Yale Endowment Report2012

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2012The Yale Endowment


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Endowment Highlights

Fiscal Year

2012 2011 2010 2009 2008

Market Value (in millions) $19,344.6 $19,374.4 $16,652.1 $16,326.6 $22,869.7

Return 4.7% 21.9% 8.9% -24.6% 4.5%

Spending (in millions) $ 994.2 $ 986.8 $ 1,108.4 $ 1,175.2 $ 849.9Operating Budget Revenues $ 2,851.7 2,734.2 2,681.3 2,559.8 2,280.2(in millions) Endowment Percentage 34.9% 36.1% 41.3% 45.9% 37.3

Asset Allocation (as of June 30)

Absolute Return 14.5% 17.5% 21.0% 24.3% 25.1Domestic Equity 5.8 6.7 7.0 7.5 10.1Fixed Income 3.9 3.9 4.0 4.0 4.0Foreign Equity 7.8 9.0 9.9 9.8 15.2Natural Resources 8.3 8.7 8.8 11.5 10.4Private Equity 35.3 35.1 30.3 24.3 20.2Real Estate 21.7 20.2 18.7 20.6 18.9Cash 2.7 -1.1 0.4 -1.9 -3.9

$25

$20

$15

$10

$5

01950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Fiscal Year

Endowment Market Value 19502012

B i l l i o n s


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Contents

1. Introduction 22. The Yale Endowment 43. Investment Policy 5 4. Spending Policy 145. Investment Performance 166. Management and Oversight 18

Front cover: Window of Sterling Memorial Library, east faade.

Right:The colonnade, at left, the Alumni War Memorial to Yale men who died in World War i , forms the southfaade of University Commons. The Beinecke RareBook and Manuscript Library is seen at right.


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Beginning in the mid 1980s, the Yale Endowment built a superior track recordon an unconventional foundation. Fromthe late 1980s through the mid 1990s, the Endowments revolutionary shift to non-traditional asset classes, coupled with theselection of excellent active managers, ledto outstanding returns in a variety of market conditions.

In the late 1990s, however, Yales non-traditional portfolio seemed out of step with the markets. Fundamentals decoupledfrom prices, creating a di cult environ-ment for bottom-up, research-driven man-agers. Diversication did not help returnsas traditional large allocations to domesticequities were rewarded year in and year out, with the S & P 500 growing at a 20.6percent annualized rate during the seven-year period ending June 30, 2000. Never-theless, in spite of the asset allocationheadwind, the Endowment outperformedits passive and active benchmarks, albeitby modest margins.

In scal 2000, the Universitys fortuneschanged. Extraordinary returns from ven-

ture capital boosted Yales returns far aboveinstitutional averages. The Endowmentsoutsized private equity returns o set thesubstantial underperformance of Yales value-oriented, marketable-security man-agers, which lagged their benchmarks asstocks climbed to unprecedented levels.

After 2000, the University producedsuperior performance based on bothsuperb active management and the Endow-ments well-diversied asset allocation. Inthe aftermath of the Internet bubble, withthe S& P 500 declining slightly in the eight-year period ending June 30, 2008, Yalesinvestment managers had the opportunity to distinguish themselves in an environ-ment without irrational exuberance.

Yales fortunes changed for the worseduring the recent nancial crisis. Marketsrewarded positions that provided a safehaven, most notably full faith and creditholdings of the U.S. government. Yalesportfolio, positioned for strong long-termreturns, lacked signicant exposure to low expected return Treasury securities andsu ered in the market meltdown. Some

institutions chose to reduce equity expo-sure near the markets nadir as concernsover portfolio illiquidity and volatility mounted. Yale sought instead to maintainequity exposure, aggressively managingliquidity and prudently employing debt. As markets rebounded, Yale beneted. Yales equity positions, both liquid andilliquid, produced outsized returns as assetprices recovered post-crisis. Endowmentperformance since June 30, 2008 is now positive, although the Endowment valueremains below peak because of spendingdistributions to fund University operations.

Yales exceptional results have beenachieved by adhering to a fundamentally sound investment program. Instead of chasing short-term performance, theUniversity invests with a long-term view. Yale consistently generated superior returnsby maintaining discipline, standing by quality managers, and retaining soundinvestments despite su ering throughoccasional market turbulence.

Disciplined Long-Term Investing

Afternoon view of the Silliman College courtyard.


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Totaling $19.3 billion on June 30, 2012, the Yale Endowment containsthousands of funds with various purposes and restrictions. Approxi-mately three-quarters of funds constitute true endowment, gifts restrictedby donors to provide long-term funding for designated purposes. Theremaining one-quarter of funds represent quasi-endowment, moniesthat the Yale Corporation chooses to invest and treat as endowment.

Donors frequently specify a particular purpose for gifts, creatingendowments to fund professorships, teaching, and lectureships (24 per-cent); scholarships, fellowships, and prizes (17 percent); maintenance(4 percent); books (3 percent); and miscellaneous specic purposes(27 percent). Twenty-ve percent of funds are unrestricted. Twenty-vepercent of the Endowment benets the overall University, with remainingfunds focused on specic units, including the Faculty of Arts and Science(35 percent), the professional schools (26 percent), the library (7 per-cent), and other entities (7 percent).

Although distinct in purpose or restriction, Endowment fundsare commingled in an investment pool and tracked with unit accountingmuch 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 scal 2012 the Endowment provided $994 million, or 35 per-cent, of the Universitys $2.852 billion operating income. Other major sources of revenues were grants and contracts of $699 million (25 per-cent); 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).

The Yale Endowment

4

2

BooksMaintenance

Scholarships

Professorships

MiscellaneousSpecic Purposes

Unrestricted

Endowment

Grants and Contracts

Tuition, Room,and Board

Medical Services

Gifts

Other Incomeand Transfers

Endowment Fund AllocationFiscal Year 2012

Operating Budget RevenueFiscal Year 2012


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Yales portfolio is structured using a combination of academic theory andinformed market judgment. The theoretical framework relies on mean- variance analysis, an approach developed by Nobel laureates James Tobinand Harry Markowitz, both of whom conducted work on this importantportfolio management tool at Yales Cowles Foundation. Using statisticaltechniques to combine expected returns, variances, and covariances of investment assets, Yale employs mean-variance analysis to estimateexpected risk and return proles of various asset allocation alternativesand 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 portfoliodecisions. The denition of an asset class is quite subjective, requiringprecise distinctions where none exist. Returns and correlations are di -cult to forecast. Historical data provide a guide, but must be modied torecognize structural changes and compensate for anomalous periods.Quantitative measures have di culty incorporating factors such as mar-ket liquidity or the inuence of signicant, low-probability events. Inspite of the operational challenges, the rigor required in conductingmean-variance analysis brings an important perspective to the assetallocation process.

The combination of quantitative analysis and market judgmentemployed by Yale produces the following portfolio:

June 2012 June 2012 Asset Class Actual Target

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

Investment Policy

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The target mix of assets produces an expected real (after ination) long-term growth rate of 6.3 percent with risk (standard deviation of returns)of 15.2 percent. Because actual holdings di er from target levels, theactual allocation produces a portfolio expected to grow at 6.2 percent with risk of 15.1 percent. The Universitys measure of ination is based ona basket of goods and services specic to higher education that tends toexceed the Consumer Price Index by approximately one percentage point.

At its May 2012 meeting, Yales Investment Committee adopted a number of changes to the Universitys policy portfolio allocations. TheCommittee approved increases in the private equity target from 34 per-cent to 35 percent, in the absolute return target from 17 percent to 18 per-cent, and in the real estate target from 20 percent to 22 percent. Thoseincreases were funded by one-percentage-point decreases in both domes-tic equity and foreign equity targets and a two-percentage-point decreasein the natural resources target.

The need to provide resources for current operations as well asto preserve the purchasing power of assets dictates investing for highreturns, causing the Endowment to be biased toward equity. The Uni- versitys vulnerability to ination further directs the Endowment away from xed income and toward equity instruments. Hence, more than 95percent of the Endowment is targeted for investment in assets expected toproduce equity-like returns, through holdings of domestic and interna-tional securities, absolute return strategies, real estate, natural resources,and private equity.

Over the past two decades, Yale dramatically reduced the Endow-ments dependence on domestic marketable securities by reallocatingassets to nontraditional asset classes. In 1992, 51 percent of the Endow-ment was committed to U.S. stocks, bonds, and cash. Today, target allo-cations call for 10 percent in domestic marketable securities, while thediversifying assets of foreign equity, natural resources, private equity,absolute return, and real estate dominate the Endowment, representing90 percent of the target portfolio.

The heavy allocation to nontraditional asset classes stems fromtheir return potential and diversifying power. Todays actual and targetportfolios have signicantly higher expected returns and lower volatility than the 1992 portfolio. Alternative assets, by their very nature, tend to beless e ciently priced than traditional marketable securities, providing anopportunity to exploit market ine ciencies through active management.The Endowments long time horizon is well suited to exploit illiquid, lesse cient markets such as venture capital, leveraged buyouts, oil and gas,

timber, and real estate.

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The Yale Investments O ce seeks to meetits investment goals through prudent assetallocation and astute manager selection.Beginning in the mid 1980s, Yales assetallocation policies, informed by quantita-tive analysis and market insight, shiftedtoward a broadly diversied portfolio witha strong orientation toward investmentsthat promise equity-like returns and strate-gies that exploit market ine ciencies. By the mid 1990s, Yale had achieved most of the gains in portfolio e ciency availablefrom a diversied, equity-orientedapproach. In subsequent years, changes inallocation targets largely reected attemptsto exploit the most attractive investmentopportunities in the context of sensiblelong-term allocation targets.

As Yales asset allocation reached a pointof relative stability and the Universityspeer institutions began employing similar endowment management models, manager selection became an increasingly importantdi erentiating factor for Yale. In fact, for the twenty years ending June 30, 2012,nearly 80 percent of Yales outperformancerelative to the average Cambridge Associ-ates endowment was attributable to the value added by Yales active managers, while only 20 percent was the result of Yales asset allocation. Over the past twodecades, the Endowment returned a cumulative 1,204 percent relative to theCambridge median of 413 percent, an out-performance of 5.2 percent per annum. If Yale had employed its actual asset alloca-tion but had earned the rate of return of the median manager in each asset class, it would have outperformed the Cambridgemedian manager by 1.1 percent per year,the value added by Yales asset allocation.The remaining 4.1 percent per annum of the Endowments outperformance resultsfrom Yales active management.

Asset Allocation and Active Management

1990

1996

20052008

2010 2012

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%

9% 10% 11% 12% 13% 14% 15%

Volatility

R e a

l G r o w

t h R a t e

Constrained E cientFrontier

Unconstrained E cientFrontier

Current Target

Yale Moves Toward Risk-Return E ciency

13.7% per annum

9.6% per annum

8.5% per annum

1400%

1200%

1000%

800%

600%

400%

200%

01993 1995 1997 1999 2001 2003 2005 2007 2009 2011

Yale Asset Allocation x MedianManager Returns

Yale Returns Cambridge Median

Asset Allocation Value Add 1.1%Manager Value Add 4.1%

Total Value Add 5.2%

Cumulative Return for Twenty Years Ending June 30, 2012

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


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Yales seven asset classes are dened by di erences in their expectedresponse to economic conditions, such as economic growth, price ina-tion, or changes in interest rates, and are weighted in the Endowmentportfolio by considering their risk-adjusted returns and correlations.The University combines the asset classes in such a way as to provide thehighest expected return for a given level of risk, subject to fundamentaldiversication and liquidity constraints.

In July 1990, Yale became the rst institutional investor to pursue abso-lute return strategies as a distinct asset class, beginning with a target allo-cation of 15.0 percent. Designed to provide signicant diversication tothe Endowment, absolute return investments are expected to generatehigh long-term real returns by exploiting market ine ciencies. The port-folio is invested in two broad categories: event-driven strategies and value-driven strategies. Event-driven strategies rely on a very specic corporate event, such as a merger, spin-o , or bankruptcy restructuring, toachieve a target price. Value-driven strategies involve hedged positionsin assets or securities with prices that diverge from their underlying eco-nomic value. Today, the absolute return portfolio is targeted to be 18.0

percent of the Endowment, below the average educational institutionsallocation of 23.8 percent to such strategies. Absolute return strategies areexpected to generate a real return of 5.25 percent with risk of 12.5 percent

Unlike traditional marketable securities, absolute return invest-ments have historically provided returns largely independent of overallmarket moves. Over the past ten years, the portfolio exceeded expecta-tions, returning 10.0 percent per year with low correlation to domesticstock and bond markets.

Financial theory predicts that equity holdings will generate returns supe-rior to those of less risky assets such as bonds and cash. The predominant

asset class in most U.S. institutional portfolios, domestic equity repre-sents a large, liquid, and heavily researched market. While the averageeducational institution invests 18.5 percent of assets in domestic equities, Yales target allocation to this asset class is only 6.0 percent. The domesticequity portfolio has an expected real return of 6.0 percent with a standarddeviation of 20.0 percent. The Wilshire 5000 Index serves as the portfoliobenchmark.

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, net of fees, annually.Because superior stock selection provides the most consistent and reliableopportunity for generating attractive returns, the University favors man-agers with exceptional bottom-up, fundamental research capabilities.Managers searching for out-of-favor securities often nd stocks that arecheap in relation to fundamental measures such as asset value, futureearnings, or cash ow.

Asset ClassCharacteristics

8

Domestic Equity

Absolute Return


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Yale directs active management e orts toless e ciently priced asset classes andemploys less aggressive approaches for more e ciently priced assets. Given equalexpenditure of time and e ort, active man-agement promises greater rewards in theinfrequently traded, illiquid world of alter-

native assets than in the heavily traded,liquid world of traditional marketablesecurities.

The distribution of actively managedreturns in a particular asset class serves asan indicator of the degree of opportunity for active management. Pricing ine cien-cies allow managers with great skill toachieve great success, while unskilled man-agers post commensurately poor results.Hard work and intelligence only reap richrewards in environments where superior information, skill, deal ow, and long-term time horizon provide an edge. Active

managers in less e cient markets exhibitgreater variability in returns.

The accompanying gure shows activemanager returns for various asset classes.The spread in returns between the top andbottom quartiles in collections of actively managed portfolios illustrates the notionthat more e ciently priced assets provideless opportunity for active managers andthat less e ciently priced assets providemore opportunity.

U.S. Treasury securities, arguably themost e ciently priced asset in the world,trade in staggering volumes in marketsdominated by savvy nancial institutions.The Treasury market provides the bench-mark for all other xed income trading.Since nobody knows where interest rates

will be, few managers employ interest rateanticipation strategies. Without potentially powerful di erentiating bets on interestrates, institutional portfolios tend toexhibit market-like interest rate sensitivity,or duration. As a result, managers generally limit themselves to modest security selec-

tion decisions, causing returns for mostactive managers to mimic benchmark results. The spread between top and bot-tom quartile results for active bond man-agers measures an astonishingly small0.8 percent per annum for the decade.

Less e ciently priced securities trade in wider ranges. Stocks provide more di cultpricing challenges than bonds. Instead of discounting relatively certain xed incomecash ows, valuation of equities involvesmanager judgment in discounting far-less-certain corporate cash ows. Greater vola-tility in equity markets contributes to the

wider active manager spread. Large-capi-talization domestic equities represent thenext rung of the e ciency ladder, with a range of 1.5 percent per annum betweentop and bottom quartiles.

Domestic small-capitalization stocksshow a larger gap, with a range of 2.3 per-cent per annum between top and bottomquartiles. The progression of degree of opportunity across types of marketablesecurities makes intuitive sense: smaller-capitalization stocks provide natural limitson the size of stakes investors can take,often precluding larger and more sophisti-cated asset managers from nding andexploiting pricing ine ciencies.

Many foreign equity markets, particu-larly emerging markets, tend to be less

e ciently priced than U.S. markets becauseof their lower liquidity, spotty researchcoverage, and smaller local investor bases.These markets present greater opportuni-ties for superior stock selection as demon-strated by the larger range in manager per-formance. The spreads between top and

bottom quartile developed and emergingmarket managers are 2.7 percent and 2.8percent per annum, respectively.

Illiquid assets show substantially larger annualized spreads with leveraged buyoutsat 13.8 percent, natural resources at 17.4percent, real estate at 19.1 percent, and ven-ture capital at 19.8 percent. Lacking invest-able benchmarks, managers of illiquidassets succeed or fail by dint of their skillsand abilities, not by the action (positive or negative) of the market. Furthermore, theoperational, strategic, and company-build-ing skills of private equity and real assets

managers can add tremendous value totheir portfolio holdings and di erentiatethe strongest performers from their lack-luster peers.

Selecting top managers in private mar-kets leads to much greater reward thanidentifying top managers in public mar-kets. On the other hand, poor private man-ager selection can lead to extremely disap-pointing results as a consequence of highfees, poor performance, and illiquid posi-tions. Careful consideration of the degreeof market opportunity when formulatingasset allocation policies and structuringportfolios makes an important contributionto investment performance.

Opportunity for Active Management

10

-10.0%

-5.0%

0.0

5.0%10.0%

15.0%

20.0%

25.0%

30.0%

U.S. FixedIncome

25th Percentile Median 75th Percentile

U.S. LargeCapitalization

Equity

U.S. SmallCapitalization

Equity

DevelopedMarket Equity

EmergingMarket Equity

U.S.LeveragedBuyouts

NaturalResources

U.S. Real Estate

U.S. VentureCapital

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

D i s

p e r s i o n o

f R e t u r n s

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


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Foreign equity investments give the Endowment exposure to the globaleconomy, providing diversication and the opportunity to earn outsizedreturns through active management. Yale allocates 3.0 percent of its port-folio to foreign developed markets and 2.0 percent to emerging markets.In addition, Yale dedicates 3.0 percent of the portfolio to opportunisticforeign positions, with the expectation that holdings will be concentratedin markets that o er the most compelling long-term opportunities, par-ticularly China, India, and Brazil. Yales foreign equity target allocation of

8.0 percent stands below the average endowments allocation of 18.2 per-cent. Expected real returns for emerging equities are 7.5 percent with a risk level of 22.5 percent, while developed equities are expected to return6.0 percent with risk of 20.0 percent. The portfolio is measured against a composite benchmark of (a) developed markets, measured by theMorgan Stanley Capital International ( msci ) Europe, Australasia, andFar East ( eafe ) Investable Market Index; (b) emerging markets, meas-ured by a blend of the msci Emerging Markets Investable Market Indexand the msci China A-Share Index; and (c) opportunistic investments,measured by a custom blended index.

Yales investment approach to foreign equities emphasizes active

management designed to uncover attractive opportunities and exploitmarket ine ciencies. As in the domestic equity portfolio, Yale favorsmanagers with strong fundamental research capabilities. Capital alloca-tion to individual managers takes into consideration the country alloca-tion of the foreign equity portfolio, the degree of condence that Yalepossesses in a manager, and the appropriate size for a particular strategy.In addition, Yale attempts to exploit compelling undervaluations in coun-tries, sectors, and styles by allocating capital to the most compellingopportunities.

Foreign Equity

Yale University Art Gallery.


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Equity investments in natural resourcesoil and gas, timberland, andmetals and miningshare common risk and return characteristics: pro-tection against unanticipated ination, high and visible current cash ow,and opportunities to exploit ine ciencies. At the portfolio level, naturalresource investments provide attractive return prospects and signicantdiversication. Yale has a 7.0 percent long-term policy allocation to natu-ral resources with expected real returns of 6.2 percent and risk of 18.2 percent. Yales 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 diversication and promises strongreturns. Superior operators have demonstrated the ability to generateexcess returns over a market cycle. The inception-to-date return of Yalesoil and gas (1986), timber (1996), and mining (2011) portfolio clocks inat an impressive 16.0 percent per annum.

Private equity o ers extremely attractive long-term risk-adjusted returns,stemming from the Universitys strong stable of value-adding managersthat exploit market ine ciencies. Yales private equity portfolio includes

investments in venture capital and leveraged buyout partnerships. TheUniversitys target allocation to private equity of 35.0 percent far exceedsthe 10.9 percent actual allocation of the average educational institution. Inaggregate, the private equity portfolio is expected to generate real returnsof 10.5 percent with risk of 26.8 percent.

Yales private equity program, one of the rst of its kind, isregarded 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 30.0percent annualized return to the University.

Yales private equity strategy emphasizes partnerships with rmsthat pursue a value-added approach to investing. Such rms work closely with portfolio companies to create fundamentally more valuable entities,relying only secondarily on nancial engineering to generate returns.Investments are made with an eye toward long-term relationshipsgen-erally, a commitment is expected to be the rst of severaland towardthe close alignment of the interests of general and limited partners.

Investments in real estate provide meaningful diversication to the Endowment. A steady ow of income with equity upside creates a naturalhedge against unanticipated ination without a sacrice of expectedreturn. Yales 22.0 percent long-term policy allocation signicantly exceeds the average endowments commitment of 4.3 percent. Expectedreal returns are 6.0 percent with risk of 17.5 percent.

While real estate markets sometimes produce dramatically cyclicareturns, pricing ine ciencies in the asset class and opportunities to add value allow superior managers to generate excess returns over long timehorizons. Since inception in 1978, the portfolio has returned 11.6 percentper annum.

Private Equity

Real Estate

2

Natural Resources


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The illiquid nature of private real estate and the time-consumingprocess of completing transactions create a high hurdle for casualinvestors. A critical component of Yales investment strategy is to createstrong, long-term partnerships between the Investments O ce and itsinvestment managers. In the last two decades, Yale played a critical rolein the development and growth of a number of successful real estateinvestment organizations.

Yale EducationalUniversity Institution Mean

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

Cash 2.7 2.7Data as of June 30, 2012

Asset Allocations

Active Management and Career Risk Successful active management requires a contrarian focus on ine cient marketsand out-of-favor assets, which present thegreatest opportunity to take advantage of mispricings and generate outsized returns.In practice, however, such contrarianbehavior is raremost fund managersherd around popular investment strategiesor hew closely to their benchmarks rather than pursue strategies that would likely produce greater rewards over the longterm.

Career risk is a signicant driver of manager behavior. A contrarian managersportfolio di ers markedly from peer port-folios and from market benchmarks. Con-sequently, the contrarian manager producesresults that diverge dramatically from thoseof peers. Although a high-quality activemanager should outperform over the longterm, the managers idiosyncratic portfoliois likely to underperform at various pointsalong the way. During those periods of underperformance, the manager will likely lose clients. Even if the contrarian invest-ment thesis ultimately proves correct, themanager may already be out of business or

managing a much diminished portfolio.These dire business consequences pushmany managers to hug their benchmarksin the name of career preservation.

Prominent investor Jeremy Granthamof Grantham Mayo Van Otterloo ( gm o )notes that the main driver in risk manage-ment for most investors is, unfortunately,career and business risk. This means thatcontrolling short-term benchmark risk dominates, and not the risk of the actualclient losing real money. Fund managersare much more likely to be red for tempo-rary underperformance as their long-terminvestments play out than they are for sus-tained mediocre performance in line withtheir peers. As John Maynard Keyneslamented in The General Theory,it isbetter for reputation to fail conventionally than to succeed unconventionally.

gm o experienced short-term bench-mark risk rst-hand with its InternationalIntrinsic Value Strategy. The strategy attracted investors in the early 1990s as itdramatically outperformed its msci eafebenchmark by 8.7 percent per year from1990 through 1993. Poor relative returns

during the manic markets of 1994 through1999 resulted in a client exodus, however,taking assets from a peak of $2.8 billion in1996 to just $578 million by 2002. Thefund robustly recovered during the 2000through 2005 period, outperforming itsbenchmark by 9.5 percent per annum, butthe majority of its clients were no longer around to participate in the recovery. Although the International Intrinsic ValueStrategy generated returns of 11.1 percentper year from its 1987 inception throughthe end of 2006, outperforming mscieafe by 4.1 percent per annum, few investors reaped the sustained successof gm o s active strategy.

Only by building an investor base witha common investment philosophy, timehorizon, resolve, and tolerance for trackingerror can a manager maintain the stablecapital base required to see its contrarianinvestments through to a successful conclu-sion. As many managers and institutionalclients cower in the face of career risk issues, nancing and executing a sensibleactive management program is challengingand rare.


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The spending rule has two implications. First, by incorporatingthe prior years spending, the rule eliminates large uctuations, enablingthe University to plan for its operating budget needs. Over the last twenty years, the standard deviation of annual changes in spending has been lessthan 65 percent of the standard deviation of annual changes in Endow-ment value. Second, by adjusting spending toward the long-term targetspending level, the rule ensures that spending will be sensitive to uctu-ating Endowment market values, providing stability in long-term pur-chasing power.

Despite the conservative nature of Yales spending policy, distribu-tions to the operating budget rose from $409 million in scal 2002 to$994 million in scal 2012. The University projects spending of $1.03billion from the Endowment in scal 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.


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Yale has produced excellent long-term investment returns. Over the ten-year period ending June 30, 2012, the Endowment earned an annualized10.6 percent return, net of fees, surpassing annual results for domesticstocks of 3.8 percent and domestic bonds of 5.6 percent, and placing itamong the top one percent of large institutional investors. Endowmentoutperformance stems from sound asset allocation policy and superior active management.

Yales long-term superior performance relative to its peers andbenchmarks has created substantial wealth for the University. Over theten 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 broaduniverse of college and university endowments.

Yales long-term asset class performance continues to be outstanding. Inthe past ten years, nearly every asset class posted superior returns, signi-cantly outperforming benchmark levels.

Over the past decade, the absolute return portfolio produced anannualized 10.0 percent return, exceeding the passive Barclays 9-12Month Treasury Index by 7.7 percent per year and besting its activebenchmark of hedge fund manager returns by 4.6 percent per year. For the ten-year period, absolute return results exhibited little correlation totraditional marketable securities.

For the ten years ending June 30, 2012, the domestic equity port-folio returned an annualized 9.8 percent, outperforming the Wilshire5000 by 3.6 percent per year and the Russell Median Manager return, netof estimated fees, by 4.5 percent per year. Yales active managers haveadded value to benchmark returns primarily through stock selection.

Yales internally managed xed income portfolio earned an annu-alized 4.5 percent over the past decade, keeping pace with the Barclays 1- Year Treasury Index and exceeding the Russell Median Manager returnby 0.4 percent per year. By making astute security selection decisions andaccepting a moderate degree of illiquidity, the Endowment beneted fromexcess returns without incurring material credit or option risk.

Investment Performance

5

0

$100

$200

$300

$400

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Endowment Mean of Broad Universe of Colleges and Universities Inati

G r o w

t h o

f $

1 0 0

Fiscal Year

Performance by Asset Class

Yales Performance Exceeds Peer Results June 30, 2002 to June 30, 2012, 2002=$100

16


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The foreign equity portfolio generated an annual return of 16.6percent over the ten-year period, outperforming its composite benchmark by 6.5 percent per year and the Russell Median Manager return by 6.8percent per year. The portfolios excess return is due to astute country allocation and e ective security selection by active managers.

Yales natural resources portfolio produced an annualized return of 16.2 percent over the past decade, outperforming its composite passivebenchmark by 4.7 percent per year though lagging the Cambridge

Associates natural resources manager pool by 0.4 percent per year. Yalesstrong 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 com-piled by Cambridge Associates by 1.4 percent per year. Since inception in1973, the private equity program has earned an astounding 30.0 percentper annum.

Real estate generated a 7.3 percent annualized return over theten-year period, underperforming the msci rei t Index by 1.9 percentper year, but outperforming a pool of Cambridge Associates real estate

managers by 5.3 percent per year. Yales active outperformance is due tosuccessful exploitation of market ine ciencies and timely pursuit of contrarian investment strategies.

0

2%

4%

6%

8%

10%

12%

14%

16%

18%

AbsoluteReturn

Domestic Equity

FixedIncome

Foreign Equity

NaturalResources

Private Equity

Real Estate

Yale Return Active Benchmark Passive Benchmark

Active Benchmarks

Absolute Return:Dow Jones Credit Suisse Composite Domestic Equity:Frank Russell Median Manager, U.S. Equity Fixed Income:Frank Russell Median Manager, Fixed Income Foreign Equity:Frank Russell Median Manager Composite,

Foreign Equity Natural Resources:Cambridge Associates Natural Resources Private Equity:Cambridge Associates Composite Real Estate:Cambridge Associates Real Estate

Passive Benchmarks

Absolute Return:Barclays 9-12 Mo Treasury Domestic Equity: Wilshire 5000 Fixed Income:Barclays 1-5 Yr Treasury Foreign Equity:Blend of msci eafe Investable Market

Index, msci Emerging Markets Investable Market Index+ msci China A-Shares, Custom Opportunistic BlendedIndex

Natural Resources:Blend of Custom Timber rei t Basket,s & p o & g Exploration & Production Index, hsbc GlobalMining Index

Private Equity:Blend of Russell 2000, Russell 2000Technology, m s ci a c wi ex-US Small-Cap Index

Real Estate: m s ci r e i t Index

Yale Asset Class Results Beat Most Benchmarks June 30, 2002 to June 30, 2012

*Yale Returns and Active Benchmarks are dollar-weighted

* * *


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Since 1975, the Yale Corporation Investment Committee has been respon-sible for oversight of the Endowment, incorporating senior-level invest-ment experience into portfolio policy formulation. The InvestmentCommittee consists of at least three Fellows of the Corporation and other persons who have particular investment expertise. The Committee meetsquarterly, 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 Endowmentportfolio, specifying investment objectives, spending policy, andapproaches for the investment of each asset category.

Management andOversight

6 Investment Committee Douglas A. Warner, iii 68

Chairman Former Chairman J.P. Morgan Chase & Co.

Byron G. Auguste 89 Director McKinsey & Company

G. Leonard Baker 64 Managing Director Sutter Hill Ventures

Joshua Bekenstein 80 Managing Director Bain Capital

Ben Inker 92 Director of Asset Allocationgmo

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

Stefan Kaluzny 88 Managing Director Sycamore Partners

Richard C. Levin 74 ph.d. President Yale University

Kevin Ryan 85 Founder and ceoGilt Groupe

Carter Simonds 99 Managing Director Blue Ridge Capital

Dinakar Singh 90ceo and Founding Partner tpg -Axon Capital

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Manager selection lies at the heart of Yalesactive management strategy. The Endow-ment has built longstanding investmentrelationships with talented active managersthat exploit a rich set of investment oppor-tunities across an array of market sectors,strategies, and asset classes. Each year, theInvestments O ce meets with countlessprospective investment managers, relent-lessly evaluating opportunities to add new high-quality managers to Yales portfolio. When the Investments O ce identies a promising fund manager, it conducts thor-ough due diligence to evaluate the groupsinvestment acumen and strategy, as well asits character and ethics, often spendingseveral months getting to know a teamprior to funding a new investment.

Yale searches for intelligent and dedi-cated managers that have high integrity,sound investment philosophies, strongtrack records, superior organizations, andsustainable competitive advantages. Yalestrives for excess returns by building size-able relationships with rms that have a long-term orientation, as well as a rigor-ous investment process and exceptionalbottom-up research capabilities. Successfulmanagers execute a program that providesthe conviction necessary to hold concen-trated portfolios. The University seeksmanagers that exhibit signicant disciplinein their investment processes, that deploy

capital only when they have found ine -ciencies, and that exploit compellingopportunities for attractive returns.

Yales marketable managers focus pri-marily on making attractive bottom-up,security-specic investments and frequently concentrate their e orts on companies withearnings driven by factors that can be rea-sonably forecast, such as production, costs,distribution, and pricing. Yales active man-agers tend to be attracted to less widely followed stocks and less e ciently pricedmarkets, which o er better opportunitiesfor superior managers to develop di eren-tiated insights and identify meaningfully mispriced securities.

In Yales private equity, real estate, andnatural resources portfolios, the Invest-ments O ce seeks cohesive and motivatedgroups with a proven ability to create valueindependent of underlying market condi-tions. Ideal real estate partners possesssuperior operating and nancial capabilitiesand focus on specic geographies or prop-erty types. Similarly, Yale seeks privateequity rms that work closely with their portfolio companies to create fundamen-tally more valuable entities, relying only secondarily on nancial engineering togenerate returns.

A critical component of Yales invest-ment strategy is the creation of long-termpartnerships with strong alignments of

interest. The Investments O ce targetsemployee-owned rms to ensure thatincentive compensation appropriately benets the investment team. Yale looksfor a substantial co-investment from thegeneral partners, which helps foster pru-dent decision-making and risk assessment. Yale aims to partner with rms that strivefor investment excellence and that are will-ing to limit assets under management,ensuring exibility to exploit attractiveopportunities.

Yale often looks to develop close rela-tionships with rms early in their lifecycles. As an investment managementorganization progresses through its lifecycle, Yale monitors the relationship care-fully to ensure that interests continue tocoincide, that assets under managementremain at reasonable levels, and that themanager remains motivated and capable of earning substantial returns. The University frequently supports emerging investmentgroups that are not well-known, brand-name players. In some cases Yale createsproprietary opportunities by helping a rmenter the world of institutional fund man-agement. The University seeks to buildlong-term relationships with high-quality investment managers, as evidenced by theaverage tenure of eleven years for managersin the Endowment portfolio.

Manager Attributes

North faade of Branford Court.


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The Investments O ce manages the Endowment and other University nancial assets, and denes and implements the Universitys borrowingstrategies. 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.Chief Investment O cer

Dean J. Takahashi 80, 83 mppmSenior Director

Peter H. Ammon 05 m.b.a. , 05m.a. Director

Alexander C. Banker Director

Alan S. Forman Director

Lisa M. Howie 00, 08 m.b.a. Director

Timothy R. Sullivan 86 Director

Kenneth R. Miller 71Senior Associate General Counsel

Stephanie S. Chan 97 Associate General Counsel

Deborah S. Chung

Associate General Counsel

J. Colin Sullivan Associate General Counsel

Carrie A. Abildgaard Associate Director

Michael E. Finnerty Associate Director

R. Alexander Hetherington 06 Associate Director

Celeste P. BensonSenior Portfolio Manager

Matthew S. T. Mendelsohn 07Senior Associate

John V. Ricotta 08Senior Associate

Cain P. Solto 08Senior Associate

David S. Katzman 10Senior Financial Analyst

Nilesh V. Vashee 09Senior Financial Analyst

Xinchen Wang 09Senior Financial Analyst

Philip J. Bronstein 12 Financial Analyst

Florence R. Dethy 11

Financial Analyst

Sebastian K. Serra 11 Financial Analyst

Kaiyuan Wang 11 Financial Analyst

David Y. Zhang 12 Financial Analyst

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Sources

Financial and Investment Information

Educational institution asset allocations andreturns from Cambridge Associates.

Much of the material in this publication isdrawn from memoranda produced by theInvestments O ce for the Yale CorporationInvestment Committee. Other material comes

from Yales nancial records, Reports of theTreasurer, and Reports of the President.

Pages 8-13 Educational institution asset allocations andreturns from Cambridge Associates.

Page 10Returns from bn y Mellon and Cambridge Associates.

Page 13 Jeremy Grantham quotation from gm o , Letters to the Investment Committeevii , April 2006. International Intrinsic ValueStrategy data provided by gm o .

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

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

Photo Credits

Front cover Steve Dunwell Photography, Inc., Boston

Additional photographsMichael Marsland, Yale O ce of Public A airs and Communications

Design

Strong Cohen/D. Pucillo

Silliman College tower.


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Berkeley College

Sterling Memorial Library Pierson College

Calhoun College School of Medicine

Silliman College

Documents

Yale Endowment Report2012