HMC’s aims to provide relatively predictable cash flows from the endowment to the different schools within the university. As stated in the case, “the general objective was to preserve the real value (adjusted for Harvard’s expense growth) of the endowment and its income distribution in perpetuity”. In recent years, the payout ratio (Endowment spending as a % of total Endowment value) has had a target range of 4.5% to 5.0%.
In the case’s example, the average growth rate of Harvard’s expenses is 3% above CPI inflation rate and annual gifts to the endowment average about 1.5%.
Hence, with a payout ratio target of 4.75%, we would get an Expected Return of 6.25%:
4.75% + 3% - 1.5% = 6.25%
The Policy Portfolio is the “neutral” guide of long-term asset allocation set by the HMC board and it serves as a benchmark of actual performance and as a metric against which compensation of portfolio managers is measured. The aim of the Policy Portfolio is to provide targets for different asset categories as a percentage of the total portfolio, in order to achieve a long-term expected return with the least risk possible. The policy portfolio is reviewed every year and it is modified as a result of changes in market conditions, needs for long-term expected returns, and risk aversion.
Jack Meyer’s vision was to keep the actual asset mix “fairly” close to the Policy Portfolio. Fairly close means that the Policy Portfolio included a minimum and a maximum percentage range for each asset class within which portfolio managers could invest, without a previous authorization of the HMC board.
If Meyer is correct in the perception of portfolio managers’ skill to “capture relative mispricing among similar securities,” then the Policy Portfolio could be a very useful investment guide. In this scenario, portfolio managers would continuously outperform the benchmarks for each asset class.
Harvard managed most (65% in 2000) of its...