On September 19, 2017, the New York Times reported that Harvard’s $37.1 billion endowment fund, managed by Harvard Management Co. (HMC), posted a return of 8.1% for its latest fiscal year, which ended June 30, 2017. Nirmal Narveker, president and CEO of HMC, stated that the results were disappointing but that the changes he was implementing would strengthen the fund going forward.
It is perhaps surprising that an 8.1% return can be regarded as disappointing for a fiscal year that never saw the Fed’s 10 Year High Quality Corporate Bond Rate Spot Rate exceed 3.84%. However, the S&P 500 was up roughly 15.46% over the same period, so some disappointment is understandable.
More noteworthy with respect to investment markets in general are the changes that HMC is making to address its disappointment. The Times reported that HMC is “massively reducing” staff to get rid of specialized investment professionals operating in category silos and instead will focus on outsourcing these functions and adopting a “generalist” investment model. Among the practice groups earmarked for elimination or outsourcing are public markets and equity management, relative value, credit, and direct real estate investment.
Outsourcing investment functions has a variety of attractions for large captive investment managers like HMC. The most obvious attraction is dramatic cost-cutting with respect to the function itself. The fees that investment managers pay to outside firms for investment related functions have fallen precipitously over the past few years, largely driven by increased reliance on technology.
For instance, in April 2017, Blackrock, the world’s biggest asset manager, reported that it had reduced the amount of research related commissions it had paid to Wall St. firms over the prior two years by more than half. Blackrock specifically cited increased reliance on technology and computer-driven data mining in achieving these cuts. (Reuters, April 4, 2017).
In addition to the cost of the function itself, money managers are also moving to an increased reliance on technology to help eliminate legal challenges to their own hiring and staffing decisions, investment choices, and fees that they charge to their constituents.
Big Banks to Benefit. Large money center banks with investment banking functions are poised to benefit from the current travails of the investment management business. According to a report released by Morgan Stanley and Oliver Wyman, the anticipated easing of crisis-era regulations on the biggest banks will help unlock over $83 billion in excess capital, triggering lending and other banking activities at a significant multiple of this number.
The table above shows the current dramatic reversal of fortunes ongoing between Wholesale Banks and Asset Managers. Wholesale Banks took it on the chin during the crisis and the post-crisis period of regulation enhancement, to the advantage of Asset Managers. Now the pendulum is swinging the other way, and Wholesale Banks appear poised to become a more significant source of capital for the economy for the foreseeable future and to reap the rewards of this more predominant role.