkers were demonized for receiving excessive compensation for their efforts:
In droves, the best portfolio managers started to leave Harvard Management Company. For most of them, the issue was money, pure and simple. Under Meyer, what Harvard paid his people was based on performance—in most cases, about 10 percent of what they made for the university. As the endowment got bigger, their incentive bonuses got bigger, too. And before long, the (mostly) men at Harvard Management Company were by far out-earning any administrator or professor at the university they were working for.

Jon Jacobson, aged 34, was Harvard’s top earner in 1995. He made $6 million that year, roughly 25 times more than the university’s then president, Neil Rudenstine. Two years later, in 1997, Jacobson, a former trader at Shearson Lehman Brothers, made $7.6 million. By 1998, Jacobson was making $10.2 million.

Resentment followed. At first, articles criticizing Harvard’s well-paid or overpaid money managers were limited to The Harvard Crimson and The Boston Globe. Then The Wall Street Journal got its hands on the story. Soon after that, in 1998, and backed by $500 million of seed capital from Harvard’s endowment, Jacobson quit to start his own hedge fund; no one had to know how much money he was earning.

Complaints about excessive compensation at Harvard Management Company gathered force, like an avalanche or a mudslide. By the early 2000s, Harvard’s top moneymen were making as much as $30 million to $40 million a year. Finally, in 2003, seven members of Harvard’s class of 1969 wrote a strong letter of protest to the university’s president, Larry Summers. They spoke out loudly, publicly, informing any member of the media who would listen that compensation at Harvard Management Company was “obscene.”

...Under Jack Meyer, making money was the sole objective of Harvard Management Company. That was its job. Located in a modern skyscraper in downtown Boston, well insulated from Harvard’s right-thinking campus, on the other side of the river, Harvard Management Company resembled a typical Wall Street trading floor. That its portfolio managers were being paid according to the rules of Wall Street should have surprised no one.

In response to the growing protests about “obscene” compensation, Meyer tried to reason with the Harvard community. If Harvard were to outsource its portfolio to various hedge funds, instead of managing its money in-house, he argued, the fees would amount to at least twice what he paid his traders. The end justified the means: consider the billions of dollars that his team was earning for the university!

Meyer’s pragmatic line of reasoning was ignored. Meanwhile, more of his best people left in disgust. “You get to the point where you just don’t want the ugly calls or the press coverage,” I was told by one of Meyer’s former portfolio managers. “I just said enough’s enough.”
What followed next was eminently predictable:
By 2005, Jack Meyer had had enough. After 15 years at Harvard Management Company, frustrated by the circular fights about compensation, and sick of justifying himself to Summers and Rubin, he walked out and started his own giant hedge fund. Shamelessly, he took many of Harvard Management Company’s best people with him, about 30 portfolio managers and traders, along with the chief risk officer, chief operating officer, and chief technology officer. Harvard’s trading floor was decimated. It was “like a Ferrari without the engine,” I was told by a portfolio manager who arrived after Meyer left. Rubin, for one, was furious, according to someone who knows him well: “In Rubin’s opinion, Meyer crippled the institution.”
If you punish success you'll get less of it. Envy has no place in setting policy. These are lessons not just for Harvard but society at large.

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