“For the fiscal year ended June 30, 2016, the return on the Harvard endowment was (2.0)%, resulting in a relative return to its benchmark of (300) basis points. The value of the endowment on June 30, 2016, was $35.7 billion. The low interest rate environment and market volatility of the past fiscal year presented a number of challenges to generating returns. However, we recognize that execution was also a key factor in this year’s disappointing results.
The last ten years, inclusive of the global financial crisis, have been challenging for the Harvard endowment. However, over the last twenty years the endowment has returned 10.4% annualized, exceeding the average annual return on the benchmark portfolio of 7.7%. The value of $1,000 invested in the Harvard endowment has significantly outpaced both a traditional US and Global 60/40 mix of stock and bonds over the same time period.
HMC’s strategic asset allocation process seeks to identify appropriate asset class allocations that best suit the long-term risk and return objectives of the University.
Fiscal year 2016 performance was disappointing on both an absolute and relative basis. The endowment portfolio’s 300 bps of underperformance relative to our benchmark was driven primarily by losses in our public equity and natural resources portfolios. Deviations from our strategic asset allocation also detracted from performance. Our real estate portfolio had material outperformance and private equity also exceeded its benchmark.
Our public markets equity portfolio returned (10.2)%, trailing the blended public equity benchmark of (6.1)%. Developed markets underperformed with both domestic and foreign equity trailing their benchmarks significantly. In emerging markets equities, our performance was relatively flat to the benchmark. We have repositioned our public equity strategy to rely more heavily on external managers. Unfortunately, a number of our domestic equity external managers underperformed for the first time in many years amid a difficult period for active management overall, particularly for value-oriented strategies. Several of our external managers also held closely correlated portfolios, particularly in underperforming healthcare stocks, further impacting the performance of the asset class. This will be a key area of focus for our team going forward.
Private equity generated modest relative outperformance for the fiscal year but performance varied by subsector. US corporate finance was the strongest performer while venture capital returns moderated after several years of very strong performance. We are actively concentrating the portfolio by scaling our commitments to a core group of top managers, and selectively adding new relationships to address gaps in the portfolio.
Our fixed income portfolio, managed entirely internally, had mixed performance for the fiscal year. Our credit strategies suffered losses, while our relative value strategies performed well as we continued to capitalize on opportunities globally.
Our absolute return portfolio was down modestly and trailed its benchmark by 90 bps for the fiscal year. Event-driven and credit-oriented strategies underperformed while systematic and uncorrelated strategies outperformed. While the hedge fund space has become more competitive over the last decade, we continue to believe that partnering with best-in-class managers will lead to attractive risk-adjusted returns in excess of our benchmarks.
Our real estate portfolio encompasses direct activities and external fund investments. Over half of our real estate portfolio is now in direct investments—a strategy HMC began in 2010. The direct strategy continued to perform especially well, earning a total return in fiscal year 2016 of 20.2%. This approach also provides the benefits of enhanced transparency, control over entry and exit, better risk control, and lower overall cost structure.
The macro environment for direct natural resources investments was challenging as commodity prices continued to decline for much of the fiscal year. Market transactions for timber and agricultural land in many regions were limited, impacting portfolio liquidity in the short term. The portfolio trailed its benchmark by over 1100 bps, primarily driven by unfavorable market and business conditions across two assets in South America. One asset experienced severe drought during the crop season as well as an unusually high cost of production. The valuation of the second asset declined as a result of a challenging economic and political environment that made it increasingly difficult to secure financing. We have hired a new head of our natural resources portfolio and are optimistic we can improve performance in this asset class going forward.
As we enter fiscal year 2017, the investment landscape continues to be full of uncertainty. With a backdrop of slowing growth and rich valuations, endowment returns could be muted for some time to come. Still, the endowment’s liquidity position is solid, and we feel confident about the moves we have made to reposition the portfolio. We continuously evaluate how we can best allocate capital and leverage HMC’s comparative advantages to maximize performance over the long term. Investing with best-in-class managers, properly allocating assets, thoughtfully structuring our portfolio, and collaborating across asset classes will be critical to our success.”
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