耶鲁捐赠基金2012年（耶鲁投资办公室年度报告）

The Yale Endowment

Endowment Highlights Fiscal Year 2012 2011 2010 2009 2008

Endowment Market Value 1950–2012 $25

$20

Billions $15

$10

$5

1. 2. 3. 4. 5. 6.

Front Window cover: of Sterling Memorial Library, east façade. The Right: colonnade, at left, the Alumni War Memorial to Yale façade men of University who died in Commons. World War The i, forms Beinecke the Rare south Book and Manuscript Library is seen at right.

Contents

Introduction 2 The Yale Endowment 4 Investment Policy 5 Spending Policy 14 Investment Performance 16 Management and Oversight 18

1 Introduction Yale’s Endowment generated a 4.7 percent return in fiscal 2012, producing an investment gain of $913 million. Over the past ten years, the Endowment grew from $10.5 billion to $19.3 billion. With annual net investment returns of 10.6 percent, the Endowment’s performance exceeded its benchmark and outpaced institutional fund indices. For nine of the past ten years, Yale’s ten-year record ranked first in the Cambridge Associates universe. The Yale Endowment’s twenty-year record of 13.7 percent per annum produced a 2012 Endowment value of nearly seven times the 1992 value. Yale’s excellent long-term record stems from disciplined and diversified asset allocation policies and superior active management results. Spending from the Endowment grew during the last decade from $409 million to $994 million, an annual growth rate of approximately 9 percent. On a relative basis, Endowment contributions expanded from 28 percent of total revenues in fiscal 2002 to 35 percent in fiscal 2012. Next year, spending will amount to $1.03 billion, or 36 percent of projected revenues. Yale’s spending and investment policies provided substantial levels of cash flow to the operating budget for current scholars while preserving Endowment purchasing power for future generations.

Disciplined Long-Term Investing

Beginning in the mid 1980s, the Yale ture capital boosted Yale’s returns far above institutions chose to reduce equity expoEndowment built a superior track record institutional averages. The Endowment’s sure near the market’s nadir as concerns on an unconventional foundation. From outsized private equity returns o≠set the over portfolio illiquidity and volatility the late 1980s through the mid 1990s, the substantial underperformance of Yale’s mounted. Yale sought instead to maintain Endowment’s revolutionary shift to non- value-oriented, marketable-security man- equity exposure, aggressively managing traditional asset classes, coupled with the agers, which lagged their benchmarks as liquidity and prudently employing debt. selection of excellent active managers, led stocks climbed to unprecedented levels. As markets rebounded, Yale benefited. to outstanding returns in a variety of After 2000, the University produced Yale’s equity positions, both liquid and market conditions. superior performance based on both illiquid, produced outsized returns as asset In the late 1990s, however, Yale’s non- superb active management and the Endow- prices recovered post-crisis. Endowment traditional portfolio seemed out of step ment’s well-diversified asset allocation. In performance since June 30, 2008 is now with the markets. Fundamentals decoupled the aftermath of the Internet bubble, with positive, although the Endowment value from prices, creating a di∞cult environ- the S&P 500 declining slightly in the eight- remains below peak because of spending ment for bottom-up, research-driven man- year period ending June 30, 2008, Yale’s distributions to fund University operations. agers. Diversification did not help returns investment managers had the opportunity Yale’s exceptional results have been as traditional large allocations to domestic to distinguish themselves in an environ- achieved by adhering to a fundamentally equities were rewarded year in and year ment without irrational exuberance. sound investment program. Instead of out, with the S&P 500 growing at a 20.6 Yale’s fortunes changed for the worse chasing short-term performance, the percent annualized rate during the seven- during the recent financial crisis. Markets University invests with a long-term view. year period ending June 30, 2000. Never- rewarded positions that provided a safe Yale consistently generated superior returns theless, in spite of the asset allocation haven, most notably full faith and credit by maintaining discipline, standing by headwind, the Endowment outperformed holdings of the U.S. government. Yale’s quality managers, and retaining sound its passive and active benchmarks, albeit portfolio, positioned for strong long-term investments despite su≠ering through by modest margins. returns, lacked significant exposure to low occasional market turbulence. In fiscal 2000, the University’s fortunes expected return Treasury securities and changed. Extraordinary returns from ven- su≠ered in the market meltdown. Some

Afternoon view of the Silliman College courtyard. 3

2 The Yale Endowment Totaling $19.3 billion on June 30, 2012, the Yale Endowment contains thousands of funds with various purposes and restrictions. Approximately three-quarters of funds constitute true endowment, gifts restricted by donors to provide long-term funding for designated purposes. The remaining one-quarter of funds 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 percent); scholarships, fellowships, and prizes (17 percent); maintenance (4 percent); books (3 percent); and miscellaneous specific purposes (27 percent). Twenty-five percent of funds are unrestricted. Twenty-five percent of the Endowment benefits the overall University, with remaining funds focused on specific units, including the Faculty of Arts and Sciences (35 percent), the professional schools (26 percent), the library (7 percent), and other entities (7 percent). Although distinct in purpose or restriction, Endowment funds are commingled in an investment pool and tracked with unit accounting much like a large mutual fund. Endowment gifts of cash, securities, or property are valued and exchanged for units that represent a claim on a portion of the total investment portfolio. In fiscal 2012 the Endowment provided $994 million, or 35 percent, of the University’s $2.852 billion operating income. Other major sources of revenues were grants and contracts of $699 million (25 percent); medical services of $541 million (19 percent); net tuition, room, and board of $256 million (9 percent); gifts of $115 million (4 percent); and other income and transfers of $246 million (9 percent).

Endowment Fund Allocation Operating Budget Revenue Fiscal Year 2012 Fiscal Year 2012

Endowment Unrestricted Professorships

Other and Transfers Income

Gifts Grants and Contracts Miscellaneous Scholarships Tuition, and Board Room, Specific Purposes Books Maintenance Medical Services

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3 Investment Policy Yale’s portfolio is structured using a combination of academic theory and informed market judgment. The theoretical framework relies on meanvariance 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 market 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 allocation process. The combination of quantitative analysis and market judgment employed by Yale produces the following portfolio:

June 2012 June 2012 Asset Class Actual Target

Absolute Return 14.5% 18.0% Domestic Equity 5.8 6.0 Fixed Income 3.9 4.0 Foreign Equity 7.8 8.0 Natural Resources 8.3 7.0 Private Equity 35.3 35.0 Real Estate 21.7 22.0 Cash 2.7 0.0

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The target mix of assets produces an expected real (after inflation) longterm growth rate of 6.3 percent with risk (standard deviation of returns) of 15.2 percent. Because actual holdings di≠er from target levels, the actual allocation produces a portfolio expected to grow at 6.2 percent with risk of 15.1 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 May 2012 meeting, Yale’s Investment Committee adopted a number of changes to the University’s policy portfolio allocations. The Committee approved increases in the private equity target from 34 percent to 35 percent, in the absolute return target from 17 percent to 18 percent, and in the real estate target from 20 percent to 22 percent. Those increases were funded by one-percentage-point decreases in both domestic equity and foreign equity targets and a two-percentage-point decrease in the natural resources target. The need to provide resources for current operations as well as to preserve the purchasing power of assets dictates investing for high returns, causing the Endowment to be biased toward equity. 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 for investment in assets expected to produce equity-like returns, through holdings of domestic and international securities, absolute return strategies, real estate, natural resources, and private equity. Over the past two decades, Yale dramatically reduced the Endowment’s dependence on domestic marketable securities by reallocating assets to nontraditional asset classes. In 1992, 51 percent of the Endowment was committed to U.S. stocks, bonds, and cash. Today, target allocations call for 10 percent in domestic marketable securities, while the diversifying assets of foreign equity, natural resources, private equity, absolute return, and real estate dominate the Endowment, representing 90 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 portfolios have significantly higher expected returns and lower volatility than the 1992 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 exploit illiquid, less e∞cient markets such as venture capital, leveraged buyouts, oil and gas, timber, and real estate.

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Asset Allocation and Active Management

The Yale Investments O∞ce seeks to meet Yale Moves Toward Risk-Return E∞ciency its investment goals through prudent asset 7.0% allocation and astute manager selection. Beginning in the mid 1980s, Yale’s asset 6.5% allocation policies, informed by quantitative analysis and market insight, shifted toward a broadly diversified portfolio with 6.0% 2008 2010 2012 a strong orientation toward investments Rate Current Target that promise equity-like returns and strate- Growth 2005 gies that exploit market ine∞ciencies. By 5.5% Unconstrained E∞cient 1996 the mid 1990s, Yale had achieved most of Frontier the gains in portfolio e∞ciency available Real from a diversified, equity-oriented 5.0% approach. In subsequent years, changes in allocation targets largely reflected attempts 4.5% 1990 to exploit the most attractive investment Constrained E∞cient opportunities in the context of sensible Frontier long-term allocation targets. 4.0% As Yale’s asset allocation reached a point 9% 10% 11% 12% 13% 14% 15% of relative stability and the University’s Volatility peer institutions began employing similar endowment management models, manager selection became an increasingly important Cumulative Return for Twenty Years Ending June 30, 2012 di≠erentiating factor for Yale. In fact, for 1400% the twenty years ending June 30, 2012, nearly 80 percent of Yale’s outperformance 1200% 13.7% per annum relative to the average Cambridge Associ- Asset Allocation Value Add 1.1% ates endowment was attributable to the 1000% Manager Value Add 4.1% value added by Yale’s active managers, Total Value Add 5.2% while only 20 percent was the result of Yale’s asset allocation. Over the past two 800% decades, the Endowment returned a cumulative 1,204 percent relative to the 600% 9.6% per annum Cambridge median of 413 percent, an outperformance of 5.2 percent per annum. If 400% Yale had employed its actual asset allocation but had earned the rate of return of 8.5% per annum the median manager in each asset class, it 200% would have outperformed the Cambridge median manager by 1.1 percent per year, 0 the value added by Yale’s asset allocation. 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 The remaining 4.1 percent per annum of Yale Returns Yale Asset Allocation x Median Cambridge Median the Endowment’s outperformance results Manager Returns from Yale’s active management.

International Center for Finance at the Yale School of Management, seen from west. 7

Asset Class Yale’s seven asset classes are defined by di≠erences in their expected Characteristics response to economic conditions, such as economic growth, price inflation, or changes in interest rates, and are weighted in the Endowment portfolio by considering their 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, subject to fundamental diversification and liquidity constraints.

Absolute Return In July 1990, Yale became the first institutional investor to pursue absolute return strategies as a distinct asset class, beginning with a target allocation of 15.0 percent. Designed to provide significant diversification to the Endowment, absolute return investments are expected to generate high long-term real returns by exploiting market ine∞ciencies. The portfolio is invested in two broad categories: event-driven strategies and value-driven strategies. Event-driven strategies rely on a very specific corporate event, such as a merger, spin-o≠, or bankruptcy restructuring, to achieve a target price. Value-driven strategies involve hedged positions in assets or securities with prices that diverge from their underlying economic value. Today, the absolute return portfolio is targeted to be 18.0 percent of the Endowment, below the average educational institution’s allocation of 23.8 percent to such strategies. Absolute return strategies are expected to generate a real return of 5.25 percent with risk of 12.5 percent. Unlike traditional marketable securities, absolute return investments have historically provided returns largely independent of overall market moves. Over the past ten years, the portfolio exceeded expectations, returning 10.0 percent per year with low correlation to domestic stock and bond markets.

Domestic Equity Financial theory predicts that equity holdings will generate returns superior to those of less risky assets such as bonds and cash. The predominant asset class in most U.S. institutional portfolios, domestic equity represents a large, liquid, and heavily researched market. While the average educational institution invests 18.5 percent of assets in domestic equities, Yale’s target allocation to this asset class is only 6.0 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 outperform the market index by a few percentage points, net of fees, annually. Because superior stock selection provides the most consistent and reliable opportunity for generating attractive returns, the University favors managers with exceptional bottom-up, fundamental research capabilities. Managers searching for out-of-favor securities often find stocks that are cheap in relation to fundamental measures such as asset value, future earnings, or cash flow.

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Fixed Income Fixed income assets generate stable flows of income, providing more certain nominal cash flow than any other Endowment asset class. The bond portfolio exhibits a low covariance with other asset classes and serves as a hedge against financial accidents or periods of unanticipated deflation. While educational institutions typically maintain a substantial allocation to fixed income instruments, averaging 13.3 percent, Yale’s target allocation to fixed income and cash is only 4.0 percent of the Endowment. 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 expected returns of the seven asset classes that make up the Endowment. In addition, the government bond market is arguably the most e∞ciently priced asset class, o≠ering few opportunities to add significant value through active management. On the basis of skepticism of active fixed income strategies and belief in the e∞cacy of a highly structured approach to bond portfolio management, the Investments O∞ce chooses to manage Endowment bonds internally. Though averse to market timing strategies, credit risk, and call options, Yale manages to add value consistently in its management of the bond portfolio.

(part The rotunda of She∞eld-Sterling-Strathcona above Memorial Hall, with Hall) Sterling at left. Tower

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Opportunity for Active Management

Yale directs active management e≠orts to will be, few managers employ interest rate e∞ciently priced than U.S. markets because less e∞ciently priced asset classes and anticipation strategies. Without potentially of their lower liquidity, spotty research employs less aggressive approaches for powerful di≠erentiating bets on interest coverage, and smaller local investor bases. more e∞ciently priced assets. Given equal rates, institutional portfolios tend to These markets present greater opportuniexpenditure of time and e≠ort, active man- exhibit market-like interest rate sensitivity, ties for superior stock selection as demonagement promises greater rewards in the or duration. As a result, managers generally strated by the larger range in manager perinfrequently traded, illiquid world of alter- limit themselves to modest security selec- formance. The spreads between top and native assets than in the heavily traded, tion decisions, causing returns for most bottom quartile developed and emerging liquid world of traditional marketable active managers to mimic benchmark market managers are 2.7 percent and 2.8 securities. results. The spread between top and bot- percent per annum, respectively. The distribution of actively managed tom quartile results for active bond man- Illiquid assets show substantially larger returns in a particular asset class serves as agers measures an astonishingly small annualized spreads with leveraged buyouts an indicator of the degree of opportunity 0.8 percent per annum for the decade. at 13.8 percent, natural resources at 17.4 for active management. Pricing ine∞cien- Less e∞ciently priced securities trade in percent, real estate at 19.1 percent, and vencies allow managers with great skill to wider ranges. Stocks provide more di∞cult ture capital at 19.8 percent. Lacking investachieve great success, while unskilled man- pricing challenges than bonds. Instead of able benchmarks, managers of illiquid agers post commensurately poor results. discounting relatively certain fixed income assets succeed or fail by dint of their skills Hard work and intelligence only reap rich cash flows, valuation of equities involves and abilities, not by the action (positive or rewards in environments where superior manager judgment in discounting far-less- negative) of the market. Furthermore, the information, skill, deal flow, and long- certain corporate cash flows. Greater vola- operational, strategic, and company-buildterm time horizon provide an edge. Active tility in equity markets contributes to the ing skills of private equity and real assets managers in less e∞cient markets exhibit wider active manager spread. Large-capi- managers can add tremendous value to greater variability in returns. talization domestic equities represent the their portfolio holdings and di≠erentiate The accompanying figure shows active next rung of the e∞ciency ladder, with a the strongest performers from their lackmanager returns for various asset classes. range of 1.5 percent per annum between luster peers. The spread in returns between the top and top and bottom quartiles. Selecting top managers in private marbottom quartiles in collections of actively Domestic small-capitalization stocks kets leads to much greater reward than managed portfolios illustrates the notion show a larger gap, with a range of 2.3 per- identifying top managers in public marthat more e∞ciently priced assets provide cent per annum between top and bottom kets. On the other hand, poor private manless opportunity for active managers and quartiles. The progression of degree of ager selection can lead to extremely disapthat less e∞ciently priced assets provide opportunity across types of marketable pointing results as a consequence of high more opportunity. securities makes intuitive sense: smaller- fees, poor performance, and illiquid posiU.S. Treasury securities, arguably the capitalization stocks provide natural limits tions. Careful consideration of the degree most e∞ciently priced asset in the world, on the size of stakes investors can take, of market opportunity when formulating trade in staggering volumes in markets often precluding larger and more sophisti- asset allocation policies and structuring dominated by savvy financial institutions. cated asset managers from finding and portfolios makes an important contribution The Treasury market provides the bench- exploiting pricing ine∞ciencies. to investment performance. mark for all other fixed income trading. Many foreign equity markets, particuSince nobody knows where interest rates larly emerging markets, tend to be less

Alternative Asset Returns Exhibit Significant Dispersion 30.0% Active Manager Returns by Quartile for Periods Ending June 30, 2012 *

25.0%

Returns 20.0% 15.0%

of 10.0% Dispersion 5.0%

0.0 -5.0%

-10.0% U.S. Fixed U.S. Large U.S. Small Developed Emerging U.S. Natural U.S. Real U.S. Venture Income Capitalization Equity Capitalization Equity Market Equity Market Equity Leveraged Buyouts Resources Estate Capital

25th Percentile Median 75th Percentile * Venture Fixed income capital, and lbo, marketable real estate, equity and performance natural resources based returns on annualized based on ten-year annualized returns since-inception of bny Mellon irrs manager of Cambridge universes, Associates adjusted manager for fees. universes.

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Foreign Equity Foreign equity investments give the Endowment exposure to the global economy, providing diversification and the opportunity to earn outsized returns through active management. Yale allocates 3.0 percent of its portfolio to foreign developed markets and 2.0 percent to emerging markets. In addition, Yale dedicates 3.0 percent of the portfolio to opportunistic foreign positions, with the expectation that holdings will be concentrated in markets that o≠er the most compelling long-term opportunities, particularly China, India, and Brazil. Yale’s foreign equity target allocation of 8.0 percent stands below the average endowment’s allocation of 18.2 percent. Expected real returns for emerging equities are 7.5 percent with a risk level of 22.5 percent, while developed equities are expected to return 6.0 percent with risk of 20.0 percent. The portfolio is measured against a composite benchmark of (a) developed markets, measured by the Morgan Stanley Capital International (msci) Europe, Australasia, and Far East (eafe) Investable Market Index; (b) emerging markets, measured by a blend of the msci Emerging Markets Investable Market Index and the msci China A-Share Index; and (c) opportunistic investments, measured by a custom blended index. Yale’s investment approach to foreign equities emphasizes active management designed to uncover attractive opportunities and exploit market ine∞ciencies. As in the domestic equity portfolio, Yale favors managers with strong fundamental research capabilities. Capital allocation to individual managers takes into consideration the country allocation of the foreign equity portfolio, the degree of confidence that Yale possesses in a manager, and the appropriate size for a particular strategy. In addition, Yale attempts to exploit compelling undervaluations in countries, sectors, and styles by allocating capital to the most compelling opportunities.

Yale University Art Gallery. 11

Natural Resources Equity investments in natural resources—oil and gas, timberland, and metals and mining—share common risk and return characteristics: protection against unanticipated inflation, high and visible current cash flow, and opportunities to exploit ine∞ciencies. At the portfolio level, natural resource investments provide attractive return prospects and significant diversification. Yale has a 7.0 percent long-term policy allocation to natural resources with expected real returns of 6.2 percent and risk of 18.2 percent. Yale’s current natural resources allocation is in line with that of the average endowment. The natural resources portfolio is a fundamental component of the Endowment as it o≠ers powerful diversification and promises strong returns. Superior operators have demonstrated the ability to generate excess returns over a market cycle. The inception-to-date return of Yale’s oil and gas (1986), timber (1996), and mining (2011) portfolio clocks in at an impressive 16.0 percent per annum.

Private Equity Private equity o≠ers extremely attractive long-term risk-adjusted returns, stemming from the University’s strong stable of value-adding managers that exploit market ine∞ciencies. Yale’s private equity portfolio includes investments in venture capital and leveraged buyout partnerships. The University’s target allocation to private equity of 35.0 percent far exceeds the 10.9 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 26.8 percent. Yale’s private equity program, one of the first of its kind, is regarded as among the best in the institutional investment community and the University is frequently cited as a role model by other investors. Since inception in 1973, private equity investments have generated a 30.0 percent annualized return to the University. Yale’s private equity strategy emphasizes partnerships with firms that pursue 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 relationships—generally, a commitment is expected to be the first of several—and toward the close alignment of the interests of general and limited partners.

Real Estate Investments in real estate provide meaningful diversification to the Endowment. A steady flow of income with equity upside creates a natural hedge against unanticipated inflation without a sacrifice of expected return. Yale’s 22.0 percent long-term policy allocation significantly exceeds the average endowment’s commitment of 4.3 percent. Expected real returns are 6.0 percent with risk of 17.5 percent. While real estate markets sometimes produce dramatically cyclical returns, pricing ine∞ciencies in the asset class and opportunities to add value allow superior managers to generate excess returns over long time horizons. Since inception in 1978, the portfolio has returned 11.6 percent per annum.

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The illiquid nature of private real estate and the time-consuming process of completing transactions create a high hurdle for casual investors. A critical component of Yale’s investment strategy is to create strong, long-term partnerships between the Investments O∞ce and its investment managers. In the last two decades, Yale played a critical role in the development and growth of a number of successful real estate investment organizations.

Asset Allocations Yale Educational University Institution Mean

Absolute Return 14.5% 23.8% Domestic Equity 5.8 18.5 Fixed Income 3.9 13.3 Foreign Equity 7.8 18.2 Natural Resources 8.3 8.2 Private Equity 35.3 10.9 Real Estate 21.7 4.3 Cash 2.7 2.7

Data as of June 30, 2012

Active Management and Career Risk

Successful active management requires a managing a much diminished portfolio. during the manic markets of 1994 through contrarian focus on ine∞cient markets These dire business consequences push 1999 resulted in a client exodus, however, and out-of-favor assets, which present the many managers to hug their benchmarks taking assets from a peak of $2.8 billion in greatest opportunity to take advantage of in the name of career preservation. 1996 to just $578 million by 2002. The mispricings and generate outsized returns. Prominent investor Jeremy Grantham fund robustly recovered during the 2000 In practice, however, such contrarian of Grantham Mayo Van Otterloo (gmo) through 2005 period, outperforming its behavior is rare—most fund managers notes that “the main driver in risk manage- benchmark by 9.5 percent per annum, but herd around popular investment strategies ment for most investors is, unfortunately, the majority of its clients were no longer or hew closely to their benchmarks rather career and business risk. This means that around to participate in the recovery. than pursue strategies that would likely controlling short-term benchmark risk Although the International Intrinsic Value produce greater rewards over the long dominates, and not the risk of the actual Strategy generated returns of 11.1 percent term. client losing real money.” Fund managers per year from its 1987 inception through Career risk is a significant driver of are much more likely to be fired for tempo- the end of 2006, outperforming msci manager behavior. A contrarian manager’s rary underperformance as their long-term eafe by 4.1 percent per annum, few portfolio di≠ers markedly from peer port- investments play out than they are for sus- investors reaped the sustained success folios and from market benchmarks. Con- tained mediocre performance in line with of gmo’s active strategy. sequently, the contrarian manager produces their peers. As John Maynard Keynes Only by building an investor base with results that diverge dramatically from those lamented in The General Theory, “it is a common investment philosophy, time of peers. Although a high-quality active better for reputation to fail conventionally horizon, resolve, and tolerance for tracking manager should outperform over the long than to succeed unconventionally.” error can a manager maintain the stable term, the manager’s idiosyncratic portfolio gmo experienced short-term bench- capital base required to see its contrarian is likely to underperform at various points mark risk first-hand with its International investments through to a successful conclualong the way. During those periods of Intrinsic Value Strategy. The strategy sion. As many managers and institutional underperformance, the manager will likely attracted investors in the early 1990s as it clients cower in the face of career risk lose clients. Even if the contrarian invest- dramatically outperformed its msci eafe issues, financing and executing a sensible ment thesis ultimately proves correct, the benchmark by 8.7 percent per year from active management program is challenging manager may already be out of business or 1990 through 1993. Poor relative returns and rare.

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Spending 4 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 earnings 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 combining a long-term spending rate target 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 spending and 20 percent of the targeted long-term spending rate applied to the fiscal year-end 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 Endowment’s inflation-adjusted market value two years prior. The smoothing rule and the diversified nature of the Endowment are designed to mitigate the impact of short-term market volatility on the flow of funds to support Yale’s operations.

Spending Growth Surpasses Inflation 1950–2012

$1,400

$1,200

$1,000

Millions $800

$600

$400

$200

Fiscal Year 14 1950 Spending Inflated Spending from Post-1950 Endowment Gifts Inflated Actual Spending

The spending rule has two implications. First, by incorporating the prior 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 65 percent of the standard deviation 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 $409 million in fiscal 2002 to $994 million in fiscal 2012. The University projects spending of $1.03 billion from the Endowment in fiscal 2013, representing approximately 36 percent of revenues.

Aerial view of Science Hill, with Kroon Hall at center left and Kline Biology Tower at the right. 15

5 Investment Performance Yale has produced excellent long-term investment returns. Over the tenyear period ending June 30, 2012, the Endowment earned an annualized 10.6 percent return, net of fees, surpassing annual results for domestic stocks of 3.8 percent and domestic bonds of 5.6 percent, and placing it among the top one percent of large institutional investors. Endowment outperformance 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, 2012, Yale added $7.3 billion relative to its composite benchmark and $7.2 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, nearly every asset class posted superior returns, significantly outperforming benchmark levels. Over the past decade, the absolute return portfolio produced an annualized 10.0 percent return, exceeding the passive Barclays 9-12 Month Treasury Index by 7.7 percent per year and besting its active benchmark of hedge fund manager returns by 4.6 percent per year. For the ten-year period, absolute return results exhibited little correlation to traditional marketable securities. For the ten years ending June 30, 2012, the domestic equity portfolio returned an annualized 9.8 percent, outperforming the Wilshire 5000 by 3.6 percent per year and the Russell Median Manager return, net of estimated fees, by 4.5 percent per year. Yale’s active managers have added value to benchmark returns primarily through stock selection. Yale’s internally managed fixed income portfolio earned an annualized 4.5 percent over the past decade, keeping pace with the Barclays 1-5 Year Treasury Index and exceeding the Russell Median Manager return by 0.4 percent per year. By making astute security selection decisions and accepting a moderate degree of illiquidity, the Endowment benefited from excess returns without incurring material credit or option risk.

Yale’s Performance Exceeds Peer Results June 30, 2002 to June 30, 2012, 2002=$100 $400

$300 $100 of Growth $200

$100

The foreign equity portfolio generated an annual return of 16.6 percent over the ten-year period, outperforming its composite benchmark by 6.5 percent per year and the Russell Median Manager return by 6.8 percent per year. The portfolio’s excess return is due to astute country allocation and e≠ective security selection by active managers. Yale’s natural resources portfolio produced an annualized return of 16.2 percent over the past decade, outperforming its composite passive benchmark by 4.7 percent per year though lagging the Cambridge Associates natural resources manager pool by 0.4 percent per year. Yale’s strong performance results from its partnership with superior operators. Private equity earned 13.2 percent annually over the last ten years, outperforming the composite passive benchmark by 5.2 percent per year and outperforming the return of a pool of private equity managers compiled by Cambridge Associates by 1.4 percent per year. Since inception in 1973, the private equity program has earned an astounding 30.0 percent per annum. Real estate generated a 7.3 percent annualized return over the ten-year period, underperforming the msci reit Index by 1.9 percent per year, but outperforming a pool of Cambridge Associates real estate managers by 5.3 percent per year. Yale’s active outperformance is due to successful exploitation of market ine∞ciencies and timely pursuit of contrarian investment strategies.

Yale Asset Class Results Beat Most Benchmarks June 30, 2002 to June 30, 2012 18% 16% 14% 12% 10% 8% 6% 4% 2% 0 Absolute Domestic Fixed Foreign Natural Private Real Return Equity Income Equity Resources * Equity * Estate * *Yale Returns and Active Benchmarks Yale Return are dollar-weighted Active Benchmark Passive Benchmark

Active Absolute Benchmarks Return: Dow Jones Credit Suisse Composite Passive Absolute Benchmarks Return: Barclays 9-12 Mo Treasury Domestic Fixed Income: Equity: Frank Frank Russell Russell Median Median Manager, Manager, Fixed U.S. Income Equity Domestic Fixed Income: Equity: Barclays Wilshire 1-5 5000 Yr Treasury Foreign Foreign Equity: Equity Frank Russell Median Manager Composite, Foreign Index, Equity: msci Blend Emerging of msci Markets eafe Investable Investable Market Market Index Natural Private Equity: Resources: Cambridge Cambridge Associates Associates Composite Natural Resources + Index msci China A-Shares, Custom Opportunistic Blended Real Estate: Cambridge Associates Real Estate Natural s&p o&g Resources: Exploration Blend & of Production Custom Timber Index, reit hsbc Basket, Global Private Mining Equity: Index Blend of Russell 2000, Russell 2000 Real Technology, Estate: msci msci reit acwi Index ex-US Small-Cap Index 17

Management and Since 1975, the Yale Corporation Investment Committee has been respon6 Oversight sible for oversight of the Endowment, incorporating senior-level investment 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 Endowment portfolio, specifying investment objectives, spending policy, and approaches for the investment of each asset category.

Investment Committee Douglas A. Warner, iii ’68 Stefan Kaluzny ’88 Chairman Managing Sycamore Partners Director Former J.P. Morgan Chairman Chase & Co. Richard C. Levin ’74 ph.d. Byron G. Auguste ’89 President Yale University Director McKinsey & Company Kevin Ryan ’85 G. Leonard Baker ’64 Founder Gilt Groupe and ceo Managing Sutter Hill Director Ventures Carter Simonds ’99 Joshua Bekenstein ’80 Managing Blue Ridge Director Capital Managing Bain Capital Director Dinakar Singh ’90 Ben Inker ’92 ceo tpg-Axon and Founding Capital Partner gmo Director of Asset Allocation

Paul Joskow ’72 ph.d. President Alfred P. Sloan Foundation

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Manager Attributes

Manager selection lies at the heart of Yale’s active management strategy. The Endowment has built longstanding investment relationships with talented active managers that exploit a rich set of investment opportunities across an array of market sectors, strategies, and asset classes. Each year, the Investments O∞ce meets with countless prospective investment managers, relentlessly evaluating opportunities to add new high-quality managers to Yale’s portfolio. When the Investments O∞ce identifies a promising fund manager, it conducts thorough due diligence to evaluate the group’s investment acumen and strategy, as well as its character and ethics, often spending several months getting to know a team prior to funding a new investment. Yale searches for intelligent and dedicated managers that have high integrity, sound investment philosophies, strong track records, superior organizations, and sustainable competitive advantages. Yale strives for excess returns by building sizeable relationships with firms that have a long-term orientation, as well as a rigorous investment process and exceptional bottom-up research capabilities. Successful managers execute a program that provides the conviction necessary to hold concentrated portfolios. The University seeks managers that exhibit significant discipline in their investment processes, that deploy

North façade of Branford Court.

capital only when they have found ine∞ciencies, and that exploit compelling opportunities for attractive returns. Yale’s marketable managers focus primarily on making attractive bottom-up, security-specific investments and frequently concentrate their e≠orts on companies with earnings driven by factors that can be reasonably forecast, such as production, costs, distribution, and pricing. Yale’s active managers tend to be attracted to less widely followed stocks and less e∞ciently priced markets, which o≠er better opportunities for superior managers to develop di≠erentiated insights and identify meaningfully mispriced securities. In Yale’s private equity, real estate, and natural resources portfolios, the Investments O∞ce seeks cohesive and motivated groups with a proven ability to create value independent of underlying market conditions. Ideal real estate partners possess superior operating and financial capabilities and focus on specific geographies or property types. Similarly, Yale seeks private equity firms that work closely with their portfolio companies to create fundamentally more valuable entities, relying only secondarily on financial engineering to generate returns. A critical component of Yale’s investment strategy is the creation of long-term partnerships with strong alignments of

interest. The Investments O∞ce targets employee-owned firms to ensure that incentive compensation appropriately benefits the investment team. Yale looks for a substantial co-investment from the general partners, which helps foster prudent decision-making and risk assessment. Yale aims to partner with firms that strive for investment excellence and that are willing to limit assets under management, ensuring flexibility to exploit attractive opportunities. Yale often looks to develop close relationships with firms early in their life cycles. As an investment management organization progresses through its life cycle, Yale monitors the relationship carefully to ensure that interests continue to coincide, that assets under management remain at reasonable levels, and that the manager remains motivated and capable of earning substantial returns. The University frequently supports emerging investment groups that are not well-known, brandname players. In some cases Yale creates proprietary opportunities by helping a firm enter the world of institutional fund management. The University seeks to build long-term relationships with high-quality investment managers, as evidenced by the average tenure of eleven years for managers in the Endowment portfolio.

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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-six professionals.

Investments O∞ce David F. Swensen ’80 ph.d. R. Alexander Hetherington ’06 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. Matthew S. T. Mendelsohn ’07 Director Senior Associate Alexander C. Banker John V. Ricotta ’08 Director Senior Associate Alan S. Forman Cain P. Solto≠ ’08 Director Senior Associate Lisa M. Howie ’00, ’08 m.b.a. David S. Katzman ’10 Director Senior Financial Analyst Timothy R. Sullivan ’86 Nilesh V. Vashee ’09 Director Senior Financial Analyst Kenneth R. Miller ’71 Xinchen Wang ’09 Senior Associate General Counsel Senior Financial Analyst Stephanie S. Chan ’97 Philip J. Bronstein ’12 Associate General Counsel Financial Analyst Deborah S. Chung Florence R. Dethy ’11 Associate General Counsel Financial Analyst J. Colin Sullivan Sebastian K. Serra ’11 Associate General Counsel Financial Analyst Carrie A. Abildgaard Kaiyuan Wang ’11 Associate Director Financial Analyst Michael E. Finnerty David Y. Zhang ’12 Associate Director Financial Analyst

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Sources Financial and Investment Information Educational institution asset allocations and returns from Cambridge Associates. Much of the material in this publication is drawn from memoranda produced by the Investments O∞ce for the Yale Corporation Investment Committee. Other material comes from Yale’s financial records, Reports of the Treasurer, and Reports of the President. Pages 8-13 Educational institution asset allocations and returns from Cambridge Associates.

Silliman College tower.

Page 10 Returns from bny Mellon and Cambridge Associates. Page 13 Jeremy Grantham quotation from gmo, April Letters 2006. to the International Investment Committee Intrinsic vii, Value

Strategy data provided by gmo.

John Maynard Keynes quotation from The General (Harcourt Theory of and Employment, Brace, 1964). Interest and Money

This section draws on David Swensen’s (Simon Pioneering and Portfolio Schuster, Management 2009).

Photo Credits Front cover Steve Dunwell Photography, Inc., Boston Additional photographs Michael Marsland, Yale O∞ce of Public A≠airs and Communications Design Strong Cohen/D. Pucillo

Silliman College Sterling Memorial Library Pierson College Calhoun College School of Medicine Berkeley College Davenport College Hall of Graduate Studies Timothy Dwight College