Not So Well Endowed

Read this article, then read below:

Reuters: 9/10/09

In case you did not read the article that I just told you to read, here is a summary:

"Harvard and Yale, America's two richest universities, said on Thursday their endowments lost roughly 30 percent of their value last year, showing how severely the financial crisis battered even the world's best managers."

Does anything seem wrong with this statement? Let me assist. There is no way an endowment fund should lose 30% of its portfolio in any given year. Let me say this again, an endowment fund (think similar thoughts for pension funds, retirement funds, college trusts, or any other fiduciary account) should never lose 30% in any given year. If this does happen, the people managing the fund should be fired and they should be investigated for dereliction of fiduciary duties. What is a fiduciary relationship? According to the legal definition, a fiduciary obligation exists whenever the relationship with the client involves a special trust, confidence, and reliance on ithe fiduciary to exercise his discretion or expertise in acting for the client. In this case the university, and ultimately the students, are the clients. Why should this matter? Because what I am indirectly saying is that they are gambling your money. Sound familiar?

Not convinced that they were gambling college funds?

"In recent years Harvard and Yale invested heavily in hedge funds, private equity funds and timber, relying on these alternative asset classes to add billions to their endowments."

or

"Additionally, Harvard is reducing its exposure to real assets, such as real estate, timber and commodities, and is investing its future commitments in private equity funds and other investment funds. Harvard will also have a bigger cash buffer, keeping roughly 2 percent of the portfolio, instead of having it fully invested."

Think about the fact that none of the endowment fund was being held in cash or ultra short-term securities. Also, consider the sheer size of the investments held in private equities, real estate, and other illiquid assets. These kinds of investments can not be bought and sold on short notice, nor is there a daily market price. Essentially what those "smart people" at Harvard and Yale were doing were acting like they were Wall St. investment bankers rather than professionals hired to safeguard university assets. There is no other way to put it; they were in breach of their fiduciary responsibilities. That is criminal, literally.

What is most disturbing about reading an article like this is that the article is completely missing the point. In fact, the article actually gives some support to the fund managers' behavior by citing how the funds' performance have historically been above market average. These funds should never have above market average returns since that implies that they are riskier than the markets themselves. These funds should be boring in their approach to investments and should focus on preservation of principal.

The role of journalism is to ask why things are the way they are and not to roll over and say, "Those smart guys lost money, so I don't feel so bad about losing mine." Does anyone perhaps think that we as a country should start actually taking a step back from our most basic assumptions and think, "Wait a second, are these people really that smart after all?" Probably, the more pertinent question is how do my incentives align with the incentives of the people managing my money? This is especially relevant here, since in reality these people were criminally negligent, but were rewarded for taking huge risks. The scary thing is that the same can be said about virtually every pension fund in America, government or otherwise.

The bottom line is that the only thing that should be shocking about this article is that nothing is being done to prevent this exact behavior in the future. When this does happen again, please just read this article again.