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When Genius Failed: Harvard Layoffs

George Soros, the famous hedge fund manager, has spent most of his career defending his “Theory of Reflexivity.”  Like ourselves, Soros is a staunch critic of the orthodox view of market efficiency, specifically the idea that the market reflects all currently available information (see our prior post “Stating the Obvious: Markets Are Not Rational“).

One of the key points of Soros’s Theory of Reflexivity is that market prices are not merely a reflection of investor views about economic fundamentals but rather that the prices and fundamentals play off of each other in a self-reinforcing cycle.   In other words, falling stock prices do not just anticipate sagging economic fundamentals; they can also cause them.

At any rate, we were thinking of this earlier this morning when we saw this Financial Times headline:  ”Harvard Axes 275 as Slump Hits Wealth“

Harvard’s situation is not exactly what Soros was talking about in his theory, but it tells a similar story.  Harvard University relies on its endowment to fund roughly a third of its operations.  This wasn’t a problem during the boom years; over the past decade, the fund earned an annual return of 13.8% (mostly by investing in illiquid asset classes, alas).  The high returns earned by the endowment management team — regarded as some of the best financial brains in the investment management industry — enabled Harvard to spend lavishly and offer quite a lot of financial aid to students.

Now, with the fund down 30%, all of this is at risk.  Education is generally one of the most recession resistant “industries” out there.  When times are hard, demand for higher education actually rises, as the unemployed and underemployed used their downtime to bolster their resumes.  But, as we have said before, this is no ordinary recession.  Harvard University — one of the finest universities in the world — is now having to layoff workers and postpone or cancel projects.   And all of this because their endowment fund got ravaged by the bear.

The question remains:  what now?  Harvard faces the same questions that many regular investors face.  Do I get more aggressive to try to make up my losses?  Or do I take my losses, get conservative, and potentially accept a lower standard of living in retirement?   (Or accept that there will be many worthwhile university priorities that simply won’t get funded now, in the case of Harvard.)

 As aging Baby Boomer investors struggle with these questions, expect them to react as any sensible person would: by spending less and saving more — which means continued sluggish consumer spending and GDP growth.  In the case of Harvard, expect lots of alumni fundraising events in the near future.

Charles Sizemore, CFA

Co-author of the recently-published  Boom or Bust: Understanding and Profiting from a Changing Consumer Economy