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Harvard's Crimson Cubs with $43 Billion Dwarf Their Former Endowment Home

Tuesday, March 1, 2011

Call them the Crimson Cubs.

Adage Capital Management LP, Charlesbank Capital Partners LLC, Convexity Capital Management LP, Highfields Capital Management LP and Regiment Capital Advisors LLC are all Boston- based investment firms run by former endowment managers at Harvard University.

Since leaving the world’s richest school, in Cambridge, Massachusetts, they have climbed into the top ranks of hedge funds and private equity. Altogether the firms oversee more than $43 billion, exceeding Harvard’s $27.6 billion fund. All have beaten their investment benchmarks since inception.

The endowment brain drain began in 1998, triggered in part by the opportunity for its traders to run their own firms and make more money, even as alumni and faculty complained they were paid too much. In 2005, 14 months after seven members of the class of 1969 criticized compensation in a letter to then- President Lawrence Summers, endowment chief Jack Meyer quit, ending a 15-year run, to form Convexity. As financial markets plunged in 2008, Harvard’s investments lost a record 27 percent.

“Spinouts from Harvard Management like Charlesbank have become some of the highest-performing investment managers in the market,” said Lawrence Golub, a Harvard donor and the New York- based chairman of Golub Capital, which manages $4.5 billion in assets as a lender to buyout firms. “It’s an economic loss for Harvard but a windfall for all the partners who are building these great businesses and making way more than they would have within the four walls of Harvard Management.”

Lost Expertise

The departing managers took with them expertise they honed under Meyer, who built an internal trading team that included fixed-income specialists David Mittelman and Maurice Samuels, who joined him at Convexity. Tim Peterson, who started Regiment, managed high-yield bonds. Charlesbank founder Michael Eisenson led an in-house private-equity group at Harvard, while Jonathon Jacobson of Highfields managed equities. Phillip Gross and Robert Atchinson of Adage were equity analysts.

Highfields, started in October 1998, has gained an average of almost 13 percent a year, according to a person with knowledge of the firm. That compares with the 3.6 percent average return, including dividends, by the Standard & Poor’s 500 Index. Adage has outperformed the S&P 500 index by about 3 percentage points annually since the firm began trading in 2001, according to two people with knowledge of its performance.

The people asked not to be identified because the firms don’t make their returns public.

Meyer has outperformed a group of benchmarks based on market indexes by an annual average of 7.7 percentage points since he began trading in February 2006, according to a letter to investors obtained by Bloomberg News.

Crimson Cachet

“The class of ‘69 spent a lot of time arguing over tens of millions in compensation and ended up losing $10 billion,’’ said Steven Drobny, author of ‘‘The Invisible Hands: Hedge Funds Off the Record -- Rethinking Real Money.’’

Officials at the funds run by former Harvard managers declined to comment or didn’t return phone calls seeking comment.

The cachet of Harvard -- where crimson is the school color and the name of the daily newspaper and the sports teams -- helped the former endowment managers recruit investors when they were on their own, said Lou Morrell, a former chief investment officer at Wake Forest University in Winston Salem, North Carolina, who invested with Meyer when he started Convexity with more than 30 endowment employees.

Seed Money

After Jacobson and Eisenson left in 1998, the university considered allowing Harvard Management Co., which oversees the endowment, to manage money for other institutions to minimize future defections. The university, which decided against the move, went on to invest with the managers in exchange for a break on fees. Convexity and Highfields received $500 million apiece, while Regiment got $300 million, according to a person familiar with the firms.

The allure of the Crimson Cubs is similar to that of the Tiger Cubs, a group of funds set up by former traders at Julian Robertson’s Tiger Management LLC or seeded by the billionaire. Robertson founded New York-based Tiger Management in 1990 and built it into one of the world’s largest hedge funds in the late 1990s before returning clients’ money in 2000.

At Harvard, Meyer transformed the investment portfolio from a conventional mix of stocks and bonds into a virtual hedge fund. He also pushed the endowment into hard-to-sell assets such as real estate, private equity and natural resources on the theory that the university could afford to lock up its money in long-term bets with the potential to exceed standard equity and fixed-income returns.

Class of 1969

Meyer, 65, more than quintupled Harvard’s fund to $25.9 billion when he left from $4.7 billion when he started in 1990. Gains averaged 16 percent a year in his final decade. Among the biggest U.S. endowments, that trailed only Yale University, in New Haven, Connecticut, and Duke University of Durham, North Carolina, which each returned 17 percent annually.

Harvard’s class of 1969 said in their November 2003 letter to Summers that the combined $107.5 million earned by the fund’s six top performers was excessive and the money would be better spent on scholarships.

‘‘What we said and continue to believe is that working for an educational institution, we didn’t think it was appropriate for them to be compensated at levels they were being compensated,” said Stanley Eleff, a lawyer in Tampa, Florida, who was part of the group of 1969 graduates who wrote to Summers. “We would never expect Harvard’s football coach to be paid like an NFL coach.”

‘Talented Investors’

Eleff said, “Whether Harvard Management would’ve done better or worse had some of these people remained, I’m not in a position to comment about.”

John Longbrake, a spokesman for the university, said he didn’t have information on fees paid to the former managers who are investing for the school.

“We are pleased that so many talented investors have been drawn to work at Harvard Management Co., and that our organizational model allows us to benefit from their expertise when they were employees and now as external managers,” he said in an e-mail.

In the year ended June 2003, Samuels, who managed non-U.S. fixed-income assets, earned $35.1 million, while Mittelman, who managed U.S. bonds, received $34.1 million. Meyer said when he resigned that scrutiny of Harvard Management’s compensation played a secondary role in his decision.

El-Erian’s Tenure

After a nine-month search, Harvard named Mohamed El-Erian, who oversaw emerging-markets investments at Pacific Investment Management Co., to succeed Meyer. El-Erian resigned after less than two years to return to Newport Beach, California-based Pimco, where he became co-chief executive officer and co-chief investment officer.

In the 12 months ended June 30, 2007, the first full year under El-Erian, Harvard gained 23 percent, compared with the 18 percent average for endowments of more than $1 billion. In his time, the percentage of money Harvard managers handled fell to about 30 percent from as much as 85 percent under Meyer, partly because of the exodus of internal managers.

El-Erian also started allocating money to hedge funds via Mark Taborsky, whom he hired from Stanford University to head investment with outside managers. Within a year, Taborsky’s team revamped Harvard’s group of managers, with some of those relationships forged in exchange for longer lockups of capital, El-Erian wrote in his 2008 book, “When Markets Collide.”

Lehman Crisis

Jane Mendillo was hired as Harvard Management’s CEO in July 2008. Her first year was marked by the collapse of financial markets in the wake of Lehman Brothers Holdings Inc.’s bankruptcy in September of that year.

As the endowment plunged, so did the value of the university’s interest rate swaps, pressuring Mendillo to liquidate investments to extricate the school from a cash squeeze. The university raised money by selling $2.5 billion in bonds in December 2008 and also froze pay for all faculty and nonunion employees that academic year.

After the record decline in the year ended June 2009, investments rose 11 percent in the past year, beating the school’s own benchmark while trailing the returns of a broad group of institutions.

Harvard’s former managers have thrived, except for Sowood Capital Management LP, started by Jeff Larson in 2004 with $500 million from the school. The $3 billion firm lost more than 50 percent as corporate bond and loan markets melted down in July 2007. Larson sold most of its assets to Citadel LLC, the Chicago-based investment firm run by Kenneth Griffin, and unwound its two funds. He spun out Denham Capital, a private- equity firm, before his fund started losing money.

Regiment Capital

The Crimson Cubs are based in the John Hancock Tower, the tallest building in New England, except for Regiment Capital, whose office is a block away.

Adage and Regiment were two of Harvard’s biggest external managers in 2008-2009, according to an internal document. Regiment was listed as one of Harvard’s largest independent contractors on a tax filing for the year ended June 2009, receiving $33.7 million in fees.

Regiment, which generally invests in below-investment grade assets, last year owned leveraged loans, options, credit-default swaps and other securities, according to an investor document.

The firm’s hedge fund gained 7.1 percent in 2010, less than the 14 percent increase of the Citigroup High Yield Index. The fund has returned more than 8 percent annually since its March 2000 inception, beating the gain of the Citigroup benchmark, according to a person familiar with the firm. The firm manages about $6 billion.

‘B or B+’

Highfields, which bets on falling and rising asset prices and invests in companies with large market capitalizations, gained almost 16 percent last year, compared with the 15 percent return by the S&P 500 index. The firm lost 18 percent in 2008, when the S&P 500 lost 37 percent in the worst crisis since the Great Depression, and rebounded 36 percent in 2009, more than the 26 percent increase of the benchmark. In 1998, his last year at Harvard Management, Jacobson earned $10.2 million, making him its highest-paid employee.

Harvard no longer invests with the hedge fund, according to a person familiar with the firm. In a January letter to investors, the firm said “from an investment perspective, I think we earned a B or B+ for 2010” and “in hindsight, we passed on some opportunities that we now wish we hadn’t.” Highfields managed $11.7 billion as of Dec. 31.

Adage, Charlesbank

The biggest Crimson Cub by assets is Adage, which is currently closed to new investors. The firm, with $13.5 billion in assets, gained 15.3 percent last year, compared with the 15.1 percent return by the S&P 500, according to two people familiar with the firm. The fund lost 38 percent in 2008 and regained 41 percent in 2009.

Charlesbank has raised seven private equity funds, starting the first three between 1991 and 1997 when the group was part of Harvard. The funds combined returned an average of more than 22 percent a year through September, according to a person with knowledge of its record.

The firm’s $590 million fifth fund, raised in 2000, was its best performer, returning about 22 percent, beating the 20 percent gain of funds in the top 25 percent as tracked by consulting firm Cambridge Associates. Charlesbank’s poorest performing fund, its $985 million pool raised in 2005, has returned about 17 percent, more than the 9.6 percent increase of peers in the top 25 percent as tracked by Cambridge.

Convexity Outperforms

Meyer’s investment strategy fares best in choppy markets, he said in a January annual letter to clients. He told clients the firm beat benchmarks by 5 percentage points last year in a “mediocre” trading climate. The $12.3 billion fund beat its targets by 4.5 percentage points in 2008, before its biggest year in 2009, when it exceeded targets by 20 percentage points.

Harvard Management had an annual average gain of 4.7 percent over the past five years, compared with a 3 percent increase for its internal benchmark.

“The compensation protesters have accomplished none of their goals,” Golub said. “The people they were complaining about are making more money and Harvard’s endowment has less money.”