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Financial Update to Council of Deans (2008)

Cambridge, Mass.

To: Council of Deans:

As we navigate our way through these turbulent economic times, we are writing with some further information on the University’s endowment performance and an update on our broader financial strategy for the time ahead. We look forward to our continued work with the Council of Deans as we address these challenges together.

Endowment Update

As has been reported, the value of the University’s endowment was $36.9 billion on June 30, 2008, the end of the last fiscal year. Since then, the severe turmoil in the world’s financial markets has affected all major asset classes in which the endowment is invested.

While historically Harvard has reported investment returns only at the end of the fiscal year, in the current extraordinary circumstances we believe it is critical that our efforts to plan responsibly be informed by a more widely shared understanding of what we expect.

Harvard Management Company, using standard industry practices for valuing assets, has calculated investment losses of approximately 22 percent from July 1 through October 31. Yet even that sobering figure is unlikely to capture the full extent of actual losses for this period, because it does not reflect fully updated valuations in certain externally managed asset classes, most notably private equity and real estate. HMC expects that as we receive more comprehensive valuations in these asset classes from our external managers, the endowment will realize further declines in value. With those considerations in mind, and in view of the uncertain outlook ahead, we continue to plan for a scenario in which our endowment is down 30 percent in value for the year. To put a loss of that size in historical context, over the last at least forty years, Harvard’s worst single-year endowment return was a negative 12.2 percent in 1974, and at that time our endowment stood at less than $1 billion and funded a much less significant proportion of University operations. Since that time, there have been only three years of negative performance, with returns ranging from -0.5 percent to -3 percent. We will of course hope to do better this year than we are now planning, but we need to plan with a clear-eyed view of the reality that confronts us, as best we can gauge it.

Income distributed from the endowment now funds roughly 35 percent of the University’s overall operating budget, and some of our Schools rely on endowment income to cover more than 50 percent of their expenses. The prospect of significant endowment losses therefore has major implications for our budgets and planning, especially since our other principal revenue streams also stand to be challenged by the economic crisis. The implications will differ in degree from school to school and department to department. But all of us will need not merely to contemplate changes at the margins, but to take a more fundamental look at how to align our spending with revenues that will be significantly reduced from what we had imagined just a few months ago.

Financial Strategy

In so fluid and unpredictable a financial environment, it is particularly important to maximize our flexibility and minimize risk so that we can respond to changing circumstances. Toward that end, we are planning to take advantage of Harvard’s strong credit ratings to increase the University’s flexible cash resources in the near term.

The major rating agencies, Moody’s and Standard & Poor’s, rate Harvard as Aaa/AAA – the highest credit ratings available. With the benefit of those ratings, we are planning to issue a substantial amount of new taxable fixed-rate debt. This will help us sustain flexibility and momentum in addressing our academic and research priorities, including financial aid, as we work to absorb the impact of anticipated losses in revenue. We also intend to convert a substantial amount of existing short-term tax-exempt debt into bonds with longer maturities, so we can reduce our exposure to volatility in the credit markets and provide a measure of greater predictability in a time of extraordinary flux. These moves will strengthen our capacity to fund ongoing operations and critical academic and research priorities.

Given our planning assumption about endowment losses and our desire to buffer the near-term impact to a reasonable extent, we also expect that we will be spending a higher percentage of the endowment next year than we have in the recent past.

Budgets and Planning

While the steps outlined above will help, they do not obviate the need to reduce expenses, beginning this fiscal year. To ensure that we are in the best position to respond to this new set of financial realities, we are working with each School to focus on a range of capital and operating budget-reduction scenarios. This approach will enable each School to make choices among its strategic objectives in the context of reduced budgets, yet preserve our collective, institutional flexibility to make adjustments as conditions evolve. We are reconsidering the scale and pace of planned capital projects, including the University’s development in Allston, and are taking a hard look at hiring, staffing levels and compensation to consider how we can reduce overall spending while at the same time invest in the academic programs that are vital to Harvard today and will propel us forward tomorrow.

University-wide Coordination and Communication

We are grateful to you, and your colleagues, for all you have been doing to analyze and understand our changed financial landscape and to share ideas about how best to chart our forward course. Especially at times like these, each of us can learn from one another’s insights and approaches, and all of us stand to benefit from seeing local challenges in a broader institutional context. In addition, our new financial realities call on us to consider more intently whether certain activities we have tended to pursue separately might better be pursued cooperatively – as we seek not just to assure our financial well-being but to continue our momentum in creating more fruitful connections among different parts of the University.

Many of you have been in touch with your School communities, through some combination of letters and meetings, to give people your perspectives on how the economic crisis bears on your own School’s activities. Please let us know how we can be most useful to you in those continuing efforts. Meanwhile, we intend to post this memorandum to the Web, so that people throughout the Harvard community will know more about our present situation and some of the steps being taken to address it.

In closing, we want to express our appreciation for the diligence and spirit of partnership with which you and your staff, as well as those who work with us in the University’s central administration, are approaching these tasks.

– Drew Gilpin Faust
– Ed Forst