Harvard's Changing Financial Family

Last year, when George Putnam '49 took over as Harvard's new treasurer, his first job was to carefully study the way that Harvard's money had been managed in the past and to figure out the best way to manage it in the future.

As Putnam and President Bok saw it, there were three basic alternatives for Harvard's $1.4 billion endowment:

* Continue the present system having one outside investment firm manage the day-to-day investment operation and report periodically to the Corporation;

* I Give part of the endowment to several different investment firms and encourage them to compete to produce the highest possible annual return; or,

* Establish an internal investment management company or department to handle all, or most of the endowment within the Corporation itself.

When he first began to consider the three alternatives, Putnam said he was leaning to the second alternative, but that he would carefully study all of them before making his recommendations to Bok and the Corporation. But in the course of a meeting with over 40 university financial managers and money men from almost every major foundation or pension fund--all of whom had a slightly different blend of the three alternatives--Putnam became intrigued with the idea of setting up an internal management company for Harvard. The idea was a novel one for universities and the possibilities for management innovation that internal management posed were unique for any large endowment.

So last fall, Putnam recommended to the Corporation that Harvard set up its own independent management company to handle most of the endowment and that the rest be divided up among several specially-selected outside firms. The decision to keep about one-third of the portfolio with outside managers resulted from a combination of factors that Putnam considered. First, President Bok expressed a very strong preference for not keeping "all of the University's eggs in one basket." Second, Putnam and Bok wanted to ensure that the University maintained close contact and good public relations with the financial world. But most important, they both saw that outside firms could offer the new management company a great deal of help and advice and provide a yardstick for some indication of how the new management company was doing its job.

The Corporation liked the idea and in the fall, Harvard announced that it would establish the Harvard Management Co. to take over $1 billion of the $1.4 billion endowment on July 1. Putnam's next job was to find someone to head the new company and to locate office space in Boston's financial district.

In February, Putnam announced that Walter M. Cabot '55 would become Harvard Management's first president on April 1. With that announcement and the locating of physical space for the company at 70 Federal St., Putnam's direct role in the company's affairs ended.

At that time, changes from the previous era of State Street Research and Management Co. began to surface. Bok, Putnam and Cabot--who is the nephew of former treasurer Paul C. Cabot '21--are part of a new generation in Harvard financial affairs. As such they are now more daring and interested in innovation than their predecessors at State Street. When Cabot was named, it became apparent that the younger generation was preparing to embark on some bold new ideas for financial management.

Putnam and Cabot began discussing the interchange the new management company would have with the several outside firms managing the rest of the portfolio. They expanded the idea that these companies could help Harvard Management get off its feet into a broader concept of a symbiotic relationship among all of the outside firms and Harvard Management.

The idea of choosing firms on the basis not only of the rate of return they can produce for the portfolio, but also on the basis of the kind of help they can offer to the overall portfolio management is a strikingly new one in financial circles. Most outside managers assume they are going to be asked to compete one with another and with the main portfolio and ranked in the order of revenue they produce. This system of competition puts a great pressure on short-run investment policy because the companies are usually ranked against each other and those at the bottom are replaced, while those at the top get more of the institution's money.

Putnam and Cabot are concerned that such short-run pressure may actually be harmful in the long run and that therefore, the heavy emphasis on competition among different firms managing the same endowment may not be the hhalthiest policy for the University to follow. The concept of complementary relationships is in its experimental stage--only the Ford Foundation and Harvard, among major endowments, are currently playing with it--but Cabot and Putnam expect it to become more prevalent in the future. The Ford Foundation has studied the new idea carefully and kept records of the methods they have used in going about it that they have made available to Harvard. Harvard, too, is keeping the same kind of records to share with Princeton--which has already shown an interest--and other universities contemplating adopting the idea in the future.

Cabot will ask the outside firms Harvard Management selects to manage $400 million of Harvard's endowment to join in an informal partnership for the exchange of investment information.

He plans to hire a small staff of eight or ten professionals for his company, but to supplement them with information derived from the personnel and facilities of the outside managers.

"I think the annual ranking of competing managers puts an undue investment pressure on the portfolio for the short run. What I hope to do is find about five partners and say that as far as I'm concerned, ours is a marriage for life," Cabot says.

Harvard will review the companies' performances over a period of about three to five years or from market cycle to market cycle.

In return for the prestige of handling part of Harvard's portfolio, Cabot expects investment advice, economic computers, or whatever help the firms can offer to help increase the overall rate of return on Harvard's portfolio.

"I'm trying to get us all to not only look at our own piece of action, but to look at the whole piece of action--the total portfolio."

Some firms may not wish to divulge secrets of their money management. "Then the trade-off is whether their money management is just so good that I'm going to give up their help and get them into he club because they'll do an outstanding job, or I can find another company with equal or slightly less return willing to have a complementary relationship," Cabot says.

Now Harvard Management is going through the process of selecting the partners with whom Cabot can attempt to set up his experimental "marriage." When Harvard announced its intention to solicit outside managers in the fall, over 160 investment firms from all over the country expressed interest in getting a piece of Harvard's action. At the time, Putnam named George Sigular, James Bailey, and Paul Kuklinski, an outside consultant, to interview and narrow down the list of possible outside managers.

Most of the firms that expressed interest in handling Harvard money started off their letters in the traditional manner of any company seeking anything from Harvard: By listing their Harvard men, stressing their importance to the firm and then stressing the firm's importance to Harvard. So, Putnam and the search committee decided that they would grant an interview to every organization that requested one. They designed a very extensive questionnaire to send to all of the firms, intended partly to deter those not seriously interested and partially to allow the search committee to go into the interview with a reasonable amount of knowledge about each company.

Some firms realized that the scope of the job and relationship that Harvard is asking for just was not within their capability, but nearly 100 firms returned the questionnaire and requested an interview. Now the search committee is busily interviewing two firms a day in an effort to narrow the field down to about 15 as soon as possible. The target time for selecting the eventual firms to manage the $400 million segment of the endowment is July 1.

This massive effort to find four to seven outside firms has already begun to pay off for Cabot and his company because the applicants have shown a surprising variance of interest in the idea of a complementary relationship. Some of the more prestigious, big-name investment houses have not put forth as strong a presentation as the search committee had expected, while some of the lesser-known firms have made very impressive presentations.

Besides looking for firms willing to enter into a complementary relationship with Harvard Management, Cabot's group is looking for a great amount of diversity among the investment styles the firms follow and the type of management they specialize in.

Not all of the firms chosen will be concentrated in Boston and New York; nor will they all be experts in managing, for instance, growth stocks; nor will all be adherents to the Harvard Business School Gospel (amen). Cabot and Putnam still do not really know what style Harvard Management will follow in handling its $1 billion, so they would like to see as much diversity as possible among the firms that will be tapped as information sources for the internal company.

Cabot is also in the process of choosing the eight or ten professional staffers who will work under him. Cabot has already said that he will not allow himself nor any of his employees to sit on the board of directors of "any corporation in which there is any possibility that Harvard might invest," a sharp contrast to the practice of State Street's policy under Bennett.

"I don't care how many safeguards you set up, I see a basic conflict in holding a corporate directorship and maintaining the freedom to act and use information to make investment decisions about that company," Cabot says.

But Cabot also has other new plans for his staff. He insists that because his staff will be a small group, he wants to run it as a team operation. He says now he is considering doing away with all of the titles for each individual and instead having "partners" and "associates" in the firm.

"I don't want anyone thinking he or she is so important around here that we've got to listen to them. With only seven or eight people, we've got to pull together; we can't have a lot of stars. I hope to work on a committee decision-making process and within that have specific individual roles," Cabot says.

The company staff will probably include a fixed income expert, a short term investments handler, a bonds researcher, an equity trader and assistant, someone experienced in general portfolio management and a few research generalists. Cabot's search for his staff is just as expansive as the search for outside firms. He hopes to begin naming his new employees soon, however.

Just as his emphasis in the performance of outside managers will be a long-term one, Cabot does not expect his staff to shine immediately and fizzle out in their investment dealings. But at the same time, he acknowledges that the need to make changes in both internal staff and outside managers sometimes arises.

"One reason Harvard decided to set up its own company was that it didn't want to get into the tenure business. There is no tenure in the financial world. We'll look at everything over the longest possible term, but if changes must be made, they'll be made. I fully expect that Harvard will fire me if I don't do my job and that's the way it's got to be across the boards."

Cabot has also demonstrated that his company will be more aware of the social behavior of the corporations in which Harvard invests than its predecessors. he will steer the portfolio clear of companies such as Middle South Utilities that end up causing a great deal of trouble for the University and may in the long run cost the University money because they must pay for past misdeeds out of profits.

Although no great changes in investment policy will be noticeable when Cabot and Harvard Management Co. take over the endowment on July 1, the general attitude will probably be more daring and liberal than State Street's. It is likely that Cabot will stick with the present two-thirds, one-third balance presently between stocks and bonds. But the turnover rate amont stocks and securities may increase under Cabot and Harvard may experiment with small investments in emerging and venture capital.

The new guard in Harvard financial affairs still adhere basically to the traditional norms of financial management followed by the great money houses in New York and Boston. But their awareness to such problems as those of conflict-of-interest and corporate responsibility, their willingness to innovate and experiment and even leave traditional bounds, ensure that the new era of management Harvard has entered into will at least be an exciting one