To read the full paper, download the PDF.

In March 2020, the S&P500 collapsed as a result of the uncertainty surrounding the Covid-19 pandemic and corresponding economic lockdowns. On March 23, after 23 gruesome days of trading, the S&P500 lost 33% of its value. Not long afterwards, more than 25 million Americans filed for unemployment, more than quadruple the number in the Great Recession.

And yet, return figures for institutional investors reported on annual and quarterly bases were totally unscathed. The rapidity of the Fed’s response and the stock market’s recovery coupled with the drawdown’s abbreviated nature obscures its severity from view when looking at any period of returns greater than dailies. Furthermore, most institutional investors have come to embrace illiquid assets, such as Private Equity, Private Debt, Real Estate, etc., where illiquidity results in thinner price discovery. Most private equity funds didn’t even notice the effect of the pandemic on the marks of their investments.

So, if you’re a CIO, and you know that economic expansions have historically lasted 6-10 years and recessions have typically lasted 12 months, can you honestly look at the synthetically-imposed rather than market-driven economic pullback of 2020 that had no effect whatsoever on your portfolio and label it a recession? We can’t. Until the economy experiences a more protracted contraction like the Tech Bubble of 2001 or the Great Recession of 2009, it’s hard to have faith that markets are healthy and realistic. In the meantime, many CIOs are likely wondering when the next true correction will take place and how their portfolios, especially illiquid investments, will fare when it does.

The general trend in the landscape of institutional investors has been that endowments, especially the Ivy Leagues, pioneer asset allocation practices and pensions follow behind. During the 21st century, Ivy League endowments have deliberately shifted towards illiquid investments (private equity, private credit, real assets). Pensions have followed this trend to varying degrees and are likely to continue to do so. (Fishman, 2018)

As institutions continue to increase the proportion of their assets dedicated to illiquid investments, the complexity of simultaneously managing liquidity to meet liability requirements and maintaining target asset allocations amid a market crash will grow. This complexity does not mean that investors should play it safe and avoid illiquid assets. On the contrary, illiquid assets should be maximized to the extent that an institution’s liability structure allows.

To explain how such a shock should be handled and to illustrate how the next market collapse might be avoided or at least mitigated by investors, we pointed to Harvard’s liquidity crisis after the Great Recession as a cautionary tale. In 2009, Harvard’s endowment dropped 28% from $43.8 billion to $31.5 billion (Harvard University, 2010). Critics have hypothesized many of Harvard’s actions as sources of the disaster. They paid too much in bonuses to their managers. They made too many risky investments in emerging markets and private equity. They liquidated part of their private equity portfolio. They mismanaged their cash, leading to margin calls they weren’t prepared to honor. Certainly a univariate explanation won’t cut it. Other contributing factors: the excessive growth of the university’s budget from 2002-2008 and the mountainous contribution of the budget from endowment income. Alternatively, maybe they did nothing wrong. Maybe the drop in AUM was an inevitable result of the nature of markets in that period and they couldn’t have been expected to have avoided the drawdown they experienced. In this paper, we seek to answer the questions:

Did Harvard go wrong? And if so, where?