HARVARD MANAGEMENT COMPANY
Answer 1: The general objective of HMC was to try to preserve the real value of the endowment and its income distribution in perpetuity. In the last years the endowment spending was on average 4.6%, annual gifts averaged about 1.5%, and Harvard expenses continued to grow at a rate of 3% above CPI. If in the long run the endowment was able to earn a 6% to 6.5% average return over the CPI inflation rate the university could spend 4.5% to 5% of the endowment. The 6.25% is the average of the real minimum expected returns (6% and 6.5%) that HMC could earn to meet the annual spending. Answer 2: The Policy Portfolio is a long term asset mix that was designed to balance HMC’s aversion to risk against its needs for long-term endowment returns. It is the portfolio that Harvard should maintain under neutral conditions. It had a smaller weighting in US and foreign stocks and a larger weighting in cash and private investments than other managed funds of the time. It is based on long term return and risk assumptions to meet Harvard’s return goals, risk tolerance, and long term scenario. The Policy Portfolio specified neutral weighting for each asset class, but HMC could deviate from these weights by moving the asset class weight away from policy in anticipation of short-term moves. HMC was given a minimum and maximum range for each asset class within which they could move without prior consultation with the HMC Board. From our point of view, the Policy Portfolio is useful since it acts as a guide that establishes the weighted asset allocation to meet Harvard’s expected returns and risk. At the same time there are parameters in which weights can be changed without consulting the board. This made the operation easier as the managers did not have to seek board’s approval for minimal deviations from the policy portfolio. The Policy Portfolio also acted as a benchmark for the managers to outperform the individual asset classes. Answer 3: Some advantages...