Harvard Learns a Lesson
November, 2010 (Bloomberg Markets) -- Jane Mendillo -- who went to Yale -- stepped in to lead the university’s endowment just as markets crashed and it lost $10.1 billion. It may be years before she can clean up the mess.
Shortly after she took over as chief executive officer of Harvard Management Co. on July 1, 2008, Jane Mendillo gathered the university endowment’s 200-member staff for a town-hall- style meeting at the Federal Reserve Bank Building in downtown Boston, across the Charles River from Harvard University.
What did Mendillo think the outlook was for global markets? asked one of the managers gathered on the fund’s 16th-story trading floor. She replied that she didn’t follow them closely, according to four people who were at the meeting.
It wasn’t long before the markets demanded Mendillo’s attention -- and everyone else’s. In September 2008, Lehman Brothers Holdings Inc. collapsed, setting off a global rout. By June 2009, 27 percent, or $10.1 billion, of investments at the world’s richest university endowment was wiped out. That’s more than any other Ivy League school lost in dollar or percentage terms, and it sparked a round of cutbacks in everything from capital spending to student services, Bloomberg Markets magazine reports in the November 2010 issue.
“I certainly didn’t expect that we would be in the type of roiling markets and crisis conditions that the whole world found itself in during the fall of 2008,” Mendillo, 52, says in an interview. “We had to put the longer-term plans on hold.”
Mendillo, who says she doesn’t believe she was asked about her view of the markets at the 2008 meeting, has focused on unwinding some of the endowment’s investments in private equity and hedge funds made by her predecessors from 2005 to 2008 and bringing more of Harvard’s money to in-house managers.
She has started to restructure the school’s real-estate holdings, which lost 50 percent of their value in the year ended on June 30, 2009. She has been increasing investments in natural resources and timber, an area that she pioneered during an earlier, 15-year stint at Harvard.
Mendillo has recouped some losses. In the fiscal year ended on June 30, the endowment crept back up 11 percent to $27.4 billion, still 26 percent below its peak. That performance lags behind the 13 percent median for public and corporate pensions, endowments and foundations during that time, according to Wilshire Associates Inc., a consulting firm based in Santa Monica, California.
The endowment of Columbia University, for instance, gained 17 percent in the same period. Yale University’s increased 8.9 percent.
“It’s a five-year proposition to reshape a portfolio of this kind,” says Mendillo, attired in a crimson knit suit and a strand of pearls.
Mendillo’s bosses say they’re willing to give her time. “Jane has been spectacular,” says James Rothenberg, a Harvard Management board member who helped hire Mendillo. “It hasn’t yet shown in terms of investment returns very dramatically, but I don’t think that’s been the issue in the past couple years.”
After a phase of upheaval in which her two predecessors, 15-year veteran Jack Meyer and emerging-markets specialist Mohamed El-Erian, exited within a three-year span, the board wanted someone who would spend at least a decade at Harvard, says Rothenberg, 64, who’s also the university’s treasurer and chairman of Capital Research & Management Co., the owner of American Funds.
In her first months on the job, Mendillo had to hasten to raise funds to extricate the university from interest-rate swaps it had entered into under former President Lawrence Summers, a Harvard economics professor who’s now an adviser to U.S. President Barack Obama. The White House said in September that Summers would resign and return to Harvard by year-end.
Mendillo has also had to deal with battling factions: alumni unhappy with the ways the school is spending its money, students facing cuts in services and faculty looking at diminished resources. Two top managers left to join El-Erian at Pacific Investment Management Co., where he’s now CEO. Several others quit. El-Erian declined to be interviewed for this article.
“She got dealt a tough deck of cards,” says Walter Cabot, who was Harvard’s chief investment officer for 16 years until he left in 1990. “It’s going to take a while to work off their private placements and time to work off their future commitments. Hopefully, they’ve learned something.”
Still, the market crash didn’t deflect Mendillo’s focus from her long-term goal of growing the endowment while managing risk. “We are acutely aware that the investment portfolio must support current university operations and maintain the purchasing power of the endowment over time,” she says.
Virtual Hedge Fund
Mendillo honed her investing skills during the years she spent working under Meyer, who transformed the endowment’s portfolio from a sleepy mix of blue-chip stocks and bonds into a virtual hedge fund with stakes in real estate, private equity and natural resources.
Meyer made the richest university in the world even richer: Harvard’s endowment quintupled under his leadership, to $25.9 billion in 2005 from $4.7 billion in 1990. By the time Mendillo took over, Harvard had $36.9 billion, $14 billion more than No. 2 Yale, her alma mater.
Harvard counted on its burgeoning wealth to finance its ambitions. The school boosted salaries for faculty, recruited top researchers, promised free education to low-income students and extended financial aid to families earning $180,000 a year or more.
In 2007, Harvard announced a grandiose 50-year expansion plan that envisioned adding as many as 12,000 jobs and 10 million square feet (930,000 square meters) of new space, including a $1 billion science center in Allston, across the river from the main campus in Cambridge.
“Harvard made more plans than it so far has been able to pay for,” says Lawrence Golub, 51, New York-based chairman of private investment firm Golub Capital and a Harvard donor.
The school also increased its dependence on the endowment fund’s returns. Under its mandate from Harvard Corp., which runs the university, Harvard Management has to use its profits to supply a set percentage of the university’s operating expenses. That was 38 percent of the $3.8 billion annual budget in fiscal 2009, up from 23 percent a decade earlier.
The spending boom was a massive miscalculation for an institution purported to be run and frequented by some of the smartest people in the world.
Harvard admitted just 1 in 14 applicants for the class of 2014. It has educated eight U.S. presidents, including Franklin D. Roosevelt, John F. Kennedy and Obama. Many Nobel Prize winners have been associated with the 374-year-old institution, either as students, professors or researchers.
On a recent afternoon in Harvard Yard, students sit under the trees typing on their laptops, and there are few overt signs of the cutbacks the school announced after the crisis. Some staff at residence halls has been trimmed, and one of the libraries has been shut. Students complain that the school scrapped hot morning meals in dorm dining rooms.
“Hot breakfasts are still the iconic issue,” senior Zane Wruble, 21, says. “Perhaps we’re being too entitled about it, but I do think that’s what most people are still upset about.”
The university froze pay for all faculty and nonunion employees for the year ended on June 30, 2009, and 556 employees took voluntary early retirement packages. Almost 275 administrative and support workers were fired.
In Allston, a working-class neighborhood bisected by the Massachusetts Turnpike that had pinned its economic hopes on Harvard’s munificence, an empty foundation sits surrounded by fencing where the science center was supposed to stand. The project, which would have brought 1,500 jobs over 50 years, is on hold indefinitely.
Harvard Management also had to tighten its belt. Mendillo fired 50 people -- a quarter of her staff -- and cut the ranks of outside fund managers by 20 percent, leaving a cadre of 150 to 200 firms that handle about two-thirds of the university’s money.
She also reduced by almost half the $11 billion that her predecessors had committed to hard-to-sell investments such as those in private equity and real estate.
Harvard found itself with a cash crunch in the fall of 2008. Four years earlier, while Summers was president, the university had bought interest-rate swaps, which were contracts to protect the university from ballooning borrowing costs should rates rise from 2.25 percent, where they stood at the time.
It turned out to be a wrong-way bet. After the Lehman collapse, rates plunged to zero, making the cost of the swaps soar.
Mendillo tried to sell some assets to help the school raise the $1 billion it needed to exit the swaps. She demurred when she learned the size of the losses the school would have had to take on the assets.
In December 2008, Harvard issued $2.5 billion of bonds, refinancing $1 billion of existing debt and taking on an additional $1.5 billion.
The timing was terrible: Harvard was borrowing money at a time when the spread between yields on corporate bonds and U.S. Treasury securities was the highest in at least 18 years, according to data from Barclays Plc. A few weeks after Harvard exited the interest-rate swaps, the contracts began to recover.
In January 2010, the school borrowed $400 million more, increasing its debt to $6.5 billion, up 71 percent from 2007, Moody’s Investors Service said in a Jan. 8 report.
Summers resigned in 2006 after provoking a firestorm of protest by suggesting in a speech that female students had less aptitude for math and sciences than males. He also publicly clashed with African-American studies professor Cornel West over a hip-hop record West participated in. West now teaches at Princeton. Summers declined to be interviewed for this story.
Today, Mendillo takes Boston’s T mass transit system’s Red Line to Cambridge to meet with Summers’s successor, Drew Faust, once a month.
Faust, a history professor and former dean of Harvard’s Radcliffe Institute, which emphasizes women’s studies, is the first woman to lead Harvard and the first president without a degree from the school since Charles Chauncy in 1654. (Faust received a bachelor’s degree in history from Bryn Mawr College in suburban Philadelphia and her master’s and doctorate from the University of Pennsylvania.)
Their talks center more on management than on what types of assets to invest in.
“Her role is not to pick stocks so much as it is to run the whole organization,” Faust, 63, says.
“One of the impressive aspects of Jane’s performance is the way she dealt with alums,” she adds. “She’s been pretty transparent and has explained things clearly and has really reassured our alumni community.”
Golub, who holds a bachelor’s, an MBA and a law degree from Harvard, concurs. “There’s got to be a bigger communication and political component of the role than there’s been in the past,” he says.
Unlike El-Erian, who appeared frequently in the media prognosticating about markets while at Harvard, Mendillo has kept a low profile.
“Jane’s approach is more soft-spoken,” says Richard Flannery, CEO of the Investment Fund for Foundations, whose board Mendillo chaired from 2006 to 2009. “People would judge that as a weakness at their peril.”
Mendillo also used New York-based public relations firm Abernathy MacGregor Group Inc. as the fund faced questions from alumni and faculty.
“She can build bridges and listen to lots of people,” says Harry Hoffman, a former business school classmate of Mendillo’s who now manages $7.5 billion in investments and pension assets at the Mayo Clinic in Rochester, Minnesota. “She’s not the kind of person who feels she has to be noticed.”
Mendillo didn’t shun the limelight while growing up as the middle of five children in New Britain, Connecticut. Young Jane was a high school cheerleader who also played Beethoven and Chopin on the piano and performed in a production of South Pacific, says her mother, Love Mendillo, 79, a retired schoolteacher.
“She loved music and reading,” her mother says. “Anything she could get her hands on, she read.”
The third generation of her family to attend Yale, Mendillo majored in English literature. Her mother expected her to become a writer.
A summer job at Yale’s investment office between her junior and senior years changed Mendillo’s mind, her mother says. She spent two years working at the university’s investment office before getting her MBA from the Yale School of Management.
In graduate school, Mendillo was an academic standout. “She was the star of my class by far -- a fabulous student,” says Richard Levin, 63, her former economics professor and now the president of Yale. “Some people learn economics and have intuitive aptitude for the subject. She was among those.”
In 1983, Mendillo made her classmates laugh at a spring follies skit in which students lampooned Levin. As students in the skit pretended to nod off during a long, post-lunch lecture, Mendillo suddenly let out a bloodcurdling scream, says Hoffman, Mendillo’s former classmate.
The sketch was so popular that people were still talking about it last year at the class’s 25-year reunion, Hoffman, 55, says. Levin was played by another classmate, Ralph Earle, now Mendillo’s husband of 24 years. Earle, a consultant, and Mendillo have two teenage children.
Steel and Insurance
Mendillo joined Harvard in 1987 after learning about an opening from Michael Eisenson, a fellow Yale alumnus who worked at Harvard. She became a stock picker, assigned to steel and insurance -- two industries no one else wanted to cover, she says. She later oversaw trusts and gifts.
It was the endowment’s heyday. Meyer, a Harvard MBA who had previously managed the Rockefeller Foundation’s investments, had assembled a team of in-house traders that handled 85 percent of Harvard’s endowment, compared with about 30 percent today.
Meyer assigned Mendillo to push into timberland, an area now managed by a team that invests in natural resources around the world, including agriculture in South America. “There weren’t many institutional investors,” Mendillo says. “Pricing was extremely inefficient. We were able to go in and look for things that were significantly underpriced relative to their intrinsic value.”
Meyer’s investments were less liquid than the traditional portfolios of U.S. stocks and bonds that Harvard had bought in the past.
The bets paid off. From 2000 to 2003, as the Nasdaq Composite Index tumbled more than 60 percent, Harvard was shielded. It fell 2.7 percent in the 12 months ended on June 30, 2001, and 0.5 percent the following year and then gained 12.5 percent a year later.
In the decade ended in June 2005, the endowment gained 16.1 percent annually compared with an 11.8 percent increase in the university’s internal benchmark.
Meyer rewarded his top managers richly. Star bond traders Maurice Samuels and David Mittelman were the highest paid in 2003, earning $35.1 million and $34.1 million apiece. The fat paychecks aroused the ire of alumni, who said the money would be better spent on scholarships.
Some members of the class of 1969 wrote a letter of protest to Summers in 2003. Harvard spokesman John Longbrake says the fund’s operating costs, including pay and bonuses, amount to only 0.3 percent of funds under management.
The complaints prompted some managers to quit and set up their own firms. Meyer himself quit in 2005, taking more than 30 Harvard staff members with him. His Boston-based Convexity Capital Management LP as of Dec. 31 managed $10.6 billion for college endowments, including a commitment of $500 million from Harvard.
Move to Wellesley
Mendillo, who oversaw $7 billion as vice president of external investments at Harvard, left in 2002 to become the first chief investment officer at nearby Wellesley College.
There, she generated returns that averaged 13.5 percent annually compared with 11 percent for the Standard & Poor’s 500 Index in the same period. Mendillo diversified the Wellesley portfolio from stocks and bonds to so-called alternative assets including private equity and real estate, a strategy popularized by her former boss Meyer and David Swensen, the top-performing endowment manager at Yale, on whose investment committee she sat from 2002 to 2008.
When Mendillo returned to Harvard, Wellesley had a $1.7 billion endowment.
El-Erian, who had previously overseen $28 billion of emerging-markets debt at Pimco, the world’s biggest manager of bond funds, joined Harvard in February 2006. A graduate of Cambridge University with a doctorate from Oxford University and a former International Monetary Fund director, El-Erian had no prior connection to Harvard or experience managing an endowment with its multimanager, multi-asset-class structure.
While Meyer’s own staff had managed as much as 85 percent of Harvard’s money, the percentage shrank under El-Erian to about 30 percent. That was partly because so many in-house managers had left with Meyer.
It was also because El-Erian had started allocating money to hedge funds via Mark Taborsky, whom he hired from Stanford University’s endowment to head investment with outside managers. Within a year, Taborsky’s team revamped Harvard’s group of managers, with some of those relationships forged in exchange for longer lockups of capital, El-Erian wrote in his 2008 book “When Markets Collide.”
In September 2007, El-Erian quit to return to Pimco. The turnover continued as Mendillo moved into the H-shaped Boston Federal Reserve Building, where she decorated her office with family pictures and sidewalk art picked up from her travels in Europe.
Among those who remained at Harvard, Stephen Blyth, who led the international fixed-income team, was disappointed at being passed over for the top job, according to two people familiar with the matter. Blyth, a 43-year-old Briton, previously led the global rates proprietary trading group at Deutsche Bank AG in London.
Blyth had joined the Harvard endowment staff after El-Erian took over. “It was a deep visceral reaction,” Blyth says of the prospect of working at Harvard, where he earned his Ph.D. in statistics on a scholarship. “I have a deep connection to Harvard.”
Blyth, who also teaches a statistics class at the school, displays a T-shirt from a 1989 football game in his office. It’s emblazoned with “Yale sucks” in red lettering.
Mendillo promoted Blyth to be in charge of all internal investment managers, and he was won over by her cool head amid the crisis. “She very quickly established herself as someone who brought confidence to the whole organization,” he says. “She’s very calm, very thoughtful.”
Blyth was her top-performing manager last year, earning compensation of $6.4 million. That compares with $1 million for Mendillo during the six months she spent at the fund in 2008. Pay packages are far lower than in Meyer’s day.
Mendillo, whose bookshelf is dotted with Michael Lewis’s Moneyball, Robert Shiller’s The New Financial Order and other finance books, now links senior managers’ pay to the returns they produce, unlike in the past, when pay was tied to benchmarks.
Trying to Sell Assets
Mendillo has hired several former hedge fund managers and has also poached John Barker, one of her two Wellesley deputies. And she’s rearranging the fund’s mix of assets. She tried to sell parts of its $5 billion in property holdings. The endowment canceled the sale after talks with China’s sovereign wealth fund collapsed, a person briefed on the matter said in September.
Mendillo declines to make projections on whether or when Harvard’s endowment will return to its 2008 levels. “The success of some investment decisions cannot be determined for probably a decade or more,” she says.
At that time, if her bosses’ instincts are right, Mendillo will still be at Harvard and can take the credit -- or the blame.
#<254160.671518.104.22.168.17757.25># -0- Sep/28/2010 16:10 GMT