Harvard Management Company

The Harvard Management Company (HMC), which we are going to deal with, was founded in 1974 to manage the University’s endowment, pension assets, working capital and trusts.

ISSUE OF THE CASE AND ADVANTAGES AND LIMITATIONS OF OPTIMAL PORTFOLIO ALLOCATION

Like all universities, Harvard was under financial pressures, due to several factors like, for example, the contraction of federal support for education and research, rising faculty salaries or the need to renovate an aging physical plant. The management of the university’s endowment (which amounts to $18.2 billion) was then of primary importance. The asset allocation decisions regarding the endowment were importantly connected to the general on-going financial condition of Harvard. There was an obvious tradeoff: choosing an allocation with higher risk that could lead to higher return and that could help decrease the current financial pressures, or an asset allocation with lower risk which may suggest a contraction of the rates of endowment spending.

When Meyer arrived to head up HMC in 1990, he started to implement a so called ‘‘Policy Portfolio’’ that should be based on long-term return and risk assumptions, because of the difficulty of predicting near-term market moves. The Policy Portfolio, which has been reviewed annually since 1992, is constructed based on the optimal asset allocation and some adjustments that HMC thinks are useful. Then, for each asset class of the portfolio, some room for manoeuvre is granted to managers. In the case, the HMC board would soon be reviewing its Policy Portfolio.

The advantage of asset allocation is that different asset classes have non-perfectly correlated returns, which enables diversification. Basically, we can spread our wealth among a variety of investment types that do not have the same behavior (for example, equities have more volatile and potentially higher returns, whereas Government Treasuries have lower risk and lower returns). This enables the investor to...