August 1, 2007
Harvard's Hedge Fund Loss
The Wall Street Journal today is reporting that Harvard University's endowment fund lost about $350 million investing in Sowood Capital Management. The amount is about 1.2% of Harvard's $29 billion endowment. Last month Sowood suffered in the bond market a loss of about $1.5 billion, approximately half of its assets under management. Earlier this week the hedge fund Citadel Investment Group agreed to buy much of Sowood's investment portfolio. Citadel has made a bit of a business buying hedge fund distressed assets; last year it purchased the remainder of Amaranth's energy portfolio.
The Harvard loss belies the fact that hedge funds and private equity have been very good investments for university endowments. A recent paper, Smart Institutions, Foolish Choices?: The Limited Partner Performance Puzzle by Josh Lerner , Antoinette Schoar and Wan Wongsunwai found that, in particular, endowments' annual returns are nearly 14% greater than average investments in this investment class. And, according to the Wall Street Journal, the top 53 university endowments, with nearly $217 billion in assets, have invested about 18% of their money in hedge funds. The superior returns are a testament to the investing skill of these endowment fund managers mixed, perhaps, with the good luck to have started investing in this area early before it became saturated with a high number of funds searching for return. Still, the Harvard loss is a reminder that hedge fund investments carry risk, and some more than others. But hopefully it will not be cited for the oft-made argument that hedge funds are too risky for investment. Presumably, the very smart people at the Harvard endowment ran their risk analysis and considered the risks associated with this investment against the superior returns Harvard has made over the years. Against this backdrop and the extraordinary returns gained, the loss is insignificant and worthwhile. Good investment is often accompanied by total failure mitigated by diversification. Here, Harvard can take solace in the fact that it only lost half of one investment, something that investors in many equity stocks cannot (remember Pets.com?).
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Are you serious with this comment?
The incentives associated with managing a hedge fund beg the managers to take risks that they otherwise would not accept in managing their own money. This Sowood Capital manager was successful for years as an internal Harvard Univ. endownent manager - his risk was monitored and controlled internally. On his own, he blew up in less time than it takes to graduate from the B-school.
The hedge fund business model is wonderful for managers (which amounts to a free call option), much less so for investors. Harvard's endowment has been a combination of lucky and smart to have earned such returns from external managers in the past - they can expect more experiences akin to Sowood Capital in the future.
Posted by: David Joseph | Aug 16, 2007 5:35:23 PM