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Harvard's Bet on Interest Rate Rise Cost $500 Million to Exit

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Oct. 17 (Bloomberg) -- Harvard Universitys failed bet that interest rates would rise cost the worlds richest school at least $500 million in payments to escape derivatives that backfired.

Harvard paid $497.6 million to investment banks during the fiscal year ended June 30 to get out of $1.1 billion of interest-rate swaps intended to hedge variable-rate debt for capital projects, the schools annual report said. The university in Cambridge, Massachusetts, said it also agreed to pay $425 million over 30 to 40 years to offset an additional $764 million in swaps.

Full story here: http://www.bloomberg.com/apps/news?pid=20601109&sid=aHou7iMlBMN8
 
I am not sure I can feel bad for Harvard when they have a multi-billion dollar endowment fund, the sole purpose of which (mostly) is to keep growing rather than helping students.
 
A good part of Havard's operating budget comes from their endowment fund. In that sense, the purpose of the fund is to help the students and the university at large.

Managing the fund in-house leads to potential conflicts. On one hand, the officers of the fund will be the best compensated employees around. On the other hand, they will not be compensated nearly as well they would be at a top firm. While the reasons for staying on could be multiple, when adding the pressure of having people at university fuming about their compensation, a very high turnover is to be expected. In the recent environment, that played a major roll in their loss.
 
Seen on another forum: "Clearly not the smartest guys in the room."
But maybe the greediest.

There's a bit of sleight-of-hand going on here. Swapping floating-rate liabilities to fixed-rate liabilities is a hedge: You sell both your upside and your downside in return for the ability to plan. This is risk transfer--the nominal purpose of swaps to a fund like this one.

The problem wasn't the swaps; they lost money in a mark-to-market sense, and led to a collateral call. Fine, as a university endowment they should have long-term assets that can be used for this purpose. Particularly if those assets are wisely invested in a large proportion of long-term Treasuries, the loss on the swaps is largely offset by a gain in the value of those positions, and their broker would assuredly accept such collateral at a very moderate haircut.

The real issue is that they're investing their General Obligations money in the fund at the same time. The liquidity squeeze isn't due to the collateral call on the swaps--it's due to the fact that they were buying illiquid assets with their lunch money.

Fortunately for them, they have alumni who actually feel sympathy when the managers cry their crocodile tears. They managed to sell bonds to exit the swaps--replacing their collateral with alumni money--and buying back their interest-rate risk in the process. So they've essentially exited their hedge at the worst possible moment, leaving those floating-rate liabilities vulnerable once again to an interest-rate rise.

No doubt they'll go back to the same bond buyers--whose fixed rate debt from last time will have significantly depreciated in the meantime--when interest rates start to go up again, asking for more capital. Nice work if you can get it.
 
Oct. 17 (Bloomberg) -- Harvard Universitys failed bet that interest rates would rise cost the worlds richest school at least $500 million in payments to escape derivatives that backfired.

Harvard paid $497.6 million to investment banks during the fiscal year ended June 30 to get out of $1.1 billion of interest-rate swaps intended to hedge variable-rate debt for capital projects, the schools annual report said. The university in Cambridge, Massachusetts, said it also agreed to pay $425 million over 30 to 40 years to offset an additional $764 million in swaps.

Full story here: http://www.bloomberg.com/apps/news?pid=20601109&sid=aHou7iMlBMN8


Same story with COUTY OF JEFFERSON.
 
When the swaps were broken early it becomes just a trade; someone will win and someone will lose and Harvard lost this time. Everyone loses on a percentage of their trades and Harvard is no different in this regard.
I remember a few short years ago the alumnis pressing issue was the compensation in internal salaries and performance fees to hedge funds. Who knows how much more their endowment might be worth today if they had kept some of the over compensated successful managers on board instead of being jealous of their W-2s.
 
No way those guys are stupid. Here is an article about Jack Meyer who was the CEO of Harvard endowment 1990-[FONT=arial,helvetica,univers][/FONT]2006. The article is from 2005.

Jack R. Meyer, the investing superstar who heads the in-house firm that manages Harvard University's massive endowment, is stepping down after a phenomenal run -- and his critics are rejoicing. Meyer announced on Jan. 11 that he plans to leave this summer to launch his own firm. Despite his strong performance, Meyer's departure is being hailed by those who complain that Harvard has grossly overpaid both Meyer and his investment team. In fiscal 2004 alone, Meyer and his top five managers were paid $78.4 million.
No doubt, that's a lot of dough. But the critics have got it wrong: Harvard was lucky to have Meyer. When he arrived in 1990, the university had a $4.7 billion endowment. Now, it stands at $22.6 billion. Over the past decade, Harvard Management Co. has achieved an annual return of 15.9% -- more than 50% higher than the returns posted by the median large institutional fund. Meyer and his team did even better in the bond market over the past five years, posting returns more than twice the industry average. Such outperformance has generated an extra $12.2 billion for Harvard over the last decade alone -- an amount nearly equal to the entire endowment of Yale, the nation's second-wealthiest university.

http://www.businessweek.com/magazine/content/05_04/b3917076_mz011.htm
 
No way those guys are stupid. Here is an article about Jack Meyer who was the CEO of Harvard endowment 1990-2006. The article is from 2005.

Smart, probably so.But while we're invoking Wall Street maxims, there's this: "Never confuse brains with a bull market."
 
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