Hmc Case Study

Case study: Harvard Management Company (HBS 9-201-129)

The primary scope of the present document is to provide a critical analysis of the most relevant issue related with the endowment fund of the HMC. First the advantages and disadvantages related to the optimal portfolio. The second part aimed at conducting an analysis on the method utilized by HMC in the process of determining the capital market assumption. Furthermore, it will discuss the Harvard’s decision to strongly emphasize in real returns. The focus point in the third part is to highlight the method of generation of an efficiency frontier and the advantage and drawbacks of the constraining portfolio weights. And finally, the most significant part we will discuss the beneficial and hammering consequences of considering TIPS as an additional asset class in Harvard’s policy portfolio.

1. the advantages and limitations of optimal portfolio allocations:

Led primarily by the need to balance between the requirements posed by the nature of its sector, and its above the ground ambitions for success, Harvard Management Co. introduced the concept of the Optimal Portfolio Allocation as a primary method through which they approach the process of maximization of their risk/return utility function. One of the advantages of this process is the high extent to which this asset allocation alternative meets the nature and needs of this institution. Another essential advantage derives from the fact that through the systematic distribution of the weights determined by the implication of mean-variance analysis for all available assets, the supreme management of the enterprise improves his diversification on the basis of correlations and its capability to forecast the future performance from a long-run perspective. Nevertheless, this analysis would not be complete without the elaborations of the drawbacks accompanying the Portfolio Asset Allocation. One of the greatest drawbacks is the introducing several nontraditional asset which lead to enhance the level risk and also may restrict liquidity. Another limitation is the sensitivity of the process to the inputs which lead the Harvard’s management team to make 2 stress tests.

1. HMC process of developing its capital market assumptions

Initially, it is important denoting that the method through which Harvard Management Co. approaches the process of determining the relevance of each asset class is based on a detailed monitor, computation and critical analysis of the expected future returns and the correlation of the real returns on each asset class with the real returns on all other asset classes. Therefore, their implications on the portfolio are determined through the mean-variance analyses, which main scope is to reveal the combinations of assets that are on the efficient frontier. The above mentioned estimates are all based on both short-term and long term historical records reflecting the overall performance of the asset classes through the years. Nevertheless, in order to avoid the arbitrarily deriving from the utilization of history as the sole base for future estimates, as well as, to ensure that the computed estimation provide an accurate forecast for the future, Harvard Management Co. through the employment of numerous high caliber consultants, not solely that investigates the predominating market trends but also, adjusts its final assumption to reflect the current market conditions.

1. Reasons HMC focus in real returns

The strong emphasis of HMC on real return is essentially based on their unique ability to provide the enterprise with a truthful and accurate perspective of the value of its investment. The reason for which being that the computational formula of the real return (as opposed to their nominal counterparts), takes into account the factor of inflation and, therefore, not only that is more accurate but also sheds lights to the growth of the purchasing power.

1. Assumptions on US equity premium and Foreign equity premium

From the exhibits of the Harvard Management Case it can be derived that the expected return for the domestic and, foreign equity class have the very same value. Which conclude that Harvard Management Co. considers that the difference in terms of equity premiums from investing in the foreign or domestic market does not exist. Therefore, the geographical factor does not play a role in the expected return on the investment.