Tags: Harvard | endowment | fund | investors

Harvard Loses $1 Billion Doing What Many Individuals Are Trying to Do

By    |   Wednesday, 13 Nov 2013 07:41 AM

Large endowment funds often earn above-market returns because, as Yale Endowment Fund CIO David Swenson has explained, they have access to better investment managers than do average individual investors. But those investment managers can also lead endowments to large losses.

Fearing high interest rates, Harvard invested in derivatives that would protect a bond issue against higher rates. The idea cost Harvard $1.25 billion over the past five years and the school has finally exited the position.

Individual investors can use a similar strategy with leveraged exchange-traded funds (ETFs) that allow them to benefit from rising rates. If rates fall or stay the same, these funds will deliver large losses, and if rates do rise, the funds will offer only limited protection. Like Harvard, many individual investors are learning that derivatives sometimes only benefit the salesmen.

Harvard’s endowment fund is the largest in the nation with about $30 billion in assets. The bet on interest rates amounts to about 4 percent of assets. Spread over five years, some investors will rationalize the cost of insurance as a small amount of less than 1 percent a year.

This is the dangerous rationale that the leveraged fund industry is built upon. If the market falls, they offer a big payoff, and if the market rises, the cost represents a small insurance premium.

Investors falling for this sales pitch are often among the smartest individual investors who use low cost ETFs because they understand that an extra 1 percent a year in fees will cost them thousands of dollars in lost gains over several decades.

Rather than using leveraged funds as insurance, they are meant to be traded and they work well for traders. In the hands of individual investors, the results often mirror Harvard’s losses; however, individuals cannot simply ask alumni to donate more so they can overcome bad decisions.

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MichaelCarr
Large endowment funds often earn above-market returns because, as Yale Endowment Fund CIO David Swenson has explained, they have access to better investment managers than do average individual investors. But those investment managers can also lead endowments to large losses.
Harvard,endowment,fund,investors
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2013-41-13
Wednesday, 13 Nov 2013 07:41 AM
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