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It's a university, not a hedge fund

October 24, 2009

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FROM THE outside, Harvard’s endowment, which once approached $37 billion, would seem to insulate the nation’s richest university from the cruelties of a global economic downturn. Instead, the university has been using its assets - and the Harvard Management Company, the unit that invests them - in ways that only magnify the pain. The school’s recent troubles show that Wall Street traders aren’t the only ones who were done in by an excess of cleverness; so, too, were Harvard money managers who emulated them.

The university should rethink its strategy. When Harvard stumbles, the pain radiates throughout Greater Boston.

Instead of relying on conservative investments, Harvard Management has taken a higher-risk approach that, over the last five years, has yielded returns more than twice as large as those of the typical large nonprofit institutional investor. But because Harvard’s operating budget relies heavily on income from its endowment, the university was caught short when that endowment plummeted to $26 billion by June. Worse still, the university also lost $1.8 billion from its cash portfolio - some of which pays for operating expenses - by entrusting it to Harvard Management rather than socking it away in more conservative investments.

Even when this approach works, it can accustom the university to an unsustainable level of spending in good times. And downturns are disastrous: Over the winter, instead of pushing ahead with a science complex in Allston, Harvard announced a slowdown and had to borrow $1.5 billion to keep up with its obligations.

This isn’t just Harvard’s problem. As university president Drew Gilpin Faust noted in comments to the Greater Boston Chamber of Commerce Thursday, Harvard also employs tens of thousands of people - both directly and through the suppliers from which it buys goods and services. Meanwhile, the turnabout on the science complex created uncertainty for an entire neighborhood. Completion of the project will transform Allston, where Harvard owns much of the land, but an indefinite delay would leave the neighborhood in limbo.

University officials are clearly chastened. In her speech, Faust acknowledged that Harvard had suffered because it couldn’t call back assets overseen by external managers. More investments will be managed internally. To its credit, Harvard Management’s pay structure allows for “clawing back’’ bonuses for employees when their choices end up hurting the university.

Harvard, with vast resources at its disposal, will always need a more sophisticated financial approach than the average household. But a university can’t base its finances on the assumption that its investment returns will be spectacular year after year. Harvard should seek greater stability for itself and all those who depend on it.

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