UPDATED: May 24, 2017 at 2:13 p.m.

It was five nights before Christmas and anything but quiet at Harvard Management Company. Earlier in December, N.P. Narvekar had taken the reigns of the University’s investment arm, which manages Harvard’s $35.7 billion endowment.

Narvekar had come to Harvard from Columbia in an effort to restore the performance of the world’s largest endowment, which had lost almost $2 billion in value in fiscal year 2016. Administrators and outside observers questioned whether Harvard’s “hybrid” investment model—a combination of internal and external money management—was still viable after years of underperformance at HMC. Still others wondered if the HMC workplace culture—characterized as “lazy,” “fat,” and “stupid” in a McKinsey & Company review— needed change after years of executive turnover. University budgets were increasingly strained under the burden of lackluster returns.

Still, the holiday season was in full swing, and HMC’s 250 employees were preparing to enjoy a black-tie winter gala on January 6, an event that the unusually large staff enjoyed every year. But with his task ahead of him, Narvekar had little interest in yuletide festivities. Just fifteen days into his tenure as HMC’s chief executive, Narvekar sent an email to his employees: the annual party would be postponed.

“This planning work is our highest priority for the coming weeks and months, and will be our primary focus,” wrote Narvekar and Chief Operating Officer Robert A. Ettl.

Within weeks, Narvekar had made his list and checked it twice. He announced later in January that the firm would be laying off half of HMC’s staff in the most dramatic restructuring of how Harvard invests its money in decades.

While it may be years before Narvekar’s overhaul could begin to shape the firm’s investment performance, they aim to address a number of factors that experts and some former employees say held back Harvard’s endowment performance for years—whether it be HMC’s internal compensation structure, portfolio distribution, or executive turnover.

A Radical Plan

Unless Narvekar abruptly jumps ship, he is slated to remain at the helm of HMC for at least the next three years—and the University will pay him nearly $6 million per year to do so.

Narvekar has his work cut out for him. Across the market in fiscal year 2016, educational investors saw their investments flounder, according to an annual report which aggregates endowment return data from universities across the country. This year’s report said what many already knew to be the case: besides a few stand-out investment offices, most universities experienced sharp declines in investment revenue as they doled out more money from their endowments to fund operating budgets.

And Harvard, once again, found itself in what was becoming an all-too-familiar position: far behind Yale.

Harvard’s endowment plunged as HMC returned negative two percent on its investments. That same year, Yale returned a positive 3.4 percent. Fiscal year 2016’s poor returns are the latest in a decade of “challenging” investments returns for the firm, according to the 2015 annual endowment report.

To some, Narvekar and his changes could not come quickly enough. In a sharp turn from the firm’s long-held “hybrid model”—in which HMC employed both internal and external money managers—Narvekar intends to gut many of the firm’s internally managed teams and outsource to non-HMC managers, aligning the University’s investment strategy more closely with peer institutions like Yale and Columbia.

While at least one team—natural resources—will remain in-house, a number of investment managers at the firm will spin off to form their own hedge funds, some of which Harvard may retain to manage its money.

In doing so, it’s likely the University will incur higher fees—generally, external managers cost more than internal staff—but the elimination of over 100 internal staffers might mitigate those financial pressures.

In his announcement, Narvekar also outlined a radically different vision for the firm’s investment strategy. He would transition HMC from a “silo investing” approach to a more “generalist” model, outsourcing the firm’s assets to external managers,

Silo investing refers to a practice where portfolio managers in a fund focus almost exclusively on generating returns for the asset classes they are responsible for. While those assets may flourish on an individual basis, Narvekar wrote, the health of the overall endowment can erode in the absence of a cross-team approach.

“I think his strategy makes sense,” said Timothy J. Keating, the president of Keating Wealth Management, said of the generalist approach. “And the issue is, at the end of the day, there’s one overall performance figure for the Harvard endowment, and I think what Narvekar was doing was saying there’s one bottom line.”

In the months since Narvekar’s announcement, the firm has also made smaller changes to its strategy. According to reports in Bloomberg and Axios, HMC is moving to sell off around $2.5 billion in private equity, real estate, and venture capital—all risky, illiquid assets. The move stymies the predictions of some experts: Narvekar himself specializes in such alternative assets.

A New Edge

Despite the major changes that have rocked HMC in the past few months, some experts and former employees say there is more that can be done to salvage the fund’s performance.

One employee who left HMC in 2014, whom the Crimson granted anonymity because he is not permitted to talk about his former employer, said that the firm’s trend towards a more risk-averse investment strategy—away from illiquid assets like private equity—has hurt its performance.

“I think a big drag on performance—the endowment went into the financial crisis 10 percent over-leveraged, and came out of the crisis very risk averse, underleveraged,” he said. “As a long term investor, as the market is selling up and recovering, you should be adding in more risk, not scaling back because you’re afraid.”

Keating also raised doubts about whether the move to external managers will close the gap between Harvard and its peer investors, arguing that Yale’s lifelong approach to external management means it has established steady relationships with its external money managers.

“Yale, relative to smaller endowments or pensions, has the internal resources to analyze and work with these managers,” Keating said. “Harvard also has that capacity, but it’s gone in a different direction.”

More broadly, Keating said, if Harvard is taking its cues from Yale—and many experts say its actions so far indicate that it is—it will lose out in the endowment game.

“I think for Harvard to try and replicate what Yale is doing today would not make sense for me, and I think the main reason is that the asset classes that Yale has made a lot of money for over time, I believe [Yale’s] heyday is over for a variety of reasons,” Keating said. “That’s why I think Harvard would be better served to have the core of the portfolio be passively managed.”

Unlike Harvard, small institutional investors often use passive management to increase returns, focusing on low-risk index funds instead of high-cost hedge funds or alternative assets. Notably, renowned investor Warren Buffett has been a vocal supporter of the strategy, arguing even large institutional investors should adopt it.

Yale, however, uses active management, and wrote a vigorous defense of the tactic in its annual endowment report in April, arguing it would not produce better returns under a passive management model.

“Such strategies make sense for organizations lacking the resources and capabilities to pursue successful active management programs, a group that arguably includes a substantial majority of endowments and foundations,” the report reads. “While passive investment strategies result in low fee payments, an index approach to managing the University’s Endowment would shortchange Yale’s students, faculty, and staff, now and for generations to come.”

Ben Carlson, a financial analyst, argues the key in improving performance at any institutional endowment is simplifying investment portfolios, not passive management. In an article for his site, Carlson described a three-fund portfolio that outpaced the returns of most schools that use the Yale Model—which is a complicated portfolio—consistently across ten years.

“This has nothing to do with active vs. passive investing. This is all about simple vs. complex, operationally efficient investment programs vs. operationally inefficient investment programs and high-probability portfolios vs. low-probability portfolios,” Carlson wrote.

Culture Wars

Investment strategy may not be the only in-house factor affecting endowment performance: some argue the culture at the firm could also be stunting its progress.

While details about the firm’s internal culture are scarce, a 2015 report by McKinsey & Company obtained by Bloomberg provided a rare glimpse into the interior of Harvard’s investment arm.

The takeaways were, for many, at HMC disconcerting: In McKinsey's 78-page PowerPoint, employees labeled the investment firm, “lazy,” “fat,” and “stupid,” centered on “stable, rather than smart, capital.”

The former HMC employee said he disagreed with the McKinsey report’s characterization of HMC’s culture, arguing that the report and subsequent news articles unfairly ignored positive aspects of the firm.

HMC is housed at the Federal Reserve Bank in Boston. By Zorigoo Tugsbayar

But to some executives, the report hit home. It described a “performance paradox”: while the endowment posted poor returns, managers consistently hit their internal benchmarks and were compensated accordingly.

The debate about compensation has raged since Jack Meyer—HMC’s CEO from 1990 to 2005, once the darling of the higher education investment world—left the firm after enduring intense public scrutiny over how much he and his top managers were paid.

“When Jack Meyer left, that’s really when our volatility started,” Keating said.

Over Meyer’s tenure, alumni and financial experts regularly and publicly questioned what they believed to be unnecessarily exorbitant compensation packages at the firm. Two top-paid bond managers at HMC in fiscal year 2003, for example, each pulled in $34.1 million and $35.1 million, respectively.

In 2004, under pressure from alumni, the University placed a “significant cap” on executive salaries. Meyer departed shortly afterwards, taking four of the firm’s top executives with him.

While HMC’s top managers are still paid highly—former HMC CEO Stephen Blyth, Narvekar’s predecessor, received $14.8 million in 2015—the firm has publicly acknowledged a need to revise its compensation packages.

In November 2016, a cohort of alumni from the Class of 1969 sent a letter to the University excoriating HMC for paying its executives so much while the endowment flatlined—the same paradox the McKinsey report pointed out. University’s Treasurer Paul J. Finnegan did not respond directly to the group’s concerns about the overall level of compensation, but starting in 2017, HMC began to tie a greater share of compensation to the fund’s overall performance. Current and former managers also forfeited pay that was held back in previous years.

An Uncertain Future

A lot has happened in the roughly six months since Narvekar came to Cambridge, and while most experts can only offer vague predictions of how HMC’s fiscal year 2017 returns will turn out—those results will come out in September—University officials are hopeful.

Thomas J. Hollister, the University’s Chief Financial Officer, said in an interview that “the stock market is up so far this year,” calling it a “good indicator” of what this year’s investment landscape might look like.

Financial executive headhunter Charles A. Skorina, though, cautioned against expecting changes in the investment office to necessarily reap high returns.

“The markets go up and down, opportunities change, you have boom times and bust times, so no matter how good they stand, you will have times that you perform less well than other times,” he said.

Narvekar has the confidence of some of Harvard’s highest administrators. University President Drew G. Faust has repeatedly praised the new CEO, and the powerhouse private equity manager David Rubenstein—the newest member of the Harvard Corporation, the University’s highest governing body—said Harvard is confronting the problems of its past head-on.

“There’s clearly been some challenges for all university endowments in the current situation, but Harvard’s now dealing with it directly and it’s obviously more challenging managing an endowment as large as Harvard’s and as visible as Harvard’s,” Rubenstein said.

Rubenstein runs one of the largest global alternative asset management firms in the world, which manages about $162 billion in assets. In an interview, he said he was confident in Narvekar’s ability to put HMC back on track.

“The Harvard Management Company has a new person running it who’s a very very talented person, so I wouldn’t presume I’m going to help him all that much,” Rubenstein said. “I’m obviously happy to give advice if asked, but I think they’re in pretty good shape. They don’t need my advice.”