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8:30 AM Monday, October 24, 2005: It's confusing times. We're into earnings season. The results look bright. If companies continue to report as they have been doing, earnings should be up 15.8%. The stockmarket hasn't reacted with glee. The S&P 500 is down 2.7% this year; Nasdaq is off 4.3%. The stockmarket is a prediction machine, usually eyeing nine months into the future. Is it telling us that it expects things to be awful in 2006?

THERE is a story - apocryphal, I suspect - that Boston-area hedge fund types like to tell about Jack R. Meyer's predecessor as head of the Harvard Management Company.

Harvard Management exists to do one thing: manage Harvard's assets. The head of the company in the 1970's and 1980's was a bearish sort who never warmed up to the bull market that began in August 1982. In late 1989, the story goes, Harvard's president, Derek Bok, began scribbling on a yellow notepad during a Harvard Management board meeting. When he was done, he ripped the sheet of paper out of his notepad, put it down in front of the man, and walked out of the room. It was the man's resignation letter.

What brings the story to mind, of course, was the news late last week that Harvard had named a successor to Mr. Meyer. During Mr. Meyer's storied 15-year tenure, Harvard's assets increased from $4.7 billion to $26 billion, with about $22 billion of that its endowment - making it the largest university endowment in the country. Posting average annual returns of almost 16 percent, Mr. Meyer consistently outperformed not only the market, but virtually every other institutional money manager in the country, with the sole exception of David Swensen, who runs Yale's endowment. Within the world of institutional investors, Mr. Meyer is a legend.

So it's not as if the current Harvard president, Lawrence H. Summers, was scribbling out Mr. Meyer's resignation letter. "Jack Meyer did a great job for Harvard," Mr. Summers said the other day. Although Mr. Meyer declined to comment for this column, he has told friends that he was leaving of his own volition; he plans to start - what else? - a hedge fund with two Harvard Management fixed-income managers who departed with him.

And yet to talk to people in both the Harvard and the Meyer camps, you come away with the feeling that Harvard is not all that terribly sorry to see him go - and that Mr. Meyer had come to feel that, if he wasn't exactly being pushed out the door, he was certainly not getting the deference or leeway he was used to. At a minimum, his successor, Mohamed A. El-Erian, an emerging markets specialist from the bond powerhouse Pimco, has his work cut out for him repairing the damage that has been done by the quiet rift between a great investor and a great university.

THERE are two models for managing endowment money: the Harvard way, and the way everybody else does it. Although virtually all endowments believe in the virtues of asset allocation, most search for talented outside fund managers who specialize in different asset classes, hedge funds very much included, and give them a small portion of the endowment to manage.

Harvard, by contrast, has historically managed its money itself. Especially in the 1990's, Harvard Management under Mr. Meyer had the feel of a big-time hedge fund, with a handful of its own talented fund managers who knew all of Wall Street's tricks. They employed complex derivative strategies, sold stocks short, searched for arbitrage opportunities, used leverage to bolster returns, and so on. They were a tight-knit group who operated out of an office in downtown Boston, several miles from the Harvard campus. They saw themselves not as Harvard employees but as Harvard Management employees.

Except they were Harvard employees, which created a problem. As a nonprofit, Harvard is required by law to publicly identify its most highly paid employees each year. Invariably, Jack Meyer's fund managers were at the top of the list.

In 2003, for instance, Maurice Samuels and David Mittleman, the two fund managers who are departing with Mr. Meyer, made $35.1 million and $34.1 million, respectively. (Mr. Meyer was paid in the millions as well, but not nearly as much as his top performers.) This in turn created an annual firestorm, led by a small group of alumni from the class of 1969. Their leader, William Strauss, believes that it's unseemly for Harvard employees to make that kind of money. "This is a nonprofit university," he told me recently. "It's just inappropriate."

Just about everybody in hedge fund land takes exactly the opposite view and thinks that the criticism is the height of foolishness. They point out, for starters, that Mr. Meyer saves the university money. After all, outside hedge fund managers who turn in investment performances like that of Mr. Mittleman and Mr. Samuels make far more than $35 million.

In addition, the compensation system Mr. Meyer set up included an extraordinary provision. When a fund manager outperformed his benchmark, he received only a certain percentage of his bonus. The rest was carried forward. If the fund manager beat his benchmark the next year, he got the rest of his "carry forward." But if he underperformed, he would have to give part - or all - of it back.

"I think Jack's compensation system was right on," said Scott C. Malpass, who manages Notre Dame's endowment, which has its own stellar record. "The incentives were aligned." That's what fund managers at Harvard Management believed as well.

Over the last half-dozen years, two things happened that began to change Harvard Management. First, the old gang broke up, as many of Mr. Meyer's protégés left to open their own hedge funds. Instead of replacing them, Mr. Meyer put Harvard endowment money in their funds, in amounts that started at $500 million. In return, he got special breaks for Harvard Management.

As a result, today about half of Harvard's money is managed by outside fund managers, though, of course, they are exactly the same people who once managed it internally. But now, the newspapers don't report their compensation.

And the second change? That would be the arrival, in 2001, of Mr. Summers, the former Treasury secretary, as president of Harvard. One of the raps on Mr. Summers is that he always has to be the smartest guy in any room, tossing off questions he means to be provocative, but which often have the effect of alienating the people he's questioning.

And so, at Harvard Management board meetings, Mr. Summers began questioning Mr. Meyer about everything from the positions in the portfolio to its level of risk. In addition, Mr. Summers's old boss, the former Treasury secretary Robert E. Rubin, became a fellow of the Harvard Corporation - the equivalent of a regent - and he began asking Mr. Meyer even tougher questions. (Mr. Rubin did not return my phone call.) For Mr. Meyer, the questioning felt like meddling, even if it wasn't meant that way.

But here was the real blow. For the last year or so, Harvard Management has been using a different compensation system - one that Mr. Summers strongly backed and the Harvard Management board approved. The carry-forward provision was eliminated. The compensation at the low end was raised. But at the high end, the pay for overachievers like Mr. Mittleman and Mr. Samuels was capped at somewhere between $20 million and $25 million.

It would be hard to imagine a more politically boneheaded move. On the one hand, a $20 million paycheck is still far too high to mollify the class of '69 critics. On the other hand, it was a crushing blow to the fund managers still left, who felt that Mr. Summers was running roughshod over Mr. Meyer's incentive system. I don't believe that Mr. Summers imposed the new system as a means of getting rid of Mr. Meyer - he simply thought it made more sense for a university endowment - but that was the inevitable result. Mr. Meyer must have thought: who needs the hassle?

So where does that leave Mr. El-Erian? He is replacing a legend with a performance record that will be nearly impossible to match. Much of the talent at Harvard Management is gone, and those who remain are demoralized. Although Mr. El-Erian is viewed as a brilliant bond guy, he has no experience dealing with hedge funds. Indeed, should he decide that the Harvard model no longer works, and wants to farm out more of the endowment, he will be starting from scratch. Unlike other universities, Harvard doesn't have the expertise to evaluate outside hedge fund managers - except Mr. Meyer's former Harvard Management colleagues.

When I spoke to him late last week, Mr. El-Erian sounded both aware of the challenges he faces, and undaunted. He insisted Harvard would continue to manage its own money. "A lot of hedge funds simply exploit inefficiencies," he told me. "If you can do that more cheaply on the inside, you should."

He liked the idea, he said, of connecting the management company more closely to the university, tapping into its brainpower for investing ideas and assistance. He noted that in the current difficult investing environment, returns were likely to be lower than they had been, that he would have to do a fair amount of "institutional rebuilding," and that he would be living, to some extent, in a "fishbowl." God bless him, he seemed pretty excited about the whole thing.

Bill Gross, the bond guru who has been Mr. El-Erian's boss at Pimco, told me that Mr. El-Erian was indefatigable, trustworthy, a great manager, a savvy investor and "very politically astute." From the looks of things, he's going to need all of those qualities.