The Performance of Harvard Management Company - Assignment Example

Assignment Questions 1. The long-term objective for investments of Harvard Management Company can include the real value of the endowment and achieve income distribution in the perpetuity. In the past, the expenses in Harvard have continued increasing where the university could spend the highest endowment of around 6% annually. Also, achieving an increase in the annual returns is part of the long-term objectives of Harvard Management Company. In the process of achieving the long-term objectives, the company has put in place the necessary strategies for managing risks. Considering the risks that are associated with the future returns the annual spending rate has been set at 5%. The risks have been predicted based on the fluctuations that have been taking place in the financial market returns and an inflation rate that can lead to increase in the spending rate. Harvard Management Company expects returns of around 5.5% while the expenses have continued growing. The company can accommodate risks of around 5% associated with the uncertainties like the future real returns. Besides, the expected changes in the market returns are among the risks that the company is ready to take. The factors that can be used in the process of determining the long-term return and risk objectives include controlling the spending rate. The rate of expenditure is targeted to remain at 3% to 6% where the annual returns are said to have significant effects on the total spending. Initially, the company was experiencing lowest rate of expenditure of around 3% and the highest rate of around 29%. Besides, the ability to meet the budget has been used in the process of determining the long-term returns and risk objectives. 2. The Harvard management company has been performing well over the past years. It has been experiencing improvement in performance as the percentage of spending has been declining. The drop in the spending can be attributed to the financial markets that rose drastically. The expenses have been increasing because of the increasing faculty salaries, renovation costs, financial aid to the students, and the need for restraining the tuition increases. New investments have been made in the process of realizing expansion that has led to improvement in the returns realized. The performance of the company was greatly affected by the 2008 crisis where the long-term objectives were put on hold due to the challenges that the firm was going through. During the crisis, the company came up with the necessary strategies that assisted in managing the asset allocation in a way that was efficient. The performance of business improved after the 2008 to 2009 crisis where the primary emphasizes were aimed at maximizing returns. There was continued improvement in the financial condition in the organization where the policies adopted geared towards ensuring improvement in the long-term returns. The financial pressures were reduced by managing the spending rate that negative implications in the budget. For instance, the spending rate was managed through ensuring small tuition increases where the allocations were associated with high risks. However, the risk management team played a crucial role in the process of managing the financial pressures in the organization. The company ensured asset allocation that could ensure improvement in the returns where risk management played a crucial role in the assessing risk appetites. 3. Jane Mendillo was right to spend much effort and time to develop the "Policy Portfolio" as it is important in the process of allocating assets. "Policy Portfolio" is critical in the process of improving the investment returns and managing risks. The policy was used at neutral conditions in the process of assessing the move of stock markets, classes of securities, and interest rates. Besides, Jane Mendillo could use the policy as the benchmark for the company performance where the necessary strategies can be taken to improve the performance. The benchmarking process using the policy is based on the different classes of the assets through the use of returns of the index benchmarks. "Policy Portfolio" can be essential in managing the assets, where right mix of the assets in the organization. Jane Mendillo can make use of the policy in making the necessary adjustments concerning the added asset classes. She can also make the necessary changes based on the results of benchmarks with the aim of improving returns in the long run. The investment professionals could also rely on the policy in the process deciding the best class of assets that can guarantee an increase in returns. The publicly traded instruments that include internally managed assets can be best managed using the Policy Portfolio. Also, Jane Mendillo can make use of the policy in managing direct investments in the long term. Therefore, the policy can be important in ensuring proper management the direct investments through benchmarking performance of various classes of assets. 4. Several factors can be used in explaining the actual asset mix changes that took place in HMC between the year 1992 and the year 2010. The first factor is a change in management policy of the company that determines the way the various assets are combined to achieve the highest benefits. The policy portfolio that determines the asset mix that can be used in direct investments. Besides, the asset mix can be determined by the management through assessing the risks associated with the various assets. It is the role of the management to come up with the appropriate structure that is considered better in the process of selecting the best asset combination (Bond, et al, 2007). The managers are the agents of the shareholders hence they work towards maximizing the wealth of the stockholders hence the need for coming up with the asset mix that can guarantee an increase in returns. The managers in the process of deciding the right asset combination they put into consideration the various market factors that keep changing hence leading to change in the asset mix. For instance, the managers have to consider the economic factors that can help in increasing the returns of the invested funds hence they have to keep changing the asset mix to ensure wealth maximization. The other factor that can be used to explain the changes in the actual asset mix in the company is the investment decisions. The investors make investment depending on the possibilities of earning returns where they try to invest in assets that have high returns. The primary interest of the investors is to ensure that they achieve highest returns hence they are involved in numerous considerations before making the final investment decision. For instance, the investors can consider the market conditions such as the risks involved in different assets aiming at venturing in assets that do not have high risks. The market conditions keep changing; hence they might affect the mix of assets depending on the level of risks associated with different assets. 5. The steps include long-term assumptions are made concerning real return, correlations, and risks of the twelve asset classes. The other step is the optimization algorithm that helps in specifying the efficient coefficient or the asset combinations that is possible that can ensure maximum returns. The steps help in managing the risks with the aim of realizing maximum benefits. Through the long-term assumptions, the necessary correlations, risks can be considered to minimize risks. The assumptions can be adjusted in the process of ensuring that they correspond to the market conditions. The optimization algorithm tries to reduce the risks with the aim of improving returns by being efficient. Also, the appropriate combination of the asset classes that can help in achieving high returns can be realized through an optimization algorithm. The necessary information concerning how the various classes of assets need to be treated during direct investments with the aim of enhancing returns on investment. The key quantitative inputs include endowment values and income distribution while the outputs include endowment spending and rate of return of the company. This analysis has some strengths such as assessing the shifts taking place in the external and internal management. The asset combination that can assist in the process of improving the returns can easily be realized through the use of the analysis. The analysis can also help in making sure that benefits of diversification are weighed against the risks and costs involved through close monitoring of various investments. Also, the analysis can help in liquidity benchmarking that is used in assessing the right levels of liquidity in an organization. However, the analysis is associated with certain weaknesses that can include the failure to guarantee accurate risks assessment in the process of managing the financial uncertainties in organizations. 6. The asset mix that I can suggest for HMC from Exhibit 19 is the first one. This is because it comprises of the lowest standard of deviation of the return and risk characteristics. The low standard of deviation is an indication that the risks and return characteristics are not likely to change. The management of the company can be in better position to manage the uncertainties associated with the assets. As a result, the company can be in better position to come up with the best asset combination that can help in achieving high returns on direct investments. References Bond, S. A., Hwang, S., Mitchell, P., & Satchell, S. E. (2007). Will private equity and hedge funds replace real estate in mixed-asset portfolios?. The Journal of Portfolio Management, 33(5), 74-84. Read More