Busy With Harvard's Billions

Each day at the Boston offices of the Harvard Management Company (HMC), Harvard's seventh-floor trading room shakes with activity as a staff of investors scrambles to keep the University's wealth growing.

With Dow Jones tickers clicking outside and electronic monitors spewing stock quotes, the traders follow the progress of different companies on computer screens, occasionally calling outside investment firms on their bank of phone lines.

"That tends to be sort of a noisy, feverish, high-pitched, somewhat of an emotional climate," says Walter M. Cabot '55, president of the company. The staff's favorite football team is the Los Angeles Raiders, and black-and-silver caps dot the heads of investors, some of whom take advantage of a nearby Nerf basketball hoop to burn off the tension.

Harvard's billions are safe for another day.

It used to be that a University could simply lay its endowment into bonds or a few good blue-chip stocks, and Harvard was no exception. But during the last decade, investing has become a frenzied, anxious business, and the potential for overnight disaster strikes most acutely at institutions like Harvard that rely on their endowment to provide much of their income.

Fortunes and blowouts that used to build up over years now happen in months and weeks. And to the old investing choice among stocks, bonds and "cash"--certificates of deposit and other short-term instruments--have been added dozens of new securities which are traded many different ways.

Harvard's way of insuring a permanent source of income while being able to capitalize on ephemeral opportunities came in 1974, with the establishment of the Management Company. Harvard is almost unique in having its own in-house investment team; the University of Texas and University of California systems both manage their endowments through state-affiliated committees, and Columbia and Rochester are the only other major private universities that do their own investing.

What sets Harvard apart in endowment management, investors say, is its degree of sophistication. The Management Company is a $6 million-a-year operation employing a staff of 90, keeping 88 percent of Harvard's $2.5 billion endowment. Lately HMC has moved into risky areas where universities never dared trod--venture capital, stock options and futures, complex bond arbitrage operations--and has even pioneered a scenario (called "stock lending") where it lends short-term securities like bonds to private investors. Harvard takes the cash those investors pay and deposits it at market rates of return--a double-edged way of boosting endowment by having money in the bank and bonds to cash in later. In addition, Harvard has begun assembling a full-time research and analysis team under John R. Chase '50, a former portfolio manager.

Cabot, who has headed the operation since its founding, says that despite these initiatives, the company remains deeply aware of how critical endowment income is to Harvard and also of how administrators' peace of mind depends on a lack of volatility in the endowment. "The President and trustees get upset if the market value is up and down and up and down. They're human beings--you know, they'll say, 'I don't like this kind of stuff,'" he notes.

Still, Cabot says he's no wimp about investing. "I am not going to be like a typical trust officer in a bank who says, 'No decision is the best decision--don't ever take a risk.' We are in the business of making money for Harvard, and therefore we are risk takers, but we are risk takers within an overall prudent environment."

That prudent environment derives from a few simple principles: first, that the endowment income is "to equally benefit today's generation of students as well as tomorrow's. I can't make you guys so rich that the guys who follow you 10 years from now don't have anything," Cabot says.

Harvard also wants a real return above inflation. Putting up buildings, luring scholars to the Faculty, and continuing a policy of aid-blind admissions demands that income rise faster than prices. And finally, some of the Crimson pride goes into endowment management: "We want to do competitively well relative to, say, 10 other major institutions," Cabot says.

Harvard has generally stayed ahead of the market, with sluggish years balancing out against booms. Since 1973, the endowment has grown by more than 10 percent in five of 11 years; Harvard took a fall in 1973 when it lost 10.1 percent, but last year the University registered its most lucrative year ever--riding the bull market of 1982. Harvard scored $700 million in gains, boosting the endowment to $2.4 billion, the highest in the nation.

What has happened since June, 1982 exemplifies the new interventionist brand of money management at Harvard. HMC had shifted heavily into stocks (at one point, almost 80 percent of the endowment was in stocks). But last December, accurately sensing an imminent tumble in the market, the company took a $300 million slug out of equities and put it into bonds, and rearranged stock holdings to include more health care and small technology companies. These two industries proved to be the only sectors rising at all in a sleepy market.

But last week reports showed that Harvard's endowment had dropped about $150 million, as some of those same computer and health care issues fell.

That heady up-and-down action reveals how intense an environment the Management Company has become over the last few years, as more and more specialized investment work is done in-house. The few areas where Harvard uses outside managers include $230 million in venture capital and $170 million in outside investment advisory--where HMC can reap both profits and knowledge from private investors. About $70 million stays in "contrary investing"--depressed or out-of-fashion stocks which managers think have bright futures; two smaller pieces--$26 million in international securities and $16 million entrusted in a new computer trading technique--are also done on the outside.

On a given day, the company has somewhere near two-and-a-quarter billion dollars to handle. The early workers come in to work around 8 a.m. to feel out what has been brewing in the London markets and what they mean for Harvard's money. Later, with newsletters and The Wall Street Journal read, the full investment staff--traders, portfolio managers, fixed-income managers and researchers--meet at 9:30 for a half-hour of quick reports.

Twice a week the group, which includes from 15 to 25 people on a given day, splits up and starts the nitty-gritty; three days the group will stay until about 10:30 discussing a specific topic, such as a company's stock to be bought or sold. Most of the staff, though, enjoys quieter days: researching, meeting with visiting representatives of companies, and occasionally visiting the trading pit to follow the progress of a buying or selling program. While everyone at HMC juggles several projects at once, Cabot says, "everything we do leads up to some kind of decision. Everything is goal-or decision-oriented."

The company's different businesses flow at separate paces. Harvard's stock holdings tend to turn over at the rate of about 25 percent a year, while bond holdings rotate as many as four times in a given 12-month period. Down on the fourth floor, Harvard's trust and gift department, headed by Assistant Treasurer Henry J. Ameral, deals with the 10 or 12 real estate-oriented gifts that come in each month, like individual houses, plots of land or shares in a building. Almost all of it gets appraised and sold. The private placement department, which handles Harvard's holdings in different real estate trusts, buildings and shopping centers, makes only one deal every two or three months--but it will turn over $20 million at a crack.

The most frenetic dealing comes in financial futures and options--commitments to buy or sell a stock on a given future date for a given price. While turnover in options is huge, Cabot says, "it's not a strategic change, but looking for noise within the strategy, finding opportunities, looking for something that is mispriced."

Most other universities don't deal with this. Princeton, which with $1.26 billion has the third largest endowment in the country, uses seven outside managers, who occasionally report to the five-person investment committee of Princeton's 30-member board of trustees.

The New Jersey school keeps secret how much each manager has and how well each is doing, and doesn't let the seven interact. About 60 percent of the portfolio is in stocks, and the managers come from as far away as Pasadena, Calif, and Boston. Princeton has done the best of the major universities over the last five years, with an annual average growth of about 19 percent.

The number two university for endowment, Texas, is in the unique position of being able to capitalize hugely on the next energy crisis as it did in 1979 and 1973. About 75 years ago the university received 2 million acres of scrub land in 19 west Texas counties--which no one expected to one day become America's version of Kuwait.

Texas, and Texas A & M, which gets one-third of the revenue on oil, gas, sulfur, and water from the land, make money in a roundabout, tricky way. Last year $176 million came into Texas's $2.3 billion endowment from the fields, but all the income from the principal of the endowment was spent. W.L. Lobb, who oversees Texas's endowment, says that all endowment income gets spent each year paying off old bond issues the universities have taken out for construction and operations.

Once the land income comes into the account, a 1956 state law tightly restricts how it will be invested. The state treasurer is custodian of the fund, and not more than I percent of the total can be invested in any single company. Texas also can't invest in stocks that don't have a five-year dividend record, which bans venture capital and real estate. Last year the endowment for the 14-branch Texas system grew a modest $176 million, a far cry from Harvard's 42 percent increase.

Across town, Boston University pursues a far more risky--and, of late, very rewarding--investment policy. With only $100 million of endowment, BU can invest more aggressively than Harvard, because endowment income only makes up I percent of the yearly budget. If they lost it all, income could easily be made up elsewhere.

With three outside managers overseen by an investment committee, the college enjoyed a 70.3 percent increase in 1982-3, according to BU official Patricia A. Doyle. That was the number three performance in the nation, and BU's three- and five-year records are the top in the country, according to a study by the Dartmouth-based National Association of Colleges and University Business Offices.

Historically, Harvard has always been on the vanguard of endowment management. Paul C. Cabot '21, a tough, profane Brahmin and the uncle of Walter Cabot, served as Harvard's treasurer from 1948 to 1965 and quintupled the endowment. He demanded complete discretion in managing Harvard's money, arguing that you can't invest by committee. Cabot shifted more than half of the endowment out of downtown Boston real-estate and high-grade bonds, and into common stocks--considered, at the time, a radically new strategy for a private university.

In 1965, Cabot passed on guardianship of Harvard's endowment to his colleague at State Street Management. George Bennett '33. State Street, under whose aegis Cabot manipulated Harvard's money, had enjoyed awesome success--a dollar put in that firm's main mutual fund in 1924 would have grown to $100 by 1980.

George Putnam Jr. '49, himself the head of a huge 17-component group of Boston mutual funds, became treasurer in 1973--conspicuously, appointed by the same search committee he had chaired as a member of the Board of Overseers Putnam will step down on June 30 from his post, and the biggest feather he can put in his cap is the creation of the Management Company.

Putnam's imprimatur is clearly evident in the makeup of the company--four of the original 10 partners came from Putnam Management, including Cabot, who got his seven year apprenticeship there after graduating from the Business School 1959. He then left Putnam for a seven year stint at the Wellington Management Company as senior investment officer and managing director.

Cabot says that while Putnam's day-to-day role at HMC has never been substantial and has further dwindled as his retirement draws near, as chairman of the company's board, "he was always available to me in terms of if I wanted to try new strategies or had personnel questions. He was a sounding board for me, and he had a response much more of an oversight role as contrasted to any day-to-day decision making."

But, Cabot adds, "there have been from time to time particular investments where I have sought out a little more than his advice--kind of his O.K." Those moves include certain real estate deals and Harvard's entrance into venture capital.

Perhaps the most important new ingredient in the management recipe during Cabot's tenure has been growing concern about Harvard's $440 million of investments in companies that do business in South Africa, and investments in companies that make components of nuclear weapons.

While reluctant to detail his own criticisms of divestiture as a means of changing companies' behavior, Cabot says he would be hamstrung if Harvard imposed a ban on South Africa-related investments.

"No company is sort of 100 percent a bad company," he says. "No company is even 50 percent a bad company, and that's the issue you run into with most corporations. What do you do with a company that's 90 percent good and 10 percent bad? Where do you draw the line?"

"My attitude in life is that it's a very imperfect world, and I don't see that it's Harvard's role to be overly moralist," Cabot says, adding that the more Harvard is confined in terms of what companies it can invest in, the lower he feels return on endowment will be--and the less money for scholarships, faculty salaries, and construction there will be.

But Cabot also says he, feels moral considerations should be an issue in investing. "Good, clean managements and management practices will make better companies and better stocks. I guess I bring my own value orientation into the process," he explains.

For instance, Harvard does not invest in combing companies, Cabot says, mostly because he says he doesn't understand them as investments and since "I guess I also have some attitude above gambling companies."

Because of Harvard's prestige, and nobel concern about what happens to the gifts they make to the University, Harvard Management Company's moves have always borne more scrutiny than those of other schools. And money managers around the country voice general approval of the company, with only some reservations.

"My impression is that they do a very good job and have a very first-class reputation," says John Q. Adams '45, a manager with the John Hanccoi Life Insurance Company. "Harvard has never had influential groups complaining about its excellent performance--my impression is that it's exactly the opposite."

"It's a very effectively run enterprise," agrees Robert A. Lawrence, a State Street manager who has served on Wellesley College's board of trustees along with Cabot and Putnam. "It's made a lot of sense for Harvard, because Harvard's endowment is so large that the expense for an in-house management company makes it very competitive."

BU's Doyle says that while "their people are very good, the disadvantage is that it doesn't suffer from competition. There's always an advantage to having clients that choose you because you're the best there is."

While HMC is a "captive" organization, in that it only serves one customer, Cabot says Harvard likes to keep some money out of the system to keep HMC's wits sharp. And at just over $6 million a year, including handsome compensation of more than $250,000 for Cabot, experts say Harvard ends up paying a much lower fee for money management relative to its account than most anyone else.

As to the future, Cabot sees HMC becoming more able to handle new kinds of complex investments, high-pressure and professional. "The whole level of intensity has significantly picked up in this enterprise. I don't want you to infer that we were sort of a country club before, but it's just that the general nature of competition has forced this organization--just like every other one--to hire better people, to focus better people on topics and to push them a little harder," he says.

Cabot says the expansion of HMC to 90 staffers promises, in the long run, more money for Harvard. "We are running our affairs better today, we have a higher level of discussion, than I think we've ever had before. The general level of quality of input can only reflect, hopefully, in better results."