The crash of Harvard’s endowment has, so far, been treated as a theoretical problem that won’t really affect that core institution. After all, Harvard’s endowment is so huge that it can withstand a big crash, right? Not necessarily. Eventually, the storms on the outside could crack the bubble of academia and the university might be put in a hard spot.
Over at Dealbook, the Steven M. Davidoff takes a close look at the universities finances and sees reason for concern:
Calculating the losses in year-end 2008, I estimate that Harvard’s total private equity portfolio declined 40 per cent to around $3 billion. I assign such a figure because I mark-it-to-market — and right now, these illiquid assets are hard to sell and even harder to price. In the long run, these investments may pan out, but for the short term, these private equity assets are at best mispriced.
Applying these calculations through the total endowment as of this date should give about $25.5 billion split with 23 per cent to 24 per cent in illiquid assets, or about $6 billion. For these purposes I have assumed that all of Harvard’s hedge fund holdings ($8.3 billion as of June 30, 2008) are liquid. This is unlikely because of the many hedge funds that have imposed lock-downs on capital withdrawal. And my aggregate number here is in line with the 30 per cent decline Harvard has stated it thinks should occur.
This is where the problem lies. Harvard pays out its endowment on a three-year basis. So for the next three years, I estimate it will still pay out on average about $1.5 billion. This may actually be low, as Harvard seeks to keep spending stable and help out colleges, such as the Harvard Divinity School, that rely heavily on the endowment.
Here’s where it gets messy. To make these payouts, Harvard has to draw down the liquid portion of its endowment, and Davidoff estimates that the illiquid portion will rise from 26% of the portfolio to 44% in just a few years — well above where the university should feel comfortable. And they can’t easily rectify this situation, because rather than pull out of various private equity deals, they already have past commitments to up its investment in private equity. Bottom line
In the short term, unless it boosts its liquid returns, Harvard is going to have to raise a lot in donations or eat up its liquid assets to fund university obligations and its private equity commitments. This results in a spiraling decline in Harvard’s liquid assets as each year they go lower to meet these needs and more and more assets become tied up in private equity. This assumes the markets stay where they are in the next three years — there are scenarios where liquid assets do worse (like yesterday), or better, of course.
Of course, the economy could totally turn around, private equity could get hot again, leverage could get back in vogue, and the univerisites alumni may get flush again and have millions to donate. Anything’s possible, right?