Harvard Management Company (HMC) reported a 2.9% return for fiscal year 2023, a slight recovery from -1.8% in FY22, but still far from its historical average. A closer look at the strategic allocation decisions made over the years reveals some recurring themes that played a significant role in shaping this outcome. The 2023 performance, in many ways, reflects both deliberate risk management and a series of missteps that prevented the endowment from fully capitalizing on market opportunities.
Reduced Public Equity Exposure: Missing Out on Market Leaders
One of the most significant factors impacting HMC’s recent performance is its reduced exposure to public equity, which dropped from 31% in FY18 to 11% in FY23. This shift was intended to reduce volatility and limit downside risks during uncertain market conditions. However, this decision also meant that HMC missed the strong recovery in public markets during FY23, especially in sectors like technology, which saw remarkable growth driven by companies such as NVIDIA. As artificial intelligence and tech stocks surged, HMC’s limited allocation to public equities resulted in a missed opportunity to benefit from these gains.
Increased Allocation to Private Equity: Facing Challenges with Valuation Lags
In contrast to public equity, HMC has significantly increased its allocation to private equity, which grew from 16% in FY18 to 39% in FY23. This was part of a strategy to seek higher long-term returns through private investments, including venture capital and growth equity. However, private equity returns in FY23 were muted, partly due to the lag in valuation adjustments. Unlike public equities, which respond quickly to market changes, private valuations are slower to update, especially during periods of market volatility. As a result, while public markets rallied, HMC’s private equity holdings did not adjust upward as quickly, which hindered overall performance.
Limited Exposure to Commodities and Natural Resources
HMC has also significantly reduced its exposure to natural resources, from 6% in FY18 to just 1% in FY23, and similarly decreased its allocation to real estate. While this decision was aimed at minimizing exposure to illiquid and historically underperforming assets, it also meant missing out on potential gains in agricultural commodities and precious metals, which performed well in FY23 due to global supply chain disruptions and geopolitical tensions. The lack of allocation to these asset classes limited HMC’s ability to capitalize on rising commodity prices, which were driven by factors such as inflation and market instability.
Mistiming of Key Allocation Shifts
A key issue that stands out in HMC’s strategy is the mistiming of major allocation changes. The increased investment in private equity coincided with a period of rising interest rates, which put pressure on leveraged assets and affected valuations. Meanwhile, the reduction in public equity exposure meant that HMC missed the stimulus-driven rally post-COVID-19. The timing of these decisions resulted in the portfolio being poorly positioned relative to broader market movements—effectively reducing exposure to growth just as the markets began to recover.
Continued Emphasis on Private Investments: A Bearish View on U.S. Equities
HMC’s increased allocation to private investments also indicates a persistently bearish outlook on U.S. public equities. By significantly reducing public equity exposure, HMC risks missing out on any potential rallies in emerging markets or China—areas that could experience accelerated growth in the coming years. This cautious approach, while protective, may not fully capture the opportunities presented by a broader global economic recovery, leaving HMC vulnerable to underperformance if emerging markets outperform.
Hedge Funds: Costly Diversification and Missed Opportunities
HMC has maintained a significant allocation to hedge funds, ranging between 31-36% over the years. These funds are intended to provide diversification and uncorrelated returns, especially during volatile market conditions. However, the returns from hedge funds in FY23 were relatively modest, contributing little to the overall growth of the portfolio. Moreover, the reliance on hedge funds comes at a high cost due to management and performance fees, and this allocation has also prevented HMC from fully embracing passive or smart beta strategies that could have offered low-cost exposure to rising markets.
Looking Ahead: A Mixed Outlook for HMC’s Performance
The outlook for HMC’s future performance depends heavily on the direction of the broader markets and how effectively the endowment can adapt its allocation strategy:
Market Stability and Potential Challenges: If public markets continue to perform well in 2025, HMC’s relatively low allocation to public equities may once again prove to be a disadvantage. The endowment’s focus on private investments means it could struggle to match the returns of peers who are more heavily invested in public markets. Underweight in Commodities: The low allocation to commodities could also be problematic, especially given the ongoing geopolitical tensions and the potential for further increases in commodity prices. If commodity prices rise, HMC’s current allocation will limit its ability to benefit from these gains, particularly in sectors like energy and agriculture. Base Effect and Prospects for Improvement: On a positive note, the base effect from returns of -1.8% and 2.9% may favor improvement in subsequent years, as the portfolio has room to rebound from these low figures. Despite the negative press, the chance of achieving returns closer to the historical average of 9% is still plausible, provided market conditions align favorably.
The Need for a Systematic and Adaptive Approach
The challenges faced by HMC in FY23 highlight the need for a more systematic and adaptive approach to asset allocation. The current strategy, characterized by caution and a focus on risk management, has resulted in missed opportunities and underperformance relative to broader market gains. To move forward, HMC must consider developing a more dynamic allocation framework—one that can better respond to multi-year trends, shifts in the global economy, and emerging opportunities. Building such a system could help HMC escape the limitations of its current strategy and ensure sustainable, long-term growth for the endowment, better aligned with the demands of a rapidly changing investment landscape.
Mukul Pal