耶鲁捐赠基金2010年（机构部分）

The Yale Endowment 2010 Endowment Highlights Fiscal Year 2010 2009 2008 2007 2006 Market Value (in millions) $16,652.1 $16,326.6 $22,869.7 $22,530.2 $18,030.6 Return 8.9% -24.6% 4.5% 28.0% 22.9% Spending (in millions) $ 1,108.4 $ 1,175.2 $ 849.9 $ 684.0 $ 616.0 Operating Budget Revenues 2,681.3 2,559.8 2,280.2 2,075.0 1,932.0 (in millions) Endowment Percentage 41.3% 45.9% 37.3% 33.0% 31.9% Asset Allocation (as of June 30) Absolute Return 21.0% 24.3% 25.1% 23.3% 23.3% Domestic Equity 7.0 7.5 10.1 11.0 11.6 Fixed Income 4.0 4.0 4.0 4.0 3.8 Foreign Equity 9.9 9.8 15.2 14.1 14.6 Private Equity 30.3 24.3 20.2 18.7 16.4 Real Assets 27.5 32.0 29.3 27.1 27.8 Cash 0.4 -1.9 -3.9 1.9 2.5 Endowment Market Value 1950–2010 $25 $20 $15 Billions $10 $5 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Fiscal Year Contents A Message from the Yale University President 2 A Message from the Chief Investment O∞cer 3 1. Introduction 4 2. The Yale Endowment 5 3. Investment Policy 8 4. Spending Policy 28 5. Investment Performance 32 6. Management and Oversight 34 Front Cover: Window of Sterling Memorial Library, east façade.

Right: Branford Courtyard in the spring.

A Message from Yale’s Endowment provides a critical foun-dation for the University’s mission, sup-men and women. Our discussions are thoughtful, rigorous, and vibrant. Amid the Yale University porting today’s scholars with annual turbulent markets and an uncertain econ-spending distributions while promising to omy, the Investment Committee has pro-President maintain support for generations to come. vided a steady hand at the tiller, o≠ering The central importance of the University’s indispensable guidance with a perspective permanent resources became acutely clear that befits Yale’s long-term goals. during the recent financial crisis. Sensible management and oversight of During this period of economic di∞- Yale’s investment portfolio cannot alone culty, we are as fortunate as ever to have ensure that Yale will have the financial the management of Yale’s financial resources it needs. An institution with resources in capable hands. Chief Invest- Yale’s scope and ambition needs active and ment O∞cer David F. Swensen and his tal- supportive alumni and friends to help ented sta≠ continue their tireless e≠orts in build the Endowment. Gifts to Yale have support of Yale’s mission. The Investments fueled the University’s growth throughout O∞ce’s stellar long-term record of wealth the centuries. Today, more than ever, Yale creation provides a critical underpinning of needs your support. the University’s current operations and Under the care of highly skilled invest-future aspirations. ment professionals and a strong Invest-Just as I am thankful for the strength of ment Committee, I am confident that the the University’s investment sta≠, so am I University’s financial resources will con-grateful for the extraordinary work of the tinue to support its dynamic and ever-Yale Corporation Investment Committee. expanding mission. I hope that you enjoy, Chaired by Douglas A. Warner, the Invest- as I have, this report on the 2010 Yale ment Committee is composed of Fellows Endowment, which provides a distillation of the Yale Corporation and other distin- of the thinking that guides the manageguished Yale alumni who bring formidable ment of Yale’s financial resources. judgment and expertise to the oversight of Yale’s investment program.

As a member of the Investment Committee, I witness firsthand the contribution of these industrious and dedicated Yale Richard C. Levin University President Richard C. Levin ’74 ph.d.

(right), with Investment Committee Chair Douglas A. Warner iii ’68 (left) and Chief Investment O∞cer David F. Swensen ’80 ph.d.

Introduction Yale’s Endowment generated an 8.9 percent return in fiscal year 2010, producing an investment gain of $1.4 billion.

Over the past ten years, the Endowment grew from $10.1 billion to $16.7 billion. With annual net investment returns of 8.9 percent, the Endowment’s performance exceeded its benchmark and outpaced institutional fund indices. The Yale Endowment’s twenty-year record of 13.1 per-cent per annum produced a 2010 Endowment value of over six times that of 1990. Yale’s long-term record results from disciplined and diversified asset allocation policies and superior active management results. Spending from the Endowment grew during the last decade from $281 million to $1,108 million, an annual growth rate of approximately 15 percent. On a relative basis, Endowment contributions expanded from 22 percent of total revenues in fiscal 2000 to 41 percent in fiscal 2010. In fiscal 2011, spending will amount to $986 million, or 38 percent of projected revenues. Yale’s spending and investment policies have provided support for current scholars while preserving Endowment purchasing power for future generations.

Endowment Growth Outpaces Inflation 1950–2010 $26 $24 $22 $20 $18 $16 $14 Billions $12 $10 $8 $6 $4 $2 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 1950 Endowment Inflated Post-1950 Endowment Gifts Inflated Endowment Market Value The Yale Endowment Totaling $16.7 billion on June 30, 2010, the Yale Endowment contains thousands of funds with a variety of designated purposes and restrictions. Approximately three-quarters of funds constitute true endowment, gifts restricted by donors to provide long-term funding for designated pur-poses. The remaining one-quarter represent quasi-endowment, monies that the Yale Corporation chooses to invest and treat as endowment. Donors frequently specify a particular purpose for gifts, creating endowments to fund professorships, teaching, and lectureships (24 per-cent), scholarships, fellowships, and prizes (18 percent), maintenance (4 percent), books (3 percent), and miscellaneous specific purposes (26 percent). Twenty-five percent of funds are unrestricted. Thirty-five percent of the Endowment benefits the overall University, with remaining funds focused on specific units, including the Faculty of Arts and Sciences (29 percent), the professional schools (23 percent), the library (7 per-cent), and other entities (6 percent). Although distinct in purpose or restriction, Endowment funds participate in a commingled investment pool and are tracked with unit accounting much like a large mutual fund. Endowment gifts of cash, securities, and property are valued and exchanged for units that represent a claim on a portion of the whole investment portfolio.

In fiscal 2010 the Endowment provided $1,108 million, or 41 percent, of the University’s $2,681 million of operating income. Other major sources of revenues were grants and contracts of $641 million (24 per-cent), medical services of $462 million (17 percent), net tuition, room, and board of $230 million (9 percent), gifts of $82 million (3 percent), and other income and transfers of $157 million (6 percent).

Endowment Fund Allocation Operating Budget Revenue in Millions Fiscal Year 2010 Fiscal Year 2010 Grants and Contracts Miscellaneous Professorships Specific Purposes Medical Services Endowment Tuition, Room, and Board Scholarships Unrestricted Gifts Maintenance Books Other Income and Transfers Gifts and Endowment Strong growth in the Endowment during Gifts Maintain the Endowment’s in 1902 with a $10 million gift, Carnegie the past two decades raises questions about Relevance made subsequent gifts to bring the 1910 contributing to an already wealthy Yale. endowment to $22 million, nearly equal to The answer is simple: had the Endowment Examining the experience of Harvard, Yale, Harvard’s 1910 fund balance of $23 million not benefited from generous gifts in recent and the Carnegie Institution over the past and vastly exceeding Yale’s $12 million. decades, current support for Yale’s broad one hundred years provides insight into Over the course of the past one hundred program of education and research would the importance of gifts. The Carnegie years, the Carnegie Institution endowment be vastly diminished. Although the Yale Institution of Washington, one of Andrew more than kept pace with inflation, with Endowment is one of the largest in the Carnegie’s many philanthropies, pursues June 30, 2010 assets of $687 million com-world, donor support remains critical to cutting-edge scientific research in astron- fortably ahead of the approximately $500 the future of the University. omy, plant biology, embryology, global million needed to match the rise in price ecology, terrestrial magnetism, and earth levels. But the formerly comparable Gifts Support Yale’s Growth sciences. After establishing the institution Harvard endowment, now at $27.6 billion, Over the past century, the growth of the Yale Endowment enabled dramatic expan-sion of the University’s programs. In 1910 Yale Expands Dramatically 1910–2010 the Yale Endowment totaled $12.1 million Times and funded 50 percent of the budget.

One hundred years later, the Endowment amounted to $16.7 billion and provided 41 percent of the University’s budget. The beginning point of 50 percent and the end point of 41 percent both represent signifi-cant departures from the average Endow- 10 ment support of 34 percent of Yale’s opera- Times tions over the last one hundred years.

In 1910, Yale had 3,317 students enrolled in the College and eight graduate and professional schools; as of June 30, 2010, Yale had 11,520 students enrolled in the College and thirteen postgraduate schools. The expansion was dramatic across the board.

New schools founded in those one hun-Students Faculty Physical Plant Financial Aid dred years include the School of Architecture, the School of Drama, and the School Growth 1910-2010 of Management. The School of Medicine expanded its program dramatically in the past century. The growth of the Yale fac- University Revenue by Source 1910–2010 ulty was even more striking. As of June 30, 100% 2010, Yale employed 3,227 faculty mem-bers, approximately eight times the 1910 figure.

With expansion in the number of stu- 80% dents and faculty at Yale came explosive growth in the size of the campus. In 1910, Yale’s physical plant totaled approximately 60% 1.5 million square feet; one hundred years later, that figure was around 17.5 million square feet, easily outpacing the growth in students and faculty. Most dramatic, 40% though, was the exponential growth of financial aid o≠ered by Yale. In the 1910 fiscal year, when much of the University’s 20% student body came from a±uent back-grounds, financial aid totaled only $4.2 million in 2010 dollars. In the year ending June 30, 2010, Yale o≠ered $296.7 million 0 of financial aid, an amazing 71-fold increase 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 from one hundred years earlier. Endowment Tuition, Room, Gifts, Grants, Medical Services Income and Board and Contracts and Other and the previously smaller Yale Endow- Yale’s current academic distinction would to maintain its importance as a global cen-ment, currently at $16.7 billion, dwarf the be unthinkable without these financial con- ter for teaching and research unless donors Carnegie fund. Because the three institu- tributions. Looking forward, Yale will fail continue to provide Endowment support. tions followed roughly comparable invest-ment and spending policies, the absence of continuing gift inflows constitutes the single most important reason for Carnegie’s Historic Impact of Gifts to the Yale Endowment 1950–2010 $25 failure to keep pace. The result is that Carnegie’s endowment, once one of the largest in the country, now ranks far lower.

By way of comparison, had the Yale $20 Endowment grown at the same rate as Carnegie’s, it would total approximately $375 million today; Endowment spending would have been an insignificant $25 mil- $15 lion in fiscal 2010, compared to the actual figure of $1.1 billion. Billions A more precise understanding of the $10 importance of gifts to the Endowment comes from a look at Yale’s post-1950 experience, covering the period for which the University has high-quality financial data. $5 Without the benefit of Endowment gifts to Yale in the last sixty years, the 1950 Endowment of $132 million would have grown to about $3.8 billion by 2010 rather 0 than $16.7 billion. The di≠erence—a stag- 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 gering $12.9 billion—comes from gifts and investment performance on those gifts. 1950 Endowment without Subsequent Gifts Actual Endowment Market Value Harkness Tower and the New Haven skyline.

Investment Policy Yale’s portfolio is structured using a combination of academic theory and informed market judgment. The theoretical framework relies on mean-variance analysis, an approach developed by Nobel laureates James Tobin and Harry Markowitz, both of whom conducted work on this important portfolio management tool at Yale’s Cowles Foundation. Using statistical techniques to combine expected returns, variances, and covariances of investment assets, Yale employs mean-variance analysis to estimate expected risk and return profiles of various asset allocation alternatives and to test sensitivity of results to changes in input assumptions. Because investment management involves as much art as science, qualitative considerations play an extremely important role in portfolio decisions. The definition of an asset class is quite subjective, requiring precise distinctions where none exist. Returns and correlations are di∞-cult to forecast. Historical data provide a guide, but must be modified to recognize structural changes and compensate for anomalous periods. Quantitative measures have di∞culty incorporating factors such as mar-ket liquidity or the influence of significant, low-probability events. In spite of the operational challenges, the rigor required in conducting mean-variance analysis brings an important perspective to the asset allo-cation process. The combination of quantitative analysis and market judgment employed by Yale produces the following portfolio: June 2010 June 2010 Asset Class Actual Target Absolute Return 21.0% 19.0% Domestic Equity 7.0 7.0 Fixed Income 4.0 4.0 Foreign Equity 9.9 9.0 Private Equity 30.3 33.0 Real Assets 27.5 28.0 Cash 0.4 0.0 David F. Swensen ’80 ph.d.

Chief Investment O∞cer Dean J. Takahashi ’80, ’83 mppm Senior Director The target mix of assets produces an expected real (after-inflation) long-term growth rate of 6.2 percent with a risk (standard deviation of returns) of 14.7 percent. Because actual holdings di≠er from target levels, the actual allocation produces a portfolio expected to grow at 6.1 percent with a risk of 14.3 percent. The University’s measure of inflation is based on a basket of goods and services specific to higher education that tends to exceed the Consumer Price Index by approximately one percentage point.

At its June 2010 meeting, Yale’s Investment Committee adopted a number of changes in the University’s policy portfolio allocations. The Committee approved an increase in the private equity target from 26.0 percent to 33.0 percent to accommodate anticipated growth in private equity exposure and decreased the real assets target allocation from 37.0 percent to 28.0 percent. These changes in the illiquid asset classes were balanced by a 4.0 percentage point increase in the absolute return target allocation to 19.0 percent, a 0.5 percentage point decrease in the domestic equity target allocation to 7.0 percent, a 1.0 percentage point decrease in the foreign equity target allocation to 9.0 percent, and a 0.5 percentage point decrease in the cash target allocation to zero percent. The need to provide resources for current operations as well as preserve purchasing power of assets dictates investing for high returns, causing the Endowment to be biased toward equity. In addition, the University’s vulnerability to inflation further directs the Endowment away from fixed income and toward equity instruments. Hence, more than 95 percent of the Endowment is targeted toward investment in assets expected to produce equity-like returns, through holdings of domestic and international securities, real assets, and private equity. Over the past two decades, Yale dramatically reduced the Endow-ment’s dependence on domestic marketable securities by reallocating assets to nontraditional asset classes. In 1990, almost three-fourths of the Endowment was committed to U.S. stocks, bonds, and cash. Today, tar-get allocations call for 11.0 percent in domestic marketable securities, while the diversifying assets of foreign equity, private equity, absolute return strategies, and real assets dominate the Endowment, representing 89.0 percent of the target portfolio.

The heavy allocation to nontraditional asset classes stems from their return potential and diversifying power. Today’s actual and target portfo-Peter H. Ammon ’05 m.b.a., ’05 m.a. Director lios have significantly higher expected returns and lower volatility than the 1990 portfolio. Alternative assets, by their very nature, tend to be less e∞ciently priced than traditional marketable securities, providing an opportunity to exploit market ine∞ciencies through active management. The Endowment’s long time horizon is well suited to exploiting illiquid, less e∞cient markets such as venture capital, leveraged buyouts, oil and gas, timber, and real estate.

Alexander C. Banker Director Policy Asset Allocation Targets Policy asset allocation targets provide the of losing half of purchasing power over a Yale held positions it had adopted as part foundation for the investment process, as fifty-year horizon—is 17 percent. In con- of the June 1987 annual policy target no other aspect of portfolio management trast, the average endowment runs a 35 review. Accordingly, the University plays as great a role in determining a fund’s percent chance of spending disruption and benefited from a sensible long-term ultimate performance. Yale derives its tar- a 28 percent chance of impairment. portfolio allocation. get allocation using a combination of quan- Even though Yale’s portfolio has Serious investors recognize that the titative and qualitative analysis. By employ- changed dramatically from its position in principles of diversification and equity-ing the quantitative tool of mean-variance the mid 1980s, moving from a typical insti- orientation underlie successful long-term optimization, the Investments O∞ce iden- tutional portfolio dominated by marketable investment strategies. Yet many institutifies e∞cient portfolios with expected securities to a well-diversified, equity- tions fail to honor these basic tenets. In the returns that surpass those of all other port- oriented collection of assets, the year-to- mid 1980s typical endowment portfolios folios for the same level of risk. Inputs to year changes tended to be small. Most exhibited neither diversification nor equity the process include estimated return, risk, years saw changes in targets of 5.0 percent orientation, with roughly 50 percent in and correlation measures for di≠erent asset or less; in fact, in seven of twenty-five domestic equities, 45 percent in domestic classes. Important qualitative considera- years no changes occurred at all. bonds and cash, and 5 percent in alternations include the nature of active manage- Yale reviews asset allocation targets only tive strategies. Two and a half decades ment opportunities, the degree of asset once per year, limiting the possibility of later, average allocations have made sub-class illiquidity, and Yale’s comparative damage from ill-considered moves made in stantial progress, with approximately 17 advantages as an investor and active response to the transient gloom or eupho- percent in domestic equities, 18 percent in manager. ria surrounding market movements. bonds and cash, and 65 percent in alterna-In producing portfolio recommenda- During the 1987 stock market crash, a 25- tive strategies. But Yale remains ahead of tions, the Investments O∞ce complements standard-deviation event in which the the curve: with the Endowment’s six asset top-down mean-variance optimization domestic equity market fell more than 20 classes exhibiting allocations between 4 with bottom-up assessment of market con- percent in one day, Yale maintained policy percent and 33 percent, the portfolio meets ditions. By evaluating the absolute and rel- targets in the face of pressure to move the test of diversification; with five high ative attractiveness of investment opportu- assets out of stocks into fixed income. In expected return asset classes accounting for nities uncovered by Yale’s far-ranging ros- fact, shortly following the crash, Yale pur- 96 percent of assets, the portfolio embodter of external investment managers, the chased tens of millions of dollars of S&P ies a substantial equity-orientation. By Investments O∞ce directs funds toward Index futures to rebalance the portfolio to implementing a diversified, equity-oriented more attractive opportunities and away long-term targets. While other institutions asset allocation, Yale’s Endowment is well from less compelling situations. That said, sold depressed equities, purchased inflated positioned to serve the needs of both cur-given the long-term nature of policy tar- bonds, and missed the ensuing recovery, rent and future generations of scholars. gets, bottom-up considerations play a secondary part in the asset allocation process relative to the lead role of mean-variance optimization. Yale’s Portfolio Achieved Diversification by the Mid 1990s In June 2010 the University adopted a Yale Target Asset Allocation 1985–2010 number of changes in its policy targets. 100% Real assets moved from a target of 37.0 percent to 28.0 percent, private equity moved from 26.0 percent to 33.0 percent, absolute return moved from 15.0 percent to 75% 19.0 percent, foreign equity moved from 10.0 percent to 9.0 percent, and domestic equity moved from 7.5 percent to 7.0 percent.

50% Yale’s newly adopted target asset allocation produces an expected real (after-inflation) long-term growth rate of 6.2 percent per annum with a risk (standard deviation of returns) of 14.7 percent. This risk-return 25% combination compares favorably to the average endowment portfolio, which o≠ers a lower expected real return with higher risk. Yale’s spending disruption risk— defined as the likelihood of a real reduction 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 of 10 percent in spending from the Endow-ment over any five-year period—is 28 U.S. Equity U.S. Bonds Foreign Equity Absolute Return Private Equity Real Assets Cash percent for the current target portfolio.

Impairment risk—defined as the likelihood Prior to 1999, real assets was made up solely of real estate. Oil and gas and timber were classified as private equity.

pantone 5455c Asset Class Yale’s six asset classes are defined by di≠erences in their expected response to economic conditions, such as price inflation or changes in interest Characteristics rates, and are weighted in the Endowment portfolio by considering risk-adjusted returns and correlations. The University combines the asset classes in such a way as to provide the highest expected return for a given level of risk.

Absolute Return In July 1990, Yale became the first institutional investor to pursue abso-lute return strategies as a distinct asset class, beginning with a target allocation of 15.0 percent. Unlike traditional domestic and foreign equity investments, absolute return investments provide returns largely indepen-dent of broad market moves. In contrast with diversifying investments such as cash and bonds, absolute return strategies have excellent prospects of generating high long-term real returns. Absolute return investments seek to generate high long-term real returns by exploiting market ine∞ciencies. The absolute return portfolio is managed by investment firms pursuing a wide variety of strategies, which can be broadly categorized as event-driven or value-driven. Event-driven strategies generally involve hedged investments in mispriced securities and depend on specific corporate events, such as mergers or bankruptcy settlements, to achieve targeted returns. Value-driven strategies also entail hedged investments in mispriced securities, but rely on chang-ing company fundamentals or increasing market awareness to drive prices toward fair value.

Today, the absolute return portfolio is targeted to be 19.0 percent of the Endowment. In contrast, the average educational institution allocates 24.6 percent of assets to such strategies. Event-driven strategies are expected to generate real returns of 5.5 percent and value-driven strategies are expected to generate real returns of 5.0 percent, both with risk levels of 15.0 percent.

An important attribute of Yale’s absolute return investment strategy concerns the alignment of interests between investors and investment managers. To that end, absolute return accounts are generally structured with performance-related incentive fees, hurdle rates, and clawback pro-visions. In addition, managers invest a significant portion of their net worth side by side with Yale. In any investment arrangement, when gains are strong, managers benefit and Yale profits. But if losses are incurred, Alan S. Forman only providers of capital su≠er. Significant general partner co-investment Director ensures that losses will be felt by both the manager and Yale. By aligning the interests of Yale and its managers, the University avoids many of the potential pitfalls of the principal-agent relationship.

Given the opportunistic nature of the absolute return asset class, Yale seeks to vary allocations in response to changes in the investment environment. Fluctuations in bankruptcy rates and merger activity, as well as changes in the regulatory environment and in valuation levels, all a≠ect the relative attractiveness of absolute return strategies. Yale structures accounts to allow timely cash flows (in and out) in order to match asset size with investment opportunities. The University is wary of dedicated specialist funds that lock up investor assets and encourage managers to put money to work regardless of the investment climate. Yale prefers to hire managers that possess the depth and scope of experience to evaluate Timothy R. Sullivan ’86 and invest in more than one strategy. Director Since June 30, 1990, the absolute return portfolio has achieved its goal of generating high returns with modest volatility and low correlation to domestic equity markets. The portfolio has returned an annualized 11.5 percent in the twenty years since its inception, outperforming its bench-mark by 0.8 percent. In addition, the portfolio has outperformed the Wilshire 5000 Index return of 7.9 percent over the relevant time period. The monthly standard deviation of the portfolio was a remarkably low 5.3 percent annualized, relative to 15.4 percent volatility exhibited by the Wilshire 5000. The correlation of monthly returns with the Wilshire 5000 has been 0.16, highlighting the significant diversifying e≠ect of the asset class.

Domestic Equity Finance theory predicts that equity holdings will generate returns superior to those of less risky assets such as bonds and cash. Traditionally a predominant asset class in U.S. institutional portfolios, domestic equity represents a large, liquid, and heavily researched market. While the aver-age educational institution invests 17.1 percent of assets in domestic equi-ties, Yale’s target allocation to this asset class is only 7.0 percent. The domestic equity portfolio has an expected real return of 6.0 percent with a standard deviation of 20.0 percent. The Wilshire 5000 Index serves as the portfolio benchmark.

Despite recognizing that the U.S. equity market is highly e∞cient, Yale elects to pursue active management strategies, aspiring to outper-form the market index by a few percentage points annually. Because superior stock selection provides the most consistent and reliable opportunity for generating excess returns, the University favors managers with exceptional bottom-up fundamental research capabilities.

In constructing the domestic equity portfolio, Yale pays little attention to benchmark allocations. In fact, the current portfolio consists of a variety of specialists seeking to apply in-depth knowledge to concentrated portfolios of securities. The combination of a number of idiosyncratic manager portfolios bears little resemblance to broad-based market indices. While such a portfolio almost guarantees short-term deviation from market returns, the focused application of deep knowledge to the security selection process sows the seeds for longer-term investment success.

Stephanie S. Chan ’97 Yale’s portfolio is typically biased toward small-capitalization stocks Associate General Counsel that are cheap in relation to fundamental measures such as book value, earnings, or cash flow. Such stocks generally outperform the market over the long term, albeit with higher volatility of returns. Patient investors reap rewards for taking uncomfortable positions in out-of-favor sectors and securities. Yale’s overweighting of small-capitalization stocks o≠ers better opportunities for managers to generate excess returns because larger-capitalization stocks tend to be better followed and more e∞ciently priced than small-capitalization stocks.

When engaging active managers, Yale structures relationships that align the University’s interests with its managers’ interests. Too many money managers profit by gathering assets at the expense of generating strong investment returns. Significant manager co-investment aligns interests, as does a manager’s desire to behave as a true fiduciary. Deborah S. Chung Associate General Counsel Yale often develops new investment management relationships with promising “young and hungry” principals or with experienced groups working independently for the first time. Newer organizations typically have a modest amount of assets under management and something to prove. As investment management organizations progress through their life cycle, Yale monitors relationships carefully to ensure that interests continue to coincide, that assets under management remain at reasonable levels, and that managers stay motivated and capable.

The Investments O∞ce monitors the size of actively managed port-folios, shifting capital both to rebalance market sector exposure and to take advantage of tactical opportunities. Capital allocation to individual managers takes into consideration the sector exposures of the domestic equity portfolio, the degree of confidence Yale possesses in a manager, and the appropriate asset size for a particular strategy. When the University perceives compelling undervaluation in a sector of the market, Yale may allocate additional capital to existing managers and, perhaps, hire new managers to take advantage of the opportunity.

Yale’s domestic equity portfolio contains a group of intelligent and dedicated managers with high integrity, sound investment philosophies, strong track records, superior organizations, and competitive advantages. In spite of the di∞culty of identifying mispriced securities, by employing a su∞ciently long time horizon, the University expects to benefit from the e≠orts of its domestic equity managers.

Given the e∞ciency of the U.S. equity market, the University’s performance in the asset class has been remarkable. Over the ten years end-ing June 30, 2010, Yale’s domestic equity portfolio returned 6.7 percent per annum, outperforming the Wilshire 5000 by 7.4 percent annually and generating $1.13 billion in value added relative to the portfolio’s benchmark.

Kenneth R. Miller ’71 Associate General Counsel J. Colin Sullivan Exterior of Saybrook College dining hall.

Associate General Counsel Diversification and Its Long-Term Benefits Market return studies indicate that high ket. When mindless momentum strategies financial crisis. The criticism, while super-levels of equity market exposure benefit produce great returns, market observers ficially true, falls short in two ways: (1) in long-term investors. However, the associ- wonder about the benefits of creating a a financial crisis (the market crash in 1987, ated risks come through less clearly. Signi- well-structured portfolio. Consider the the Long-Term Capital Management failure ficant concentration in a single asset class stock market bubble at the turn of the mil- in 1998, the Internet bubble collapse, and poses extraordinary risk to portfolio assets. lennium. In the five years ending June 30, the downturn in 2008) all risky assets fall Fortunately, diversification provides 2000, the S&P 500 returned an amazing in price as market participants seek the investors with a powerful risk management 23.8 percent per year, trouncing the perfor- safety of government bonds, leaving gov-tool. By combining assets that vary in mance of foreign developed and foreign ernment bonds as the only diversifying response to forces that drive markets, emerging markets, which returned 9.7 asset that works; and (2) when evaluated investors create more e∞cient portfolios. percent and negative 1.1 percent per year, over a reasonably long time frame, the At a given risk level, properly diversified respectively. During the same period, the opportunity costs of holding government portfolios provide higher returns than less median educational endowment returned bonds impose a significant drag on portfo-diversified portfolios. Conversely, through 16.6 percent annually. Simply owning the lio returns. appropriate diversification, a given level S&P 500 would have generated a wealth The fact that diversification among a of returns can be achieved at lower risk. multiple of 2.9 times, while the average variety of equity-oriented alternative Harry Markowitz, known as the father of endowment lagged with a multiple of 2.2 investments sometimes fails to protect modern portfolio theory, maintains that times. portfolios in the short run does not negate portfolio diversification provides investors By the late 1990s, many investors ques- the value of diversification in the long run. with a “free lunch,” since risk can be tioned the wisdom of owning any assets Consider an investor in Japanese equities reduced without sacrificing expected other than U.S. equities, especially high- in 1989. An equity-oriented undiversified return. flying technology stocks, asserting the portfolio invested in the Nikkei at the end Yale’s Endowment pioneered diversi- inherent superiority of American compa- of 1989 su≠ered a decline of 73 percent fication into alternative asset classes like nies and the inevitable dominance of high over the subsequent two decades. Diversi-absolute return, real assets, and private tech businesses. Not surprisingly, U.S. fication matters. equity. By the mid 1990s, Yale achieved equity markets eventually collapsed. When The University’s discipline of sticking most of the gains in portfolio e∞ciency the bull market came to a halt in the spring with a diversified portfolio has contributed available from a diversified, equity-ori- of 2000, Yale was in an extremely strong to the Endowment’s market-leading longented approach. Today, the University position to generate handsome returns. term record. Going forward, Yale expects boasts one of the most diversified institu- Strong performance by the absolute return superior results from its diversified tional portfolios, with allocations to six and real assets portfolios, which had lagged approach to investing. The University’s asset classes with weights ranging from 4.0 overall Endowment performance in the late target portfolio produces an expected real percent to 33.0 percent. Yale’s allocations of 1990s, bolstered Endowment returns. (after-inflation) annual return of 7.2 per-7.0 percent to domestic equity and 4.0 per- Just as roaring bull markets encourage cent with a risk (standard deviation of cent to fixed income cause only 11.0 percent diversification skeptics, so do acute finan- returns) of 14.7 percent. In contrast, the of the University’s assets to be invested in cial panics. Based on the substantial decline undiversified institutional standard of 70 traditional U.S. marketable securities. In in Yale’s Endowment during the recent percent stocks and 30 percent bonds pro-contrast, the average endowment has over financial crisis, some observers questioned duces expected real annual returns of 4.8 a third of its assets in U.S. stocks, bonds, the University’s diversified, equity-oriented percent with risk of 15.2 percent. Yale’s and cash. approach. Particular criticism focused on diversified portfolio promises higher Sticking with portfolio diversification the Yale model’s failure to protect the expected returns with lower risk. can be painful in the midst of a bull mar- Endowment in the early months of the Aerial view of Cross Campus area showing Sterling Memorial Library at far right.

Fixed Income Fixed income assets generate stable flows of income, providing greater certainty of nominal cash flow than any other Endowment asset class. The bond portfolio exhibits a low correlation with other asset classes and serves as a liquidity reserve and as a hedge against financial accidents. While educational institutions maintain a substantial allocation to fixed income instruments and cash, averaging 15.3 percent, Yale’s target allocation to fixed income and cash constitutes only 4.0 percent of the Endow-ment. Bonds have an expected real return of 2.0 percent with risk of 10.0 percent. The Barclays Capital 1-5 Year U.S. Treasury Index serves as the portfolio benchmark.

Yale is not particularly attracted to fixed income assets, as they have the lowest historical and expected returns of the six asset classes that make up the Endowment. Still, fixed income plays an important role in the Endowment by providing a liquidity reserve to support portfolio management activities. To ensure access to liquidity, the Endowment invests primarily in high-quality instruments backed by the full faith and credit of the U.S. government.

The market for government bonds is the most e∞cient and liquid in the world, making it di∞cult for active managers to outperform the benchmark net of fees. In fact, most active managers play a cynical game, consciously exposing client assets to greater-than-benchmark risk and claiming that the incremental returns represent superior performance. As the bond managers pocket fees for providing a disservice, clients lose in more than one way. In addition to the out-of-pocket costs paid for active management, clients lose the protection a≠orded by high-quality, non-callable fixed income instruments.

One way in which active managers “outperform” a fixed income benchmark is by overweighting credit-sensitive issues. Under normal circumstances, corporations meet their contractual obligations, providing a spread over the U.S. Treasury return to investors willing to accept credit risk. However, in times of crisis, just when investors most need the protection provided by fixed income portfolios, markets discount the value of corporate promises-to-pay, impairing the defensive character of bond investments.

Another method employed by active managers is to increase the optionality of fixed income holdings. By holding callable corporate or Carrie A. Abildgaard mortgage-backed securities, bond managers again increase returns under Associate Director normal circumstances. Yet, when interest rates decline, companies and homeowners repay callable debt to refinance existing obligations at lower rates. Just when declining rates ought to boost bond portfolio value, the presence of callable instruments dampens portfolio appreciation and undermines the fundamental reason for holding bonds.

Most active management strategies hurt investors by failing to generate risk-adjusted excess returns and by diluting the hedging characteris-tics of high-quality, non-callable bond investments. Investors holding pure fixed income—obligations of the U.S. government—best meet the liquidity provision requirements for bond portfolios.

Michael E. Finnerty Associate Director 15 15 Sensible investors focus on the superior diversifying characteristics of government bonds, holding only the amount necessary to provide su∞cient liquidity for portfolio management activities. If portfolios include the minimum allocation necessary, investors free up assets to diversify into alternative asset classes, achieving volatility reduction with-out sacrificing return. A low allocation to high-quality fixed income reduces the costs associated with holding bonds during normal circum-stances and periods of unanticipated inflation, the environments in which fixed income positions tend to impair portfolio performance. Tailoring the bond portfolio to emphasize fixed income’s essential diversifying characteristics increases expected benefits, while reducing the long-term costs of holding bonds.

In spite of an aversion to market timing strategies, credit risk, and call options, Yale manages to add value consistently in its internal management of the bond portfolio. Primarily by identifying overlooked securities, over the past decade the Investments O∞ce produced returns of 0.3 percent per year above its composite benchmark. Simply avoiding paying a premium for the most heavily traded, so-called on-the-run securities provides a sensible starting point for portfolio construction. Returns are enhanced by identifying occasional opportunities to purchase full faith and credit obligations of obscure government agencies at spreads of up to a full percentage point over Treasuries. Creative, patient portfolio management leads to superior investment results without impairing the port-folio protection characteristics of high-quality fixed income.

Lisa M. Howie ’00, ’08 m.b.a.

Associate Director Suzanne K. Wirtz The Yale Bowl, completed in 1914, with a seating capacity of more than 61,000. Associate Director Foreign Equity Foreign equity investments give the Endowment exposure to the global economy, providing diversification and the opportunity to earn outsized returns. This diversification, quantitatively reflected in the foreign equity portfolio’s expected correlation of 0.68 to domestic equities, reduces the Endowment portfolio’s level of risk. Additionally, the large number of underfollowed companies listed in foreign markets and the ine∞ciencies in their pricing create opportunities to earn above-market returns through active management.

Yale targets 4.0 percent of its portfolio to foreign developed equities and 2.5 percent to emerging market equities. Yale dedicates 2.5 percent of the portfolio to opportunistic foreign positions, with the expectation that holdings will be concentrated in markets, such as China and India, that o≠er the most compelling long-term opportunities. While Yale’s total tar-get foreign equity allocation is 9.0 percent, the average educational institution allocates 18.1 percent to the asset class. Expected real returns for developed equities are 6.0 percent with a risk level of 20.0 percent, while emerging and opportunistic equities both have expected real returns of 7.0 percent with risk levels of 22.5 percent. The foreign equity portfolio is benchmarked against a composite of 44 percent developed markets, mea-sured by the Morgan Stanley Capital International (msci) Europe, Australasia, and Far East Index; 28 percent emerging markets, measured by the msci Emerging Markets Index; and 28 percent custom opportunistic index, measured by a blend of the msci China, msci China A-Shares, and msci India Indices.

Country allocations heavily influence overall performance in foreign equities. Unfortunately, forecasting country returns proves di∞cult and generally provides an unreliable source of value added. Even though country valuations of overseas markets sporadically move to extremes that o≠er identifiable top-down opportunities to generate excess returns, Yale’s managers predominantly focus on generating outperformance through bottom-up security-specific investments. Although some of Yale’s managers have global mandates, Yale recognizes the value of man-agers who specialize regionally. A regional mandate facilitates the execution of intensive company research, creating an edge over less focused global funds.

Emerging markets tend to be less e∞cient than developed markets, resulting from a lack of liquidity, scant research coverage, and a dearth Celeste P. Benson of sophisticated local investors. Periodic inflows and outflows of institu-Senior Portfolio Manager tional capital to and from emerging markets exacerbate these ine∞ciencies. Emerging markets provide a considerable set of investment opportunities, particularly in companies well positioned to benefit from rapidly growing and changing economies. This combination of dynamic busi-nesses and less e∞cient markets creates a wealth of opportunities for Yale’s managers to add value.

Although Yale’s foreign equity managers pursue a broad range of investment mandates, they share a commitment to high-quality research. The University’s managers conduct deep due diligence to build di≠erentiated insights on the companies in their investment universe. Comprehensive, fundamental research gives rise to an analytical edge and allows managers to identify undervalued securities at discounts to fair value. Yale’s long time horizon enables foreign equity managers to invest in R. Alexander Hetherington ’06 Senior Associate companies that will compound value over several years.

Liquidity Investors frequently encounter opportuni- centages of long-term assets contains more November 2009, after the crisis subsided, ties to generate excess returns from accept- liquidity than might be immediately appar- Yale issued $1 billion in five-year fixed-rate ing illiquidity. Of course, pursuing every ent. Yale’s holdings in marketable bonds taxable bonds. The deal was oversub-premium return associated with illiquid and equities, absolute return positions, real scribed and Yale achieved attractive pricing. assets and thereby creating a completely assets (real estate, oil and gas, and timber), The issuance proceeds funded new and illiquid portfolio is neither reasonable nor and private equity (leveraged buyouts and existing capital projects and generated a realistic. Sensible investors preserve su∞- venture capital) generate a fair amount of substantial amount of University liquidity. cient liquidity to meet the full range of natural internal liquidity. For instance, Yale’s Endowment can also generate dis-portfolio commitments, bolstered by a bonds pay interest, stocks pay dividends, ruptive liquidity, namely liquidity created comfortable cushion. Yale’s Endowment real estate produces rents, energy reserves in a manner that changes the Endowment’s must maintain the ability to fund spending provide both returns on capital and returns asset class exposure. Outright sales of to support current University operations, of capital (through depletion), and private bonds or stocks generate liquidity, but alter to satisfy commitments to contribute capi- equity partnerships distribute proceeds portfolio characteristics. Withdrawals from tal to investment partnerships, to capitalize from realizations. The Investments O∞ce absolute return managers provide an addi-on attractive investment opportunities, and carefully forecasts how these distributions tional source of disruptive liquidity. Whole to provide support for the University’s will change under a range of economic or partial sales of private equity and real financing activities. scenarios. assets represent a third, albeit quite unap-Yale’s allocation to private equity and Holdings of marketable securities pro- pealing, means of confronting liquidity real assets investments has grown steadily vide a source of non-disruptive liquidity, squeezes. Even under the best of circum-over the past twenty-five years, as the namely liquidity generated in a manner stances, sales of illiquid partnerships take University’s long-term time horizon that does not change the Endowment’s place at meaningful discounts to fair value. enabled it to take advantage of opportuni- asset class exposure. For example, bonds In the heart of a financial crisis, sales of ties to add substantial value in less liquid and stocks can serve as collateral for repur- illiquid holdings generally occur at dra-alternative assets. As the Endowment’s chase agreements (repos) and security matic discounts to fair value, producing asset allocation has evolved, the importance lending, respectively. The owner of the liquidity that is both expensive and of understanding and monitoring Yale’s securities generates liquidity through pro- disruptive. liquidity profile has increased. The evapo- ceeds produced by the repo and security Liquidity matters, even to portfolios ration of liquidity during the recent eco- lending activity, while retaining the eco- with modest spending requirements and nomic and financial market turbulence nomic exposure associated with the long-term horizons. By implementing highlights the importance of prudent liq- securities. mechanisms to tap a variety of internal and uidity management. Yale carefully monitors External borrowing represents another external sources of liquidity, endowment its liquidity, stress-testing the University’s source of non-disruptive liquidity. For managers provide the means for educa-sources and uses of capital under a variety example, for nearly two decades Yale has tional institutions to satisfy the full range of market conditions and a number of tapped the commercial paper market to of portfolio commitments. Careful moni-operating scenarios. provide funds to support operations and toring and forecasting of Yale’s liquidity The University has both internal and capital projects. During the recent financial ensures that the University will meet its external sources of liquidity at its disposal. crisis, the University had access to nearly cash needs, even during periods of market Even a portfolio characterized by high per- $2 billion of commercial paper funding. In stress, without disrupting the portfolio.

Average Endowment Liquidity Yale Endowment Liquidity June 30, 2010 June 30, 2010 Liquid Assets Liquid Assets 53.3% 21.3% Quasi-Liquid Assets 21.0% Illiquid Assets Illiquid Assets 21.8% Quasi-Liquid Assets 24.6% 57.8% Yale’s preference for regionally focused managers that perform bot-tom-up, fundamental analysis may cause Yale’s country, sector, and security allocations to diverge significantly from those of broad global indices. Yale’s managers have identified stocks throughout the capitalization spectrum that are cheap in relation to fundamental measures such as book value, earnings, or cash flow. Small-capitalization stocks, lying below the radar screen of large institutional funds, have historically o≠ered greater opportunities for active managers to add value. In recent years, however, Yale’s foreign equity managers have found ine∞ciencies even in large-capitalization stocks and premier companies. The Investments O∞ce continuously monitors the size of actively managed portfolios, shifting capital both to rebalance market exposures and to take advantage of tactical opportunities. Capital allocation to indi-vidual managers takes into consideration the degree of confidence Yale possesses in a manager, the country allocation of the manager’s portfolio, and the appropriate size for a particular strategy. In addition, Yale will exploit compelling undervaluations in a country, sector, or strategy by allocating additional capital or, on occasion, by hiring a new manager. In general, Yale’s managers do not hedge currencies, since a modest amount of exchange rate exposure actually improves overall portfolio diversification. However, managers will occasionally incorporate insights on exchange rates into security selection decisions, such as by favoring exporters in countries with weakening currencies. In extreme circum-stances, some of Yale’s managers will selectively hedge foreign exchange exposure.

The University’s performance in foreign equities has been outstand-ing. Over the ten years ending June 30, 2010, Yale’s foreign equity portfolio returned 13.8 percent per annum, easily besting the annualized 5.9 per-cent return of the asset class’s composite benchmark, generating $1.17 bil-lion in value added relative to the portfolio’s benchmark.

Matthew S.T. Mendelsohn ’07 Senior Financial Analyst Jonathan Rhinesmith ’08 Interior of Ingalls Rink. Designed by Eero Saarinen, the rink was completed in 1958 and recently renovated. Senior Financial Analyst Private Equity Private equity o≠ers extremely attractive long-term risk-adjusted return characteristics, stemming from the University’s strong stable of managers that exploit market ine∞ciencies. Yale’s private equity investments include participations in venture capital and leveraged buyout partnerships. The University’s target allocation to private equity of 33.0 percent far exceeds the 10.2 percent actual allocation of the average educational institution. In aggregate, the private equity portfolio is expected to generate real returns of 10.5 percent with risk of 27.7 percent.

Yale was among the first institutional investors to participate in the now widely pursued asset class of private equity, making its first commit-ment to leveraged buyouts in 1973 and to venture capital in 1976. The University participates in private equity through partnerships managed by the nation’s leading private equity firms, including venture capitalists Greylock Partners, Kleiner Perkins Caufield & Byers, and Sutter Hill Ventures and buyout specialists Bain Capital, Berkshire Partners, Clayton Dubilier & Rice, and Golden Gate Capital.

Yale’s private equity program is regarded as one of the best in the institutional investment community and the University is frequently cited as a role model by other investors. Since inception in 1973, Yale’s private equity portfolio has generated a 30.3 percent annual return. Over the past ten years, it has produced a 6.2 percent annual return, outpacing the S&P 500 by 7.8 percent per annum. The success of Yale’s program led to a 1995 Harvard Business School case study, “Yale University Investments O∞ce,” by Professors Josh Lerner and Jay Light. The popular case study was updated in 1997, 2000, 2003, and 2006.

Yale’s private equity assets concentrate on partnerships with firms that emphasize a value-added approach to investing. Such firms work closely with portfolio companies to create fundamentally more valuable entities, relying only secondarily on financial engineering to generate returns. Investments are made with an eye toward long-term relation-ships—generally, a commitment is expected to be the first of several— and toward the close alignment of the interests of general and limited partners.

Of particular note has been the success of Yale’s venture capital man-agers, which have helped start some of the nation’s leading companies. In the 1970s and 1980s, Yale participated in a number of start-ups that helped define the technology industry, including Compaq Computer, John V. Ricotta ’08 Oracle, Genentech, Dell Computer, and Amgen. The high-flying 1990s Senior Financial Analyst included lucrative investments in Amazon.com, Yahoo, Cisco Systems, Red Hat, and Juniper Networks. Yale’s more recent investments in Google, Facebook, LinkedIn, Twitter, and Zynga illustrate the home-run potential of venture capital investing; for example, the University’s $300,000 investment in Google generated $75 million of gains after the company went public in 2004.

While lacking the dramatic appeal of venture investments, Yale’s leveraged buyout investments have delivered high returns with remark-able consistency. Notable transactions in which Yale participated through its leveraged buyout firms include Snapple Beverage, AutoZone, Lexmark International, Kinko’s, Carter’s, Domino’s Pizza, and Bare Escentuals.

Michael R. Schmidt ’08 Senior Financial Analyst Increasingly, Yale has invested in private equity abroad. The Euro-pean leveraged buyout market provides appealing investment opportuni-ties and Asian venture capital presents explosive potential, albeit with the increased risks of investing in developing countries with less well-estab-lished laws and markets. India and China, in particular, represent areas of great opportunity for private equity investors.

The success of Yale and other long-time investors in private equity has attracted numerous new investors to the field. Vastly larger sums of capital were raised in the 2000s, prompting concerns about future returns. Because the recent financial crisis has dampened many investors’ appetites for illiquid asset exposure, Yale sees a better future for the asset class. The hallmark of Yale’s successful private equity program has been long-term relationships with the very best venture capital and leveraged buyout managers. By aligning itself with premier firms, the University hopes to continue to generate attractive returns to support Yale’s educational mission.

Real Assets Real estate, oil and gas, and timberland share common characteristics: sensitivity to inflationary forces, high and visible current cash flow, and opportunity to exploit ine∞ciencies. Real assets investments provide attractive return prospects, excellent portfolio diversification, and a hedge against unanticipated inflation. Yale’s 28.0 percent long-term policy allo-cation significantly exceeds the average endowment’s commitment of 11.6 percent. Expected real returns are 6.0 percent with risk of 15.5 percent. Holdings of real assets o≠er risk and return characteristics well suited for the Yale Endowment. Real assets investments provide claims on future streams of inflation-sensitive income, supplying protection against unanticipated inflation and playing an important diversifying role in the portfolio. In addition to attractive diversifying characteristics, real assets present tremendous opportunities for superior managers to add value and outperform industry averages. The illiquid nature of real assets and the information-intensive aspects of the transaction processes favor skilled and experienced investors.

To take advantage of ine∞cient real estate, oil and gas, and timber-land markets, the University seeks talented and motivated investment managers with proven ability to create value independent of underlying market or commodity price movements. Believing that the basic return Cain P. Solto≠ ’08 from real assets investments can be augmented by operational expertise, Senior Financial Analyst Yale looks for firms with superior operating capabilities, as opposed to groups with only financial engineering skills. Yale’s strong preference is to work with operators that focus on a geographic region or property type, or both, believing that specialized managers with deep market knowledge and experience gain an important edge over more di≠use organizations. Yale attempts to create strong, long-term partnerships in which the interests of the University and its investment managers are closely aligned. Yale requires investment managers to own a meaningful eco-nomic interest in every deal, encouraging thoughtful acquisitions, careful oversight, and timely dispositions. Yale targets employee-owned firms to ensure that incentive compensation benefits the individuals doing the work and that general partner co-investment comes principally from the partners of the firm. Yale demands that its partners maintain reasonable Tess A. Dearing ’09 Financial Analyst levels of assets under management, encouraging pursuit of only the most History of Yale’s Spending Policy Until the mid 1960s, the University limited applied to the Endowment’s market value. spending level because it was determined the Endowment’s annual contribution to The 70 percent weight on prior year spend- using prior fiscal year data. The second the operating budget to investment yield— ing promised budgetary stability, while the revision established a cap and floor with the interest, dividend, and rental income 30 percent weight on market value pro- the cap set at 6.0 percent and the floor set generated by the Endowment. In 1967, rec- vided purchasing power sensitivity. at 4.5 percent. While the cap and floor ognizing that simply spending yield could Since 1982, the spending rule has been structure does not preclude contemporane-result in too high or too low a spending adjusted five times. In 1992 the Corpor- ous spending rates below the sensible rate and could bias investment decisions ation authorized an increase in the long- threshold of 4.0 percent or above the rea-toward securities with high yield but low term spending rate from 4.5 percent to 4.75 sonable limit of 6.5 percent, the new struc-appreciation potential, Yale adopted a total percent. In 1995 Yale adopted a further ture materially reduces the likelihood of return spending policy. Under the total increase in the target rate to 5.0 percent. In such extreme outcomes. Both modifica-return policy, the University supported 2004 the Corporation increased the spend- tions operated as if the changes were made operations with current yield plus a pru- ing rate to 5.25 percent and changed the as of fiscal 2002 and included one-time dent portion of the appreciation of Endow- smoothing rule from 70/30 to 80/20. The compensating distributions (special divi-ment market value. increases in spending rates resulted from dends) made in fiscal 2008 and 2009. Concurrent with the decision to employ improvement in Endowment portfolio Unfortunately, action (in the form of a total return concept, Yale instituted a characteristics. The change in weight special dividends) to address the problem formal method, called the “University assigned to budgetary stability stemmed of underspending came right before the Equation,” to calculate the total amount from recognition that increased budgetary onset of the financial crisis. Had Yale sim-that could responsibly be spent from the dependence on Endowment income ply followed the spending policy in place in Endowment. The method set spending in a required greater stability in flows of 2004, the University would have benefited given year by adjusting the previous year’s Endowment income to support operations. from year-over-year increases in spending spending by the di≠erence between the The final two adjustments were made distributions, even through the financial University’s long-term investment return in 2007. Both were intended to address a crisis. Instead, the special dividends (measured over the prior twenty-year period of spending at rates substantially inflated spending levels and caused Yale period) and the current percentage of the below Yale’s target due to exceptional to cut distributions from Endowment to Endowment being spent. Higher long- investment performance. The first revision return to sustainable spending levels. term returns would lead to higher annual modified the calculation used to adjust the spending, while lower long-term returns would lead to reduced spending. Unfortu-nately, the University Equation did not adjust rapidly enough to changes in Endowment market value. As a result, in the 1970s, when inflation increased and market returns dropped, the University Yale’s Endowment Spending Rate 1950-2010 spent an unsustainably high portion of the 9% Endowment to support current operations.

In 1977, recognizing that the rate of 8% spending was eroding the real value of the Endowment, the Yale Corporation voted to 7% cap spending at the existing level (adjusted for inflation) until the spending rate was brought in line with the expected real 6% (after-inflation) return from the Endow-ment. The Endowment’s expected real 5% return was taken to be 4.5 percent, consis-tent with historical experience. 4% In 1982, upon bringing spending to an appropriate level, the Corporation adopted 3% a spending rule that attempted to release substantial income for current scholars and 2% preserve purchasing power of the Endow-ment for future generations. Under the new rule, Endowment spending amounted 1% to the weighted average of 70 percent of the previous year’s spending, adjusted for 0 inflation, plus 30 percent of the targeted 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 long-term spending rate of 4.5 percent Spending Rate Monte Carlo Simulations To assess the e∞cacy of various combina- world states, each with its own distinct Endowment values diminishing by 50 tions of investment and spending policies, underlying normal distribution.

Defining percent over fifty years. By 2000, when the Investments O∞ce developed a model various world states, such as bear and bull absolute return, private equity, and real that uses simulations to evaluate the markets, allows Yale to improve specifica- assets accounted for nearly 60 percent of impact of a range of policy combinations tion of the asset class characterizations. For the Endowment, disruptive spending drop on Yale’s Endowment and operating bud- example, by increasing the likelihood of a risk fell to 31 percent and purchasing power get. Using “Monte Carlo” techniques, the bear market state, Yale can control the impairment risk declined to 27 percent.1 model employs random numbers to pro- skew and fatness of the left tail in the over- Investment and spending policies of duce portfolio return patterns consistent all distribution, improving the description other educational institutions provide more with assumptions regarding asset class of financial market reality relative to an disturbing results.

Using Monte Carlo sim-expected return, risk, and correlation char- unadjusted normal distribution. ulations and the typical endowment spendacteristics. The resulting path of simulated Monte Carlo simulations applied to the ing rule (5 percent target rate applied to a returns determines Endowment values and Endowment’s current target asset allocation three-year moving average of endowment spending levels, based on the modeled and spending policies indicate a 28 percent value), the Investments O∞ce estimates investment and spending policies. Thou- chance of real spending falling by more that the average endowment faces a 35 per-sands of simulations provide a robust pic- than 10 percent over a five-year span. cent chance of a 10 percent spending drop ture of the potential e≠ectiveness of any Although the Endowment’s real growth over five years and runs a 28 percent given policy combination. rate is expected to outpace the 5.25 percent chance of losing half of its purchasing The two most important criteria used to target spending rate, a roughly 17 percent power over a fifty-year period. analyze the results of various policies are chance exists that the purchasing power of In the simulations, the median purchas-(1) the likelihood of a significant, sustained the Endowment would drop by more than ing power of the average endowment after intermediate-term drop in Endowment 50 percent after fifty years.

The only means fifty years amounts to only 85 percent of its support for the operating budget; and to improve spending stability and purchas- beginning purchasing power. In general, (2) the likelihood of a dramatic long-term ing power preservation would be to lower educational institutions spend at rates far reduction in Endowment purchasing Yale’s target spending rate. too high to be supported by undiversified power. A significant decline in support for Using the metrics of stable operating portfolios that contain far too many low-the operating budget is defined as a real budget support and purchasing power returning assets. Yale’s simulations show reduction of 10 percent over a five-year preservation, the Endowment demon- relatively significant probabilities of cir-period. A dramatic decline in Endowment strated substantial improvement over cumstances that would be traumatic for purchasing power is defined as a 50 percent the past twenty years.

As Yale improved educational institutions, highlighting drop over a fifty-year horizon. diversification by allocating more of the the tenuous balance between protecting The Monte Carlo simulations represent Endowment to the alternative asset Endowment purchasing power and main-a substantial extension of (and improve- classes of absolute return, private equity, taining a steady and substantial stream ment over) conventional mean-variance and real assets, risks plummeted for both of spending. optimization techniques. Mean-variance spending and purchasing power degra- 1 As both spending policies and capital markets analysis simply identifies a set of e∞cient dation. In 1990, when alternative asset assumptions have changed between 1990 and portfolios, namely portfolios with the high- classes accounted for only 15 percent of the today, the Investments Office used today’s policy est return for a given level of risk or portfo- Endowment, Yale faced a 40 percent chance and assumptions to calculate the disruptive spend-ing drop risk and purchasing power impairment lios with the lowest risk for a given level of of real spending dropping 10 percent over risk using the historical asset allocations of 1990 return.

The mean-variance framework pro- five years and a 49 percent chance of real and 2000. vides no intuitive mechanism for portfolio choice and fails to incorporate the impact of spending policy. In contrast, by extend-ing the analysis with Monte Carlo simulations, decision makers enjoy the opportunity to assess the trade-o≠ between easily understood criteria: stable operating bud-get support (probability of losing 10 per-cent of Endowment spending) and pur-chasing power preservation (probability of losing 50 percent of Endowment purchas-ing power). Empirically, financial economists find that market returns exhibit fat tails—a greater frequency of extreme results—than would be found in normal distributions with the same mean and variance. Though Monte Carlo simulations often use nor-mally distributed random numbers, Yale addressed this weakness by running simu-lations that transition between di≠erent Gateway to Silliman College.

attractive opportunities and forcing managers to create wealth through the generation of high returns rather than the collection of large annual management fees.

Yale’s investment strategy compels the University to support emerg-ing investment management groups that are not well-known, brand name companies. Even though newly formed groups typically include several highly experienced and talented founding partners, backing startups exposes the University to managerial and organizational risk as the individuals attempt to jell as a team and the management company seeks to reach break-even. In spite of the risks, the University benefits enormously from the close relationships forged with organizations that the Investments O∞ce introduced to the institutional funds management business.

Yale prefers real assets investments that generate a current cash yield, whether from property rents, reserve production, or sustainable timber harvests. The presence of a substantial cash yield makes the total return on investment less sensitive to the length of the holding period and reduces valuation risk. Yale attempts to garner a margin of safety by pay-ing a low purchase price. In real estate deals, Yale pursues investments in which asset pricing is at a discount to replacement cost; in oil and gas, reserve acquisitions at a discount to long-term normalized pricing; and in timber, forestland at a substantial discount to standing timber value. In the real estate portfolio, Yale has developed a deep roster of investment managers focused on multiple property types and geogra-David S. Katzman ’10 Financial Analyst phies. Because local supply and demand dynamics play a large role in determining market returns, much of the real estate portfolio is located in supply-constrained areas. Reflecting the University’s bias toward focused managers, the portfolio’s largest managers are niche players, concentrat-ing on narrowly defined areas. Specialized managers with excellent mar-ket knowledge add enormous value, supporting the notions that real estate is not a commodity and that values can vary tremendously even between neighboring properties.

In the oil and gas and timber arenas, price changes in the underlying commodity strongly influence investment returns. Unfortunately, macro-economic and political factors drive commodity prices, making them extremely di∞cult, if not impossible, to forecast. Rather than depend on uncertain future price increases, Yale’s natural resource investments must Nilesh V. Vashee ’09 meet return targets in flat price environments. If commodity prices rise, Financial Analyst Yale’s natural resource portfolio will generate handsome performance even as other parts of the Endowment su≠er from the higher costs of basic materials and energy.

In the oil and gas portfolio, Yale emphasizes the low-risk purchase of high-quality proven reserves. In finding managers that evaluate and oper-ate assets more e∞ciently than large oil and gas companies, Yale generates substantial returns without depending on higher-risk exploration strate-gies. A portion of the energy portfolio is allocated to private investments in which investment managers take meaningful stakes in energy explo-ration, production, or service companies with attractive growth prospects. When investing in timberland, Yale concentrates on the purchase and sustainable management of natural forests in the United States. While generally slower growing than plantation forests, natural forests Xinchen Wang ’09 tend to be priced less e∞ciently and to o≠er more opportunities for Financial Analyst skilled managers to add value through silvicultural activities, selective harvests, and wood merchandising. Like value stocks in the marketable securities world, slower growing forests sometimes can be purchased for overly discounted prices because of lack of interest by other investors. In real assets, like other asset classes, Yale seeks value and behaves in a contrarian manner. Investments reflect compelling opportunities and the University’s ability to find suitable managers, regardless of activity in the broad market. This approach has generated strong investment performance and important diversification to the Endowment. Over the ten years ending June 30, 2010, the portfolio returned an annualized rate of return of 10.9 percent, surpassing the benchmark return of 9.8 percent. Correlations with other asset classes over the last decade have ranged from a low of 0.23 with the fixed income asset class to a high of 0.42 with the domestic equity asset class.

Asset Allocations Yale Educational University Institution Mean Absolute Return 21.0% 24.6% Domestic Equity 7.0 17.1 Fixed Income 4.0 15.3 Foreign Equity 9.9 18.1 Private Equity 30.3 10.2 Real Assets 27.5 11.6 Cash 0.4 2.8 Data as of June 30, 2010 Thad C. Brown ’92 Matthew L. Ramadanovic Degree of Investment Opportunity Yale directs active management e≠orts to accurately, success will be transitory. Since returns between the first and third quar-less e∞ciently priced asset classes and e∞cient markets present no significant tiles in collections of actively managed employs less aggressive approaches for mispricings for active managers to exploit, portfolios illustrates the notion that more more e∞ciently priced assets. Given equal good results stem from luck, not skill. e∞ciently priced assets provide less oppor-expenditure of time and e≠ort, active man- Eventually, luck runs out and results disap- tunity for active managers and that less agement promises greater rewards in the point.

Over time, managers in e∞cient e∞ciently priced assets provide more infrequently traded, illiquid world of pri- markets gravitate toward “closet indexing,” opportunity. vate assets than in the heavily traded, liq- structuring portfolios with only modest The accompanying chart shows active uid world of fixed income. deviations from the market, ensuring both manager returns for various asset classes In the absence of direct measures of mediocrity and survival. for the decade ending June 30, 2010. U.S. market e∞ciency, active manager behavior In contrast, active managers in less Treasury securities, arguably the most provides clues about the degree of oppor- e∞cient markets exhibit greater variability e∞ciently priced assets in the world, trade tunity in various markets. In those markets in returns. In fact, many private markets in staggering volumes in markets domi-with limited opportunities for active man- lack benchmarks for managers to “hug,” nated by savvy financial institutions.

The agement, managers deviate little from the eliminating the problem of closet indexing. Treasury market provides the benchmark market portfolio, tending to obtain market- Ine∞ciencies in pricing allow managers for all other fixed income trading. Since like returns. Why do managers in e∞cient with great skill to achieve great success, nobody (with the possible exception of the markets “hug” the benchmark? In a world while unskilled managers post commensu- Federal Reserve) knows where interest of e∞ciently priced assets, consider the rately poor results. Hard work and intelli- rates will be, few managers employ interest business consequences to investment gence reap rich rewards in an environment rate anticipation strategies. Without poten-managers who hold portfolios that di≠er where superior information and deal flow tially powerful di≠erentiating bets on inter-markedly from the market portfolio. Large provide an edge. est rates, institutional portfolios tend to overweights and underweights in security The degree of opportunity for active exhibit market-like interest rate sensitivity, holdings cause portfolio results to vary dra- management (at least as measured by man- or duration.

As a result, managers generally matically from the benchmark. Underper- ager behavior) relates to the distribution of limit themselves to modest security selec-forming managers lose clients, su≠ering a actively managed returns in a particular tion decisions, causing returns for most punishing loss in assets. Overachievers asset class. Any measure of dispersion pro- active managers to mimic benchmark gain clients (and public adulation), yet vides some sense of the richness of active results. The spread between first and third because e∞cient markets price securities management opportunities. The spread in quartile results for active bond managers Dispersion of Active Management Returns Asset Returns by Quartile. Ten Years Ending June 30, 2010 Asset Class First Median Third Range Quartile Quartile U.S. Fixed Income 5.9% 5.6% 5.2% 0.6% U.S. Large-Capitalization Equity 2.5 (0.0) (2.0) 4.5 Absolute Return 6.3 4.2 1.4 4.9 U.S. Small-Capitalization Equity 8.5 5.6 2.1 6.5 Venture Capital 3.7 (2.6) (8.7) 12.4 Leveraged Buyouts 20.3 12.0 4.3 16.0 Real Estate 20.8 11.3 (4.1) 24.8 measures an astonishingly small 0.6 per- quartiles.

The progression of degree of At the opposite end of the spectrum, the cent per annum for the decade. opportunity across types of marketable Investments O∞ce devotes considerable Less e∞ciently priced securities trade in securities makes intuitive sense. time and e≠ort to identify opportunities in wider ranges. Stocks provide more di∞cult Illiquid assets show substantially larger the far less e∞cient private equity market. pricing challenges than bonds. Instead of spreads, with venture capital at 12.4 percent The Endowment bond portfolio, struc-discounting relatively certain fixed income per annum, leveraged buyouts at 16.0 per- tured with respect for market e∞ciency, cash flows, valuation of equities involves cent per annum, and real estate at 24.8 per- produced a 0.4 percent per annum excess discounting more-di∞cult-to-project cor- cent per annum. Lacking a benchmark to return over the past two decades.

In conporate cash flows. The greater volatility in hug, managers of illiquid assets succeed or trast, Yale’s private equity positions boast a equity markets also contributes to the fail by dint of their abilities, not by action 30.6 percent per annum return over the last wider active manager spread. Large-capi- (positive or negative) of the market. twenty years, far exceeding the 16.6 pertalization domestic equities represent the Selecting top managers in private mar- cent per annum results of a pool of private next rung of the e∞ciency ladder, with a kets leads to much greater reward than equity managers compiled by Cambridge range of 4.5 percent. identifying top managers in public mar- Associates. While both the bond portfolio Absolute return strategies, which gener- kets. In the extreme case, over the past and the private equity portfolio benefited ate returns independent of markets and decade, choosing a first-quartile fixed from superior active management, the lack an investible benchmark, demonstrate income manager added only 0.3 percent absolute contribution from superior results less e∞ciency than fixed income and large- per annum relative to the median result.

In in the ine∞cient world of private equity far capitalization equity securities, with a contrast, the first-quartile real estate man- exceeded the contribution from superior range of 4.9 percent between top and bot- ager added 9.5 percent per annum relative results in the e∞cient world of government tom quartiles. In all likelihood, survivor- to the median. Ironically, identifying supe- bonds. Careful consideration of the degree ship bias in the absolute return data under- rior managers in the relatively ine∞ciently of market opportunity when structuring states the true spread of manager results. priced private markets proves less challeng- portfolios makes an important contribution If failed managers, with their poor results, ing than in the e∞ciently priced marketable to Yale’s investment performance. were included, the reported dispersion securities markets. would increase. In the ultra-e∞cient bond market, Yale Domestic small-capitalization stocks holds a portfolio with market-like interest show a larger gap, with a range of 6.5 per- rate sensitivity, occasionally making care-cent per annum between top and bottom fully controlled security selection bets.

Alternative Asset Returns Exhibit Significant Dispersion Asset Returns by Quartile. Ten Years Ending June 30, 2010 30% 25% 20% 15% Dispersion of Returns 10% 5% -5% -10% -15% U.S. Fixed U.S. Large- Absolute U.S. Small- Venture Leveraged Real Income Capitalization Return Capitalization Capital Buyouts Estate Equity Equity First Quartile Median Third Quartile Spending Policy The spending rule is at the heart of fiscal discipline for an endowed institution. Spending policies define an institution’s compromise between the conflicting goals of providing substantial support for current operations and preserving purchasing power of Endowment assets. The spending rule must be clearly defined and consistently applied for the concept of budget balance to have meaning.

The Endowment spending policy, which allocates Endowment earn-ings to operations, balances the competing objectives of providing a stable flow of income to the operating budget and protecting the real value of the Endowment over time. The spending policy manages the trade-o≠ between these two objectives by using a long-term spending rate target combined with a smoothing rule, which adjusts spending in any given year gradually in response to changes in Endowment market value. The target spending rate approved by the Yale Corporation currently stands at 5.25 percent. According to the smoothing rule, Endowment spending in a given year sums to 80 percent of the previous year’s spend-ing and 20 percent of the targeted long-term spending rate applied to the market value two years prior. The spending amount determined by the formula is adjusted for inflation and constrained so that the calculated rate is at least 4.5 percent, and not more than 6.0 percent of the Endow-ment’s inflation-adjusted market value one year prior. The smoothing rule and the diversified nature of the Endowment are designed to miti-gate the impact of short-term market volatility on the flow of funds to support Yale’s operations.

Spending Growth Surpasses Inflation 1950–2010 $1,400 $1,200 $1,000 $800 Millions $600 $400 $200 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 1950 Spending Inflated Spending from Post-1950 Endowment Gifts Inflated Actual Spending The spending rule has two implications. First, by incorporating the previous year’s spending, the rule eliminates large fluctuations, enabling the University to plan for its operating budget needs. Over the last twenty years, the standard deviation of annual changes in spending has been less than two-thirds that of annual changes in Endowment value. Second, by adjusting spending toward the long-term target spending level, the rule ensures that spending will be sensitive to fluctuating Endowment market values, providing stability in long-term purchasing power.

Despite the conservative nature of Yale’s spending policy, distributions to the operating budget rose from $281 million in fiscal 2000 to $1,108 million in fiscal 2010. The University projects spending of $986 million from the Endowment in fiscal 2011, representing 38 percent of revenues.

Helen Betts Joyce Jepsen Aerial view of Harkness Tower.

Illiquid Asset Valuation Accurate and timely valuations serve many figures di≠er measurably from true eco- sales studies and discounted cash flow important functions in the investment and nomic value. analyses. Comparable transactions yield a management of Endowment assets. Valu- According to Topic 820, three valuation series of pricing data that serves as a reaations help determine spending levels, techniques are generally accepted in the sonable basis for the valuation of real Endowment unit values, asset allocation determination of fair value: market estate. However, transactions involving targets, and investment performance. approach, income approach, and cost similar properties contemporaneous with Sensible valuation policies enhance confi- approach. the measurement date are rare, necessitatdence in portfolio management and facili- The market approach, or comparable ing subjective adjustments to account for tate fiduciary oversight. sales analysis, uses recent transactions of di≠erences in timing, property quality, and Spending policies specify the trade-o≠ comparable assets to derive a range of mar- location. During periods of relatively low between protecting assets for the benefit of ket-based pricing metrics that are applied transaction activity, real estate appraisal future scholars and providing stable oper- to non-marketed assets. The income relies on the income approach. This ating support to the University. An accurate approach, or discounted cash flow analysis, method, however, is no more accurate than Endowment valuation plays an important converts a stream of repeated future cash the assumptions used for rental growth, role in achieving inter-generational fair- flows to a single present value at a required vacancy, operating expenses, capital expen-ness. An undervalued Endowment disad- rate of return for the asset. The cost ditures, and exit multiples. Timberland vantages the scholars of today, as too little approach, or replacement analysis, is based assets are valued primarily through an money is released to the operating budget. on the estimated cost required to replace an appraisal process using valuation tech-Conversely, an overstated Endowment dis- asset; that is the price at which a market niques developed for real property. Simi-advantages future generations of Elis, as participant would be indi≠erent between larly to real estate, appraisers use both the too much is put toward current use. acquiring an asset and constructing a sub- market approach and the income approach, Correct valuations are vital in the for- stitute of comparable utility. with the latter representing the more premulation and maintenance of Endowment The private equity portfolio consists of valent method for Yale. Appraisals per-asset allocation. Studies have shown that leveraged buyout and venture capital formed using the income method examine asset allocation is the primary determinant investments. Most leveraged buyout firms the size, species mix, and growth rate of of fund performance. If the true value of provide Yale with quarterly statements that the timber on the property, as well as the certain asset classes is misstated, the Uni- reflect the fair value of underlying invest- potential value from development rights, versity may unintentionally be holding a ments. For public companies held within easement sales, and recreational leases. misallocated pool of assets, adversely the portfolio, general partners may dis- The valuation of privately held oil and a≠ecting its ultimate performance. count public market quotes to reflect trad- gas assets hinges on projected hydrocarbon The University’s policy is to record ing restrictions. For private companies, production and expenses (operating and investments at fair value, defined by values are determined using multiples of capital), expected commodity prices, and Financial Accounting Standards Board operating cash flow or earnings for compa- the cost of capital employed to discount (fasb) Topic 820, formerly codified in rable public companies or recent transac- future cash flows to their present value. fasb-157 as the “price that would be tions involving comparable private Production and expense forecasts are the received to sell an asset or paid to transfer a companies. result of well-by-well analysis by oil and liability in an orderly transaction between Most of Yale’s venture capital firms gas engineers and are subject to annual market participants.” For marketable secu- employ similar valuation techniques to third party audits. Price projections depend rities in the domestic equity, foreign equity, produce quarterly reports. Early stage com- on the futures markets for both oil and absolute return, and fixed income portfo- panies tend to be valued at cost. Should a natural gas. Discount rates are a function lios, holdings are marked using closing company complete a major round of exter- of interest rate levels and the risk premi-prices or quotations from major stock nal financing, Yale’s managers most often ums associated with producing oil and exchanges and over-the-counter markets. mark up or mark down their investment to gas assets.

Illiquid investments, such as those held the valuation at which the financing was Several problems arise from the valua-in the private equity and real assets portfo- completed. For more mature positions that tion of illiquid assets. The infrequency of lios, are much more di∞cult to value given have not raised recent third-party financ- appraisals and lack of current data result in the lack of a publicly quoted system. In ings, comparable company analysis has values that reflect past, rather than current, general, Yale uses valuations provided by become increasingly common. Like their market conditions. The timing mismatch the general partner to account for illiquid peers in the leveraged buyout world, ven- generally causes private values to lag assets. fasb Accounting Standards Update ture capital firms sometimes take liquidity behind their public counterparts. Further-No. 2009-12 allows the Endowment to discounts on publicly traded stocks in their more, periodic valuation naturally mutes employ general partner valuations without portfolio. volatility, dampening short-term changes adjustment provided that the net asset The real assets portfolio consists of real in value and complicating evaluation of the value of the underlying investments is estate, timberland, and energy investments. risk profile of the asset. determined in accordance with Topic 820. Real estate valuations rely on the appraisal Analysis of disposition proceeds (acqui-However, in rare situations the Investments process as the primary method for deter- sitions, public o≠erings, bankruptcies, etc.) O∞ce may report valuations di≠erent from mining fair value. The two most important compared to the previous June 30 carrying those provided by managers if there is a valuation techniques employed in the values for illiquid assets over the last ten strong reason to believe that reported appraisal of real property are comparable years shows a conservative bias on the part of illiquid asset managers, with notable lower than in other years, leading to an pendent third party appraisals in detail exceptions after significant equity market average ratio over ten years of approxi- with its partners to understand the funda-corrections in 2001 and 2009. In 2001, dis- mately 160 percent, indicating that the mental inputs involved in the process. By position proceeds came in at 47 percent of average disposition value exceeded the paying careful attention to illiquid asset June 2000 Internet bubble valuations, and carrying value by 60 percent. valuation, the University improves day-to-in 2009, disposition proceeds came in at 92 The Investments O∞ce recognizes both day management of the overall portfolio percent of the pre-crisis June 30, 2008 car- the importance of accurate valuation and and increases understanding of the charac-rying value. Fortunately, disposition activ- the complexity of the process. Yale periodi- ter of individual manager portfolios. ity in 2001 and 2009 was significantly cally reviews internal valuations and inde- Spires of Yale Law School, completed in 1931, designed by James Gamble Rogers.

Investment Performance Yale has produced excellent long-term investment returns. Over the ten- year period ending June 30, 2010, the Endowment earned an annualized 8.9 percent return, net of fees, surpassing annual results for domestic stocks of -0.7 percent and domestic bonds of 6.5 percent, and placing it in the top one percent of large institutional investors. Endowment out-performance stems from sound asset allocation policy and superior active management.

Yale’s long-term superior performance relative to its peers and benchmarks has created substantial wealth for the University. Over the ten years ending June 30, 2010, Yale added $0.6 billion relative to its composite benchmark and $7.9 billion relative to the average return of a broad universe of college and university endowments.

Performance by Yale’s long-term asset class performance continues to be outstanding. In Asset Class the past ten years every asset class posted superior returns, outperforming benchmark levels.

Over the past decade, the absolute return portfolio produced an annualized 11.1 percent, exceeding the passive benchmark of the One-Year Constant Maturity Treasury plus 6 percent by 1.3 percent per year and besting the active benchmark of hedge fund manager returns by 5.1 per-cent per year. For the ten-year period, absolute return results exhibited little correlation to traditional marketable securities, although correlation has risen in recent years.

For the ten years ending June 30, 2010, the domestic equity port-folio returned an annualized 6.7 percent, outperforming the Wilshire 5000 by 7.4 percent per year and the Russell Median Manager return by 6.8 percent per year. Yale’s active managers have added value to bench-mark returns primarily through stock selection. Yale’s internally managed fixed income portfolio earned an annualized 6.3 percent over the past decade, exceeding the Barclays Capital Treasury Index by 0.3 percent per year and the Russell Median Manager Yale’s Performance Exceeds Peer Results 2000 to 2010, 2000=$100 $400 $300 $200 $100 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Endowment Mean of Broad Universe of Colleges and Universities Inflation return by 0.6 percent per year. By making astute security selection deci-sions and accepting a moderate degree of illiquidity, the Endowment benefited from excess returns without incurring material credit or option risk.

The foreign equity portfolio generated an annual return of 13.8 percent over the ten-year period, outperforming its composite benchmark by 8.0 percent per year and the Russell Median Manager return by 7.9 percent per year. The portfolio’s excess return is due to astute country allocation and e≠ective security selection.

Results from Yale’s non-marketable assets demonstrate the value of superior active management. Private equity earned 6.2 percent annually over the last ten years, underperforming the passive benchmark of University inflation plus 10 percent by 7.7 percent per year, but outper-forming the return of a pool of private equity managers compiled by Cambridge Associates by 2.4 percent per year. Since inception in 1973, the private equity program has earned an astounding 30.3 percent per annum.

Real assets generated a 10.9 percent annualized return over the ten-year period, outperforming the passive benchmark of University inflation plus 6.0 percent by 1.1 percent per year and the active bench-mark of real assets manager returns by 1.5 percent per year. Yale’s outperformance is due to successful exploitation of market ine∞ciencies and timely pursuit of contrarian investment strategies.

Yale Asset Class Results Beat Benchmarks 2000–2010 16% 14% 12% 10% 8% 6% Kelsie Newsom 4% 2% -2% Absolute Return Domestic Equity Fixed Income Foreign Equity Private Equity Real Assets Yale Return Active Benchmark Passive Benchmark Active Benchmarks Passive Benchmarks Absolute Return: csfb/Tremont Composite Absolute Return: 1-year Constant Maturity Treasury + 6% Domestic Equity: Frank Russell Median Manager, U.S. Equity Domestic Equity: Wilshire 5000 Fixed Income: Frank Russell Median Manager, Fixed Income Fixed Income: BarCap 1-5 Yr Treasury Foreign Equity: Frank Russell Median Manager Composite, Foreign Equity: 44% msci eafe Index, 28% msci em Index, Foreign Equity 28% Opportunistic Benchmark (custom China/India blend) Kimberly E. Stewart Private Equity: Cambridge Associates Composite Private Equity: University Inflation + 10% Real Assets: ncreif and Cambridge Associates Composite Real Assets: University Inflation + 6% Management and Since 1975, the Yale Corporation Investment Committee has been respon- sible for oversight of the Endowment, incorporating senior-level invest-Oversight ment experience into portfolio policy formulation. The Investment Committee consists of at least three Fellows of the Corporation and other persons who have particular investment expertise. The Committee meets quarterly, at which time members review asset allocation policies, Endowment performance, and strategies proposed by Investments O∞ce sta≠. The Committee approves guidelines for investment of the Endow-ment portfolio, specifying investment objectives, spending policy, and approaches for the investment of each asset category.

Investment Committee Current Members Douglas A. Warner iii ’68 Richard C. Levin ’74 ph.d.

Chairman President Former Chairman Yale University J.P. Morgan Chase & Co.

G. Leonard Baker ’64 Joshua Bekenstein ’80 Stefan Kaluzny ’88 Henry F. McCance ’64 Managing Director Managing Director Former Managing Director Chairman Emeritus Sutter Hill Ventures Bain Capital Golden Gate Capital Greylock Management William I. Miller ’78 Ranji Nagaswami ’86 m.b.a. Dinakar Singh ’90 Fareed R. Zakaria ’86 Chairman Chief Investment Advisor ceo and Founding Partner Host Irwin Management Company City of New York tpg-Axon Capital cnn pantone 5455c The Investments O∞ce manages the Endowment and other University financial assets, and defines and implements the University’s borrowing strategies. Headed by the Chief Investment O∞cer, the O∞ce currently consists of twenty-five professionals.

Investments O∞ce Sta≠ David F. Swensen ’80 ph.d. Suzanne K. Wirtz Chief Investment O∞cer Associate Director Dean J. Takahashi ’80, ’83 mppm Celeste P. Benson Senior Director Senior Portfolio Manager Peter H. Ammon ’05 m.b.a., ’05 m.a. R. Alexander Hetherington ’06 Director Senior Associate Alexander C. Banker Matthew S. T. Mendelsohn ’07 Director Senior Financial Analyst Alan S. Forman Jonathan Rhinesmith ’08 Director Senior Financial Analyst Timothy R. Sullivan ’86 John V. Ricotta ’08 Director Senior Financial Analyst Stephanie S. Chan ’97 Michael R. Schmidt ’08 Associate General Counsel Senior Financial Analyst Deborah S. Chung Cain P. Solto≠ ’08 Associate General Counsel Senior Financial Analyst Kenneth R. Miller ’71 Tess A. Dearing ’09 Associate General Counsel Financial Analyst J. Colin Sullivan David S. Katzman ’10 Associate General Counsel Financial Analyst Carrie A. Abildgaard Nilesh V. Vashee ’09 Associate Director Financial Analyst Michael E. Finnerty Xinchen Wang ’09 Associate Director Financial Analyst Lisa M. Howie ’00, ’08 m.b.a.

Associate Director Sources Photo Credits Much of the material in this publication Pages 11-25 Cover photo: Michael Marsland, is drawn from memoranda produced by Educational institution asset allocations Yale O∞ce of Public A≠airs. the Investments O∞ce for the Yale from Cambridge Associates.

Corporation Investment Committee. Photographs of Committee members on Other material comes from Yale’s Page 26 page 34: courtesy of the individual members. financial records, Reports of the Domestic and foreign equity, absolute return, Treasurer, and Reports of the President. and fixed income numbers are based on bny Other photographs by Michael Marsland, Mellon data; venture, leveraged buyout, and Yale O∞ce of Public A≠airs. Pages 6-7 real estate numbers are based on Cambridge Yale data from George W. Pierson, Associates data. Design A Yale Book of Numbers: Historical Statistics of the College and University Page 32 Strong Cohen/D. Pucillo 1701-1976 (New Haven: Yale The Endowment’s annual return for the University Press, 1983) and Yale ten years ending June 30, 2010 ranks in O∞ce of Institutional Research. the top one percent of institutional funds as measured by the sei Large Plan Universe.

Opposite: The Yale shield, from Sheffield-SterlingStrathcona Hall.

Left: Gargoyle at Yale Law School.