Dear friends,

We’ve just passed the midpoint of fall term at Augustana, and I spent some time last week avoiding the prospect of grading 32 sets of Propaganda midterms. As a result, I spent time with Kent Barnds who oversees admissions at the college. We talked about strategies for a bit, before Kent offered this definitive judgment: "There’s nothing we can learn from Harvard." His point was simple: Harvard’s situation is so vastly different from ours that any "lesson" is more likely an illusion.

I disagree. While Kent’s right in the limited sense that Harvard’s admissions and marketing strategies aren’t meaningful to Augustana, other parts of the Harvard experience are relevant to us all.

What Harvard and drunken sailors have to teach about investing

Two parts of the Harvard lesson are widely known. First, they’re filthy rich with $26 billion or so in their endowment. Second, their wealth was immensely filthier until about a year ago, at $37 billion.

$37 billion. $37,000,000,000.00. That’s the equivalent of $2,000,000 for every student on campus. Invested conservatively, they could generate $100,000 per student per year. That’s enough that they have no need to charge tuition (currently $33,600/year). They could let everyone in free and still pocket $50,000/year in endowment growth. They could pay each of their poor, huddled faculty members an extra $1,000,000 year – and still not need to charge tuition.

But Harvard’s endowment, for better and worse, is not invested conservatively and has not been so for a long time. And therein lies a tale.

For better: Harvard made an enormous amount of money. Their endowment grew from $4.7 billion in 1990 to $37 billion by June 2008. While part of the growth was generated by gifts to the university, the great bulk came from insightful investment choices. Harvard Management Company, the folks who run the endowment, estimate that they earned 11.7% a year for the past 20 years while their peer group made about 8%. That means that $1 invested with HMC 20 years ago has grown to $10 while $1 in most other endowments grew to less than $5.

How’d they did it? They got there first. HMC seemed to realize early that they could profit most by exploiting inefficiently priced markets, that is, places where there simply weren’t enough active buyers and sellers to keep the prices fair. By being among the first institutional investors to move heavily into managed timberland, for example, HMC made outsized profits year after year.

But, then again, so did Garrett Van Wagoner.

For worse: Harvard spent an enormous amount of money. Faced with a seemingly-endless torrent of money, the university went on a spending spree worthy of an entire shipload of drunken sailors on shore leave. Between 1980 and 2000, they added 3.2 million square feet in new construction. Between 2000 and 2008, they got particularly giddy and added another 6.2 million. During those years, they didn’t add students – just hundreds of faculty, buildings, programs and debt. All of which worked if and only if the goose continued laying golden eggs.

But it didn’t. In the past year or so, the endowment crashed, losing $8 billion in just the first quarter of fiscal 2008. A less generous calculation, which accounts for Harvard’s huge stake in illiquid assets, suggests that the loss was actually closer to 50% in four months.

How’d they do it? Presumably the same way the rest of us manage to bungle our finances: they got cocky, then they got careless and finally they got panicked. HMC got involved in increasingly complex derivatives and unconventional bets, driven in part by the fact that the managers’ compensation was directly tied to outperforming their peers. They hired more and more outside managers – often former HMC employees who’d left in search of even-greener pastures – until they had over 200 external managers and another 200 internal staff managing their money.

With so much money and so many people, it’s easy to imagine more and more stuff sort of slipping through the cracks. Their interest rate swaps, for example. To hedge against rising interest rates on the money it had borrowed, the university bought hedges: if interest rates rose, the swaps would generate big gains to offset rising interest payments. But, instead, interest rates in dropped dramatically: the prime rate fell from about 8.25% to 3.50% in the last two years of the Bush administration. Each of those swaps then became a huge money loser and, for reasons unknown to mere mortals, HMC didn’t cancel the swaps. As a result, they lost $1 billion on what were supposed to be low-risk hedges.

Harvard, the university, was enormously dependent on those rich cash flows which provided a third of its operating budget. As the cash flows shrank, the administrators hastily engaged in "resizements" on a grand scale: they cut out free coffee, stopped emptying trash cans so frequently and fired 300 clerical workers in an effort to cut $220 million from this year’s Faculty of Arts and Sciences budget. What’s the prospect for moving a famously inert bureaucracy quickly enough to adjust to the new world (i.e., the one that rest of us live in)? I don’t know, though one hedge-fund manager who does know the workings of the Harvard system put it this way: "They are completely f****d."

And so what might Harvard and the drunken sailors teach us? A lot.

• About seeking outsized gains: it makes sense that pursuing new sorts of investments (real estate investment trusts in the 1990s, frontier markets today) offer the best potential for huge, long-term gains. It probably makes sense to allocate a small portion of a portfolio into such areas. The situation changes dramatically, though, when you choose to invest your entire portfolio is a collection of financial oddities.



• About maintaining your portfolio: ask, for example, who can actually make sense of twenty or thirty funds, much less 200-300 managers.



• About maintaining your perspective: ask, for example, which investor ever returned 50% more than the market forever. If you’ve figured out that the answer is "none of them," then (a) you’re a step ahead of at least one famous university and (b) you’re a step along the path to keeping your consumerist fantasies in check.



• And about understanding that even "long term" portfolios need to be responsive to horribly destructive, unforeseen events whether they’re market crashes, Bernie Madoff's wiles, or a catastrophic illness.

"Summary Prospectuses" make their long-awaited appearance

Modern people value their freedom: they like having lots of choices and lots of information with which to make those choices. That’s understandable. It’s also disastrous, since our brains are pretty poorly adapted to the task of routinely making sense out of hundreds of bits of data. We freak out, our brains seize up and we grab for whatever catches our eye. That makes evolutionary sense (primitive people who spent too much time analyzing the source of that sound in the night rarely survived to pass along their genes) and a bunch of folks have offered clear and useful discussions of the problem: Torkel Klingberg (what a great name) in The Overflowing Brain (2008) and Barry Schwartz, The Paradox of Choice (2005) are both good places to catch up on the research and its implications for your life.

The Securities and Exchange Commission implicitly addressed those concerns when it authorized the use of "summary prospectuses," two-page fund snapshots that extracted the most essential information from the full prospectus – which must be available on the firm’s website – and gave investors what they hope is "just enough" information to facilitate rather than paralyze intelligent choice-making. While many fund firms have used compact "fund profiles" in their marketing for years, the new summary prospectus will be the first short document to meet the Commission’s statutory disclosure requirement. By January, all funds will be using them.

For those interested in following the remarkably consistent Mr. Kaiser into the wilds of the developing world, the fund launched September 28 and is now available for purchase.

Predictably, a swarm of companies are now marketing their services as writers of summary prospectuses, most with the claim that paying them will somehow save money for advisors and their shareholders. Those same communication consultants are hyping the prospect of managers "tweeting" their shareholders: "smaller summaries combined with online documents, frequent ‘tweets’ and blog posts, and other new means of outreach will mean fewer dollars will be spent on conventional printing." And will, by the way, require an expensive communication consulting contract.

Should We Call Them T(weet) Rowe Price?

But there already have been a huge numbers of tweets on the subject.

Russ Kinnel, Morningstar’s estimable Fund Spy, managed to sleuth out a gem for you: One of the Best Fund Companies You've Never Heard Of. Nuts. If you haven’t heard of Manning & Napier, it’s because you haven’t been paying attention. FundAlarm first began profiling M&N funds back in early 2006, when they were still the Exeter funds. (Thanks to Ted, retired titan of the board, for highlighting that first profile.) Since then, their funds have shown up 37 times in the Annex, the New-Funds pages, or on the discussion board. But, since Morningstar didn’t notice them, apparently no one else did.

Morningstar has also figured out that Hussman Strategic Real Return (HSTRX) is a "better, but not perfect, competitor" for Permanent Portfolio (PRPFX). After ignoring PRPFX for 13 years (from 1995 – 2008), Morningstar resumed coverage just as its long streak of top 10% returns ended; they also began their coverage of HSTRX in 2009. FundAlarm’s profile of HSTRX, which made many of the points that Morningstar recently apprehended – including a favorable comparison to PRPFX – ran in February 2008.

Heck, the New York Times even wrote up "the undies indicator" – just four months after us. The gap is closing!

FMI Common Stock (FMIMX) is slated to close on December 31, 2009. With nearly $900 million in assets, it’s too large and well-established to warrant coverage here (remember: "new and underfollowed funds") but FMIMX is a real gem. It’s posted great returns in both up- and down-markets, producing consistently high returns with below-average risk. Folks interested in a great smaller cap fund owe it to themselves to poke around FMI’s homepage. Thanks to The Shadow for posting notice on the FundAlarm Discussion Board!

Kiplinger.com recently profiled Leuthold Global Clean Tech (LGCTX, The New Green Fund on the Block, 9/28/09). While praising the managers’ grasp of "the big picture," editor Bob Frick concludes that the high expenses and lack of a track record means that you’d be better off with Winslow Green Solutions (WGSLX). It seems a little odd to worry about the lack of a track record for the Leuthold fund while crowning Green Solutions "the brightest green fund" when it was less than two years old. In the FundAlarm’s profile of Leuthold Global Clean Tech, I expressed concern that Leuthold’s track record using the particular stock selection strategy in place here, has not be great but it’s certainly true that Leuthold has been following and investing in clean tech as a sector since the 1980s.

There’s a world of good reading out there, and so you might consider supporting FundAlarm’s ongoing operations by using FundAlarm’s link to Amazon.com to pick up a copy of Klingberg’s The Overflowing Brain or Schwartz’s Paradox of Choice. Or perhaps one of the 328,767 Harvard-related books on sale there. Really: 328,767. How They Got In. Hacking Harvard. The Chosen. They’re all there. If you’re not feeling particularly literate at the moment, please consider using one of the other options to support the site.