HMC’s Outlook on the Financial Markets.
By Jennifer Pline, Managing Director, Harvard Management Company

Amid the turbulence and uncertainty in the financial markets, I want to share with readers some thoughts about what we at Harvard Management Company (HMC) expect in the year ahead and the general strategies we are using to best position the University’s trust assets.

The markets performed well for the first half of 2007, capping an exceptional run during the previous five years. The endowment enjoyed outstanding results over that timeframe, including a 23 percent return in the fiscal year ending June 30, 2007. For donors who have charitable trusts invested in the endowment option, this has meant that their trust market values have grown significantly, as have their quarterly income payments.

In previous communications, we have noted that these high returns would be unlikely to persist, and that future returns will be muted. The volatility of the markets over the last few months has provided us with a powerful reminder that markets can and do go down. However, given the long time horizon for planned gifts and a carefully diversified portfolio, we are confident that the long-term gains for the endowment and trust assets will be solid.

Looking ahead to the remainder of 2008, we expect the economy to experience slow growth, with the possibility that we will enter a reces- sion during the second quarter. The impact of the difficulties in the credit markets combined with a down- turn in the housing market and tight credit conditions will likely continue well into 2008, and we will probably see consumer spending decrease as labor markets weaken. We anticipate a reduction of inflationary pressures despite high commodity prices, espe- cially for oil and food, which are driven by demand from China and India. A weaker dollar should fuel healthy growth in exports.

The Fed’s recent actions to lower interest rates significantly had a tem- porarily positive impact, yet it will take more than Fed action to improve the current tone of the markets. However, if the world’s central banks also cut their rates aggressively, that may fuel stronger global demand and economic growth.

“ We are opting for ample global exposure as well as a higher fixed income component.” JENNIFER PLINE

Bearing these factors in mind, we have implemented a well-diversified asset allocation across various asset classes that we believe will deliver superior returns over the long term. We are opting for ample global expo- sure as well as a higher fixed income component. In an environment of slowing economic growth and rising inflation, we find it effective to turn to real assets such as Treasury Inflation Protected Securities (TIPS). We also look to optimize access to commodi- ties and other hard assets.

HMC is fortunate in having endow- ment managers with expertise in and access to a wide variety of asset classes that can be difficult for individual investors to tap into. Sectors such as timber, hedge funds, private equity, and infrastructure investments are attractive not only for their return potential but also for their beneficial diversifying effect on the portfolio.

As we navigate the choppy waters in the financial markets, HMC’s interim CEO, Robert S. Kaplan, is at the helm, effectively leading our organi- zation. A faculty member at Harvard Business School and former vice chair at Goldman Sachs, Rob is well equipped to head up HMC at this transitional time.

By focusing on the fundamentals of investing and planning for long- term success, we are optimistic about uncovering opportunities and delivering results that will ultimately advance Harvard’s mission. Your charitable gifts remain in skilled hands and are sure to make a differ- ence to the work of the University for generations to come.

© 2008 President and Fellows of Harvard College. All rights reserved.