Size Matters: Endowment Troubles Traced to Venture Capital

Before the completion of Harvard's massive Capital Campaign took center stage last week, the University's fundraising machine released a bit of bad news.

Harvard's endowment failed to reach its targets for growth in fiscal 1999, the University said last month.

Harvard's endowment ended last fiscal year--which began July 1, 1998--seven percentage points below targets set at the beginning of the year. It was the first time in six years that University fell below its targets for financial growth.

Its growth rate of 12.2 percent was down from Harvard's average of 20.1 percent over the last five years. But the world's richest university isn't hitting the panic button yet.

First of all, at $14.4 billion the University's endowment is nearly double that of its closest competitors--including the University of Texas system and Yale University.

And part of Harvard's problem last year was that it simply had too much money. Venture capital firms, which returned some of the highest profits for investors last year, often cap the amount any one institution can invest in them.

So Harvard was stymied from investing as large a percentage of its billions as it would have liked in this area, while other schools with less to spend got proportionally more of their money into venture capital.

But even so, University investors say they're confident of increasing returns on the endowment down the road, through investments in uncapped second-tier venture capital firms.

Venture Capital Problems

Harvard's Vice President for Finance Elizabeth C. "Beppie" Huidekoper says Harvard's problems with venture capital stem from a quirk of the financial world.

Venture capital funds provide money to new companies. In recent years, with the advent of hot new markets like the Internet, venture capital funds have become increasingly popular. Venture capitalists have begun limiting to make sure large corporations don't dominate.

Within venture capital, caps on the highest-paying funds mean that big investors and smaller investors often put about the same amount of money into a given fund.

So Harvard was prevented from taking the bull market by its horns. It had planned to put 15 percent of its investments in venture capital, but ended up on investing ten percent, according to Harvard Management Company President Jack R. Meyer.

Huidekoper says this problem with under-representation is similar to the problem populous states like California would face in the federal government if there were no House of Representatives.

"It's a little bit like there's only [the] Senate," she says.

So with twice the money in its coffers but the same amount in dollars invested in venture capital as other schools, Harvard feels the benefit of these lucrative funds, which paid off 136 percent in 1999, in a proportionally smaller way.

According to Huidekoper, the extra money Harvard could not put into venture capital was invested elsewhere.

According to Harvard Management Company (HMC) President Jack Meyer, with venture capital returns hitting triple digits this year, this capping problem became more important than ever before.

HMC can circumvent the problem by investing the leftover money in second-tier venture capital funds, which are less likely to be capped but may not be as lucrative.

"We will look for new groups with people who are a little bit less experienced," Meyer says. "We may look for secondary funds to get this exposure."

The Big Picture

But Harvard's endowment success doesn't rest entirely on venture capital. Most of its investments are in other areas, including real estate, stocks and bonds.

These don't produce the spectacular numbers of venture-capital investments, but over the long term they're far less risky.

This year, in fact, investments in these areas made up for some of the under-performance in venture capital.

Even though venture capital was a problem this year, the overall return of 12.2 percent was more than 10 percent above the inflation rate, according to HMC.

"Our long-term goal is inflation plus 6 to 6.5 percent," Huidekoper says. "So we absolutely met our goal."

"The problem we had in 1999 is sort of overwhelmed by our other numbers, and it turned out just fine," Meyer says.

With investments in these areas still producing steadily, Meyer said in a September letter from HMC to "friends of Harvard" that according to a five-year timetable, Harvard is still "on target."

With extremely high yields in recent years and a campaign that pumped over $2.2 billion into the University's coffers, Harvard is still the richest it's ever been.

"Fortunately, the strong results of recent years have provided a cushion against the inevitable rainy days, weeks, or even years that may lie ahead," Meyer says.