2004The Yale Endowment

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Endowment Highlights

Fiscal Year

2004 2003 2002 2001 2000

Market Value (in millions) $12,747.2 $11,034.6 $10,523.6 $10,725.1 $10,084.9Return 19.4% 8.8% 0.7% 9.2% 41.0%

Spending (in millions) $ 502.0 $ 470.1 $ 409.3 $ 337.5 $ 280.8 Operating Budget Revenues 1,630.8 1,553.7 1,466.6 1,352.9 1,263.5(in millions)Endowment Percentage 30.8% 30.3% 27.9% 24.9% 22.2%

Asset Allocation (as of June 30)

Domestic Equity 14.8% 14.9% 15.4% 15.5% 14.2%Absolute Return 26.1 25.1 26.5 22.9 19.5 Foreign Equity 14.8 14.6 12.8 10.6 9.0Private Equity 14.5 14.9 14.4 18.2 25.0Real Assets 18.8 20.9 20.5 16.8 14.9 Fixed Income 7.4 7.4 10.0 9.8 9.4Cash 3.5 2.1 0.3 6.2 8.1

Endowment Market Value 1950–2004

Billions

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Contents

1. Introduction 2

2. The Yale Endowment 3

3. Investment Policy 4

4. Spending Policy 14

5. Investment Performance 16

6. Management and Oversight 19

Front cover:A window in Sterling Memorial Library with a view of the Selin Courtyard

Right: Evening view of the Yale campus, facing west

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Yale’s Endowment produced extraordinarily strong results in fiscalyear 2004, generating returns of 19.4 percent and producing dollargains of $2.1 billion. Every asset class, with the exception of bonds,contributed double-digit gains over the course of the year. Onceagain, Yale benefited from the Endowment’s equity orientation,broad diversification, and active management.

Over the past ten years, the Endowment grew from $3.5 billionto $12.7 billion. With annual net investment returns of 16.8percent, the Endowment’s performance exceeded its benchmarksand outpaced institutional fund indices. The Yale Endowment’sresults over the past two decades are no less impressive, asinvestment returns of 16.1 percent per annum produced a 2004Endowment value of more than ten times that of 1984. Yale’s long-term record resulted from disciplined and diversified asset allocationpolicies, superior active management results, and strong capitalmarket returns.

Spending from Endowment grew during the last decade from$132 million to $502 million, an annual growth rate of over 14percent. On a relative basis, Endowment contributions expandedfrom 14 percent of total revenues in fiscal 1994 to 31 percent infiscal 2004. Next year, spending will approximate $562 million, or32 percent of projected revenues. During the decade Yale’s spendingand investment policies provided handsome levels of cash flow tothe operating budget for current scholars while preservingEndowment purchasing power for future generations.

Introduction

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Post-1950 Endowment Gifts Inflated1950 Endowment Inflated Endowment Market Value

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Endowment Growth Outpaces Inflation 1950–2004

Billions

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Totaling $12.7 billion on June 30, 2004, the Yale Endowment is aninvestment pool composed of thousands of funds with a variety ofdesignated purposes and restrictions. Approximately four-fifths offunds constitute true endowment, gifts restricted by donors toprovide long-term funding for designated purposes. The remainingone-fifth represent quasi-endowment, monies which the YaleCorporation chooses to invest and treat as endowment.

Donors frequently specify a particular purpose for gifts,creating endowments to fund professorships, teaching, andlectureships (23 percent), scholarships, fellowships, and prizes (18 percent), maintenance (4 percent), books (3 percent), andmiscellaneous specific purposes (31 percent). The remaining funds(21 percent) are unrestricted. Twenty-seven percent of theEndowment benefits the overall University, with remaining fundsfocused on specific units including the Faculty of Arts and Sciences(38 percent), the professional schools (21 percent), the library (8 percent), and other entities (6 percent).

Although distinct in purpose or restriction, Endowment funds are commingled in an investment pool and tracked with unitaccounting much like a large mutual fund. Endowment gifts of cash,securities, or property are valued and exchanged for units thatrepresent a claim on a portion of the whole investment portfolio.

In fiscal 2004 the Endowment provided $502 million, or 31 percent, of the University’s $1,631 million current fund income.Other major sources of revenues were grants and contracts of $491million (30 percent), medical services of $250 million (15 percent),net tuition, room, and board of $216 million (13 percent), gifts of$76 million (5 percent), other investment income of $21 million (1 percent), and other income of $75 million (5 percent).

The Yale Endowment

2

Endowment Fund Allocation Fiscal Year 2004

Professorships

Books

Scholarships

Miscellaneous Specific Purposes

Unrestricted

Maintenance

Operating Budget RevenueFiscal Year 2004

Tuition, Room, Board Endowment

Grants & Contracts

Gifts

Other Investments

Medical Services

Other Income

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3Yale’s portfolio is structured using a combination of academictheory and informed market judgment. The theoretical frameworkrelies on mean-variance analysis, an approach developed by Nobellaureates James Tobin and Harry Markowitz. In fact, both Tobinand Markowitz conducted work on this important portfoliomanagement tool at Yale’s Cowles Foundation. Using statisticaltechniques to combine expected returns, variances, and covariancesof investment assets, Yale employs mean-variance analysis toestimate expected risk and return profiles of various asset allocationalternatives and to test the sensitivity of the results to changes ininput assumptions.

Because investment management involves as much art asscience, qualitative considerations play an extremely important role in portfolio decisions. The definition of an asset class is quitesubjective, requiring precise distinctions where none exist. Returnsand correlations are difficult to forecast. Historical data provide aguide, but must be modified to recognize structural changes andcompensate for anomalous periods. Finally, quantitative measureshave difficulty incorporating factors such as market liquidity or the influence of significant, low-probability events.

The combination of quantitative analysis and marketjudgment employed by Yale produces the following portfolio:

June CurrentAsset Class 2004 Target

Domestic Equity 14.8% 15.0%Fixed Income 7.4 7.5Absolute Return 26.1 25.0Foreign Equity 14.8 15.0Private Equity 14.5 17.5Real Assets 18.8 20.0Cash 3.5 0.0

Investment Policy

Fixed Income

Absolute Return

Foreign Equity

Private Equity

Real Assets Domestic Equity

Yale Endowment Target Asset Allocation June 30, 2004

Domestic Equity

Foreign Equity

Real Assets

Fixed Income

Absolute Return

Private Equity

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The target mix of assets produces an expected real (after inflation)long-term growth rate of 6.2 percent with a risk (standard deviationof returns) of 11.7 percent. Primarily because of shortfalls relativeto the target in private equity holdings, the actual allocationproduces a portfolio expected to grow at 5.8 percent with a risk of11.0 percent. The University’s measure of inflation is based on abasket of goods and services specific to higher education that tendsto exceed the Consumer Price Index by approximately one percent.

The need to provide resources for current operations as wellas preserve purchasing power of assets dictates investing for highreturns, causing the Endowment to be biased toward equity. Inaddition, the University’s vulnerability to inflation further directs the Endowment away from fixed income and toward equityinstruments. Hence, 92.5 percent of the Endowment is targeted forinvestment in some form of equity, through holdings of domesticand international securities, real assets, and private equity.

Over the past two decades, Yale has reduced dramatically the Endowment’s dependence on domestic marketable securities byreallocating assets to nontraditional asset classes. In 1984, morethan three-quarters of the Endowment was committed to U.S.stocks, bonds, and cash. Today, target allocations call for 22.5percent in domestic marketable securities, while the diversifyingassets of foreign equity, private equity, absolute return strategies,and real assets dominate the Endowment, representing 77.5 percentof the target portfolio.

The heavy allocation to nontraditional asset classes stemsfrom their return potential and diversifying power. Today’s actualand target portfolios have significantly higher expected returns andlower volatility than the 1984 portfolio. Alternative assets, by theirvery nature, tend to be less efficiently priced than traditionalmarketable securities, providing an opportunity to exploit marketinefficiencies through active management. The Endowment’s longtime horizon is well suited to exploiting illiquid, less efficientmarkets such as venture capital, leveraged buyouts, oil and gas,timber, and real estate.

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Yale’s six asset classes are defined by differences in their expectedresponse to economic conditions, such as price inflation or changesin interest rates, and are weighted in the Endowment portfolio byconsidering risk-adjusted returns and correlations. The Universitycombines these assets in such a way as to provide the highestexpected return for a given level of risk.

Finance theory predicts that equity holdings will generate returnssuperior to those of less risky assets such as bonds and cash. The predominant asset class in most endowments and other U.S.institutional portfolios, domestic equities represent a large, liquid,and heavily researched market. While the broad group ofeducational institutions invest 36.8 percent of assets in domesticequities, Yale’s target allocation to this asset class is only 15.0percent. The domestic equity portfolio has an expected real returnof 6.0 percent with a standard deviation of 20.0 percent. TheWilshire 5000 Index serves as the portfolio benchmark.

Despite recognizing that the U.S. equity market is highlyefficient, Yale elects to pursue active management strategies, aspiringto outperform market indices by a few percentage points annually.Because superior stock selection provides the most consistent andreliable opportunity for generating excess returns, the Universityfavors managers with exceptional bottom-up fundamental researchcapabilities. Managers searching for out-of-favor securities oftenfind stocks that are cheap in relation to current fundamentalmeasures such as book value, earnings, or cash flow. Yale’smanagers tend to emphasize small-capitalization stocks, as they are less efficiently priced and offer greater opportunities to addvalue through active management. Recognizing the difficulty ofoutperforming the market on a consistent basis, Yale searches formanagers with high integrity, sound investment philosophies, strongtrack records, superior organizations, and sustainable competitiveadvantages.

Fixed income assets generate stable flows of income, providinggreater certainty of nominal cash flow than any other Endowmentasset class. The bond portfolio has a low covariance with otherasset classes, and provides a hedge against financial accidents orperiods of unanticipated deflation. While educational institutionsmaintain a substantial allocation to fixed income instruments andcash, amounting to 20.7 percent, Yale’s target allocation to fixedincome constitutes only 7.5 percent of the Endowment. Bonds havean expected real return of 2.0 percent with risk of 10.0 percent. The Lehman Brothers U.S. Treasury Index serves as the portfoliobenchmark.

Fixed Income

6

Asset ClassCharacteristics

Domestic Equity

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Foreign Equity

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Yale is not particularly attracted to fixed income assets, asthey have the lowest historical and expected returns of the six assetclasses that make up the Endowment. In addition, the governmentbond market is arguably the most efficiently priced asset class,offering few opportunities to add significant value through activemanagement. Based on skepticism of active fixed income strategiesand belief in the efficacy of a highly structured approach to bondportfolio management, the Investments Office chooses to manageEndowment bonds internally. In spite of an aversion to markettiming strategies, credit risk, and call options, Yale manages to add value consistently in its management of the bond portfolio.Willingness to accept illiquidity leads to superior investment resultswithout impairing the portfolio protection characteristics of high-quality fixed income.

Investments in overseas markets give the Endowment exposure to the global economy, providing diversification along withopportunities to earn above-market returns through activemanagement. Emerging markets, with their rapidly growingeconomies, are particularly intriguing, causing Yale to target one-half of its foreign portfolio to developing countries. Yale’s foreignequity target allocation of 15.0 percent stands slightly below theoverall educational institution allocation of 15.6 percent. Expectedreal returns for emerging equities are 8.0 percent with a risk level of25.0 percent, while developed equities are expected to return 6.0percent with risk of 20.0 percent. The portfolio is measured againsta composite benchmark of 50 percent developed markets, measuredby the Morgan Stanley Capital International (MSCI) Europe,Australasia, and Far East Index, and 50 percent emerging markets,measured by the MSCI Emerging Markets Index.

Yale’s investment approach to foreign equities emphasizesactive management designed to uncover attractive opportunities andexploit market inefficiencies. As in the domestic equity portfolio,Yale favors managers with strong bottom-up fundamental researchcapabilities. Capital allocation to individual managers takes intoconsideration the country allocation of the foreign equity portfolio,the degree of confidence Yale possesses in a manager, and theappropriate asset size for a particular strategy. In addition, Yaleattempts to exploit compelling undervaluations in countries, sectors,and styles by allocating additional capital and, perhaps, by hiringnew managers to take advantage of the opportunities.

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Until the mid 1960s, the Universitylimited the Endowment’s annualcontribution to the operating budget toinvestment yield—the interest, dividend,and rental income generated by theEndowment. In 1967, recognizing thatsimply spending yield could result in toohigh or too low a spending rate andcould bias investment decisions towardsecurities with high yield but lowappreciation potential, Yale adopted a“total return” spending policy. Underthe total return policy, the Universitysupported operations with current yield plus a prudent portion of theappreciation of Endowment marketvalue.

Concurrent with the decision toemploy a total return concept, Yaleinstituted a formal method, called theUniversity Equation, to calculate thetotal amount that could responsibly bespent from the Endowment. Themethod set spending in a given year byadjusting the previous year’s spendingby the difference between theUniversity’s long-term investment return(measured over the prior twenty-yearperiod) and the current percentage ofthe Endowment being spent. Higherlong-term returns would lead to higher

annual spending, while lower long-termreturns would lead to reduced spending.Unfortunately, the University Equationdid not adjust rapidly enough tochanges in Endowment market value.As a result, in the 1970s, when the rateof inflation increased and marketreturns dropped, the University spent an unsustainably high portion of theEndowment to support currentoperations.

In 1977, recognizing that the rate ofspending was eroding the real value ofthe Endowment, the Yale Corporationvoted to cap spending at the existinglevel (adjusted for inflation) until thespending rate was brought in line withthe expected real (after-inflation) return from the Endowment. TheEndowment’s expected real return wastaken to be 4.5 percent, consistent with historical experience.

In 1982, upon bringing the spendinglevel to an appropriate level, theCorporation adopted a spending rulethat attempted to produce substantialincome for current scholars andpreserve purchasing power of theEndowment for future generations.Under the new rule, Endowmentspending amounted to the weighted

average of 70 percent of the previousyear’s spending, adjusted for inflation,plus 30 percent of the targeted long-term spending rate of 4.5 percentapplied to the previous year’sEndowment’s market value. The 70percent weight on prior year spendingpromised budgetary stability, while the30 percent weight on current marketvalue provided purchasing powersensitivity.

Since 1982, the spending rule hasbeen adjusted three times. In 1992 theCorporation authorized an increase inthe long-term spending rate from 4.5percent to 4.75 percent. In 1995, Yaleadopted a further increase in the targetrate to 5.0 percent. In 2004 theCorporation increased the spending rateto 5.25 percent and changed thesmoothing rule from 70/30 to 80/20.The increase in spending rate resultedfrom improvement in Endowmentportfolio characteristics. The change inweight assigned to budgetary stabilitystemmed from recognition thatincreased budgetary dependence onEndowment income required greaterstability in flows of Endowment incometo support operations.

History of Yale’s Spending Policy

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Yale’s Endowment Spending Rate 1950-2004

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In July 1990, Yale became the first institutional investor to pursueabsolute return strategies as a distinct asset class, beginning with atarget allocation of 15 percent. Designed to provide significantdiversification to the Endowment, absolute return investments seek to generate high long-term real returns by exploiting marketinefficiencies. Approximately half of the portfolio is dedicated toevent-driven strategies, which rely on a very specific corporateevent, such as a merger, spin-off, or bankruptcy restructuring, toachieve a target price. The other half of the portfolio contains value-driven strategies, which involve hedged positions in assets orsecurities that diverge from underlying economic value. Today, theabsolute return portfolio is targeted to be 25.0 percent of theEndowment. In contrast, the educational institutions allocate only15.1 percent of assets to such strategies. Absolute return strategiesare expected to generate real returns of 6.0 percent with risk levelsof 10.0 percent for event-driven strategies and 15.0 percent forvalue-driven strategies.

Unlike traditional marketable securities, absolute returninvestments provide returns largely independent of overall marketmoves. Over the past ten years, the portfolio exceeded expectations,returning 12.2 percent per year with essentially no correlation todomestic stock and bond markets.

An important attribute of Yale’s investment strategy concernsthe alignment of interests between investors and investmentmanagers. To that end, absolute return accounts are structured withperformance-related incentive fees, hurdle rates, and clawbackprovisions. In addition, managers invest a significant portion oftheir net worth alongside Yale, enabling the University to avoidmany of the pitfalls of the principal-agent relationship.

Absolute Return

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Private equity offers extremely attractive long-term risk-adjustedreturn characteristics, stemming from the University’s strong stableof value-added managers that exploit market inefficiencies. Yale’sprivate equity investments include participations in venture capitaland leveraged buyout partnerships. The University’s targetallocation to private equity of 17.5 percent and its actual allocationof 14.5 percent both far exceed the 5.5 percent actual allocation ofeducational institutions. In aggregate, the private equity portfolio isexpected to generate real returns of 11.4 percent with risk of 29percent.

Yale’s private equity program, one of the first of its kind, is regarded as among the best in the institutional investmentcommunity. The University is frequently cited as a role model byother investors pursuing this asset class. Since inception, privateequity investments have generated a 30.6 percent annualized returnto the University. The success of Yale’s program led to a 1995Harvard Business School case study—“Yale University InvestmentsOffice”—by Professors Josh Lerner and Jay Light. The popular casestudy was updated in 1997, 2000, and 2003.

Yale’s private equity assets concentrate on partnerships withfirms that emphasize a value-added approach to investing. Suchfirms work closely with portfolio companies to create fundamentallymore valuable entities, relying only secondarily on financialengineering to generate returns. Investments are made with an eyetoward long-term relationships—generally, a commitment isexpected to be the first of several—and toward the close alignmentof the interests of general and limited partners. Yale avoids fundssponsored by financial institutions because of the conflicts ofinterest and staff instability inherent in such situations.

10

Private Equity

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Real estate, oil and gas, and timberland share commoncharacteristics: sensitivity to inflationary forces, high and visiblecurrent cash flow, and opportunity to exploit inefficiencies. Realasset investments provide attractive return prospects, excellentportfolio diversification, and a hedge against unanticipated inflation.Yale’s 20.0 percent long-term policy allocation significantly exceedsthe educational institution commitment of 6.3 percent. Expectedreal returns are 6.0 percent with risk of 15.0 percent.

The real assets portfolio plays a meaningful role in theEndowment as a powerful diversifying tool and a generator ofstrong returns. Real assets provide relative stability to theEndowment during periods of public market turmoil, at the price ofan inability to keep pace during bull markets. Pricing inefficienciesin the asset class and opportunities to add value allow superiormanagers to generate excess returns over a market cycle. Sinceinception in 1978 the portfolio has returned 15.5 percent perannum.

The illiquid nature of real assets combined with theexpensive and time-consuming process of completing transactionscreates a high hurdle for casual investors. Real assets providetalented investment groups with the opportunity to generate strong returns through savvy acquisitions and managerial expertise.A critical component of Yale’s investment strategy is to createstrong, long-term partnerships between the Investments Office andits investment managers. In the last decade Yale played a criticalrole in the development and growth of more than a dozenorganizations involved in the management of real assets.

Real Assets

Yale Educational University Institutions

Domestic Equity 14.8% 36.8%Fixed Income 7.4 17.5Foreign Equity 14.8 15.6Absolute Return 26.1 15.1 Private Equity 14.5 5.5 Real Assets 18.8 6.3Cash 3.5 3.2

Data as of June 30, 2004.

Asset Allocations

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To assess the efficacy of variouscombinations of investment andspending policies, the Investments Officedeveloped a model that uses simulationsto evaluate the impact of a range ofpolicy combinations on Yale’sEndowment and operating budget.Using “Monte Carlo” techniques, themodel employs random numbers toproduce portfolio return patternsconsistent with assumptions regardingasset class expected risk and returncharacteristics. The resulting path ofsimulated returns determinesEndowment values and spending levels,based on the modeled investment andspending policies. Thousands ofsimulations provide a robust picture ofthe potential effectiveness of any givenpolicy combination.

The two criteria used to analyze theresults of various policies are: 1) thelikelihood of a significant, sustainedintermediate-term drop in Endowmentsupport for the operating budget; and 2) the likelihood of a dramatic long-term reduction in Endowmentpurchasing power. A significant declinein support for the operating budget isdefined as a real reduction of 10 percentover a five-year period. A dramaticdecline in Endowment purchasingpower is defined as a 50 percent dropover a fifty-year horizon.

The Monte Carlo simulationsrepresent a substantial extension of (and improvement over) conventionalmean-variance optimization techniques.Mean-variance analysis simply identifiesa set of efficient portfolios, namelyportfolios with the highest return for agiven level of risk or portfolios with thelowest risk for a given level of return.The mean-variance framework providesno intuitive mechanism for portfoliochoice and fails to incorporate theimpact of spending policy. In contrast,by extending the analysis with MonteCarlo simulations, decision makersenjoy the opportunity to assess thetrade-off between easily understoodcriteria: stable operating budget support(probability of losing 10 percent ofEndowment spending) and purchasingpower preservation (probability oflosing 50 percent of Endowmentpurchasing power).

Monte Carlo simulations applied to the Endowment’s current assetallocation and spending policies indicatea 22 percent chance of real spendingfalling by more than 10 percent over a five-year span. Although theEndowment’s real growth rate isexpected to outpace the 5.25 percenttarget spending rate, a roughly 10percent chance exists that thepurchasing power of the Endowmentwould drop by more than 50 percentafter fifty years.

Using the metrics of stable operatingbudget support and purchasing powerpreservation, the Endowmentdemonstrated substantial improvementover the past fifteen years. As Yaleallocated more of the Endowment to the alternative asset classes of absolutereturn, private equity, and real assets,risks plummeted for both a significantdecline in spending and a dramaticreduction in Endowment purchasingpower. In 1990, when alternative assetclasses accounted for only 15 percent ofthe Endowment, Yale faced a 34 percentchance of real spending dropping by 10percent over five years and a 31 percentchance of real Endowment valuesdiminishing by 50 percent over fiftyyears. By 2000, when absolute return,private equity, and real assets accountedfor nearly 60 percent of the

Endowment, disruptive spending droprisk fell to 24 percent and purchasingpower impairment risk declined to 14 percent.

Investment and spending policies ofother educational institutions providemore disturbing results. Using MonteCarlo simulations and the typicalendowment spending rule (5 percenttarget rate applied to a three-yearmoving average of endowment value),the Investments Office estimates theaverage endowment faces a 37 percentchance of a 10 percent spending dropover five years and runs a 32 percentchance of losing half of its purchasingpower over a fifty-year period.

After fifty years, the median endingpurchasing power of the averageendowment amounts to only 73 percentof its beginning purchasing power. Ingeneral, educational institutions spendat rates far too high to be supported by undiversified portfolios that containtoo many low-return assets. Yale’ssimulations show relatively significantprobabilities of circumstances thatwould be traumatic for educationalinstitutions, highlighting the tenuousbalance between protecting Endowmentpurchasing power and maintaining asteady and substantial stream ofspending.

Monte Carlo Simulations

Yale’s Changes in Asset Allocation Dramatically ReduceSpending Volatility and Risk to Purchasing Power

Purc

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Yale changes spending policyinfrequently. Since the concept ofbudgetary balance acquires realmeaning only with a well-defined,faithfully implemented spending rule,changes in the rule should be few andfar between. Yet Yale must ensure thatits spending policy strikes anappropriate balance between the twingoals of stable, substantial support forthe operating budget and maintenanceof the Endowment’s purchasing power.As a result, spending policy must bereviewed in light of structural changesin the Endowment’s investmentportfolio and in the operating budget’sreliance on Endowment support.

In the twenty-two years followingthe inception of Yale’s modern spendingrule in 1982, the University changed itsspending policy three times. In 1992 theYale Corporation authorized an increasein the long-term spending rate from 4.5percent to 4.75 percent. In 1995 thespending rate was increased again, thistime to 5.0 percent. These spending rateincreases were supported by changes inthe Endowment’s investment portfolio.Starting in the early 1980s with atraditional portfolio that consistedprimarily of domestic stocks and bonds,

Yale transformed the Endowment into a well-diversified, equity-orientedportfolio with superior risk and returncharacteristics. As the portfolioimproved, Yale increased its payout rate accordingly.

In October 2004 the YaleCorporation authorized the thirdchange in spending policy, voting toincrease the spending rate from 5.0percent to 5.25 percent and to changethe smoothing rule from 70/30 (i.e., a70 percent weight on last year’s actualEndowment spending and 30 percentweight on the current year’s targetEndowment spending) to 80/20. Likethe spending rate increases in 1992 and1995, the 2004 spending rate increasestemmed from changes in theEndowment’s asset allocation thatboosted expected return and loweredexpected volatility. In fact, Yale’sportfolio attributes improvedsufficiently between 1995 and 2004so that the 2004 Endowment with the higher spending rate exhibitedapproximately the same risk ofpurchasing power degradation as did the 1995 Endowment with thelower spending rate.

Along with the modification in thespending rate, Yale changed thesmoothing rule to reflect the growingimportance of Endowment spending tothe operating budget. In fiscal 1986,spending from Endowment amountedto a mere 10 percent of revenues. By 2004, spending amounted toapproximately 31 percent of Universityrevenues. While the actual impact of adrop in Endowment value depends onthe recent history of returns, all elseequal, a decline today would have morethan three times the impact on thebudget as would a comparable declinein 1986. By increasing the weighting onlast year’s spending, Yale increases thespending rule’s ability to act as a shockabsorber and dampens the volatility ofthe flow of funds to the operatingbudget.

2004 Change in Spending Policy

Endowment Supports 32 Percent of the Fiscal 2005 Budget

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The spending rule is at the heart of fiscal discipline for an endowedinstitution. Spending policies define an institution’s compromisebetween the conflicting goals of providing substantial, sustainablesupport for current operations and preserving purchasing power ofEndowment assets. The spending rule must be clearly defined andconsistently applied for the concept of budget balance to havemeaning.

Yale’s policy is designed to meet two competing objectives.The first goal is to release substantial current income to theoperating budget in a stable stream, since large fluctuations inrevenues are difficult to accommodate through changes in Universityactivities or programs. The second goal is to protect the value ofEndowment assets against inflation, allowing programs to besupported at today’s level far into the future.

Yale’s spending rule attempts to achieve these two objectivesby using a long-term spending rate of 5.25 percent combined with a smoothing rule that adjusts spending gradually to changes inEndowment market value. The amount released under the spendingrule is based on a weighted average of prior spending adjusted forinflation (80 percent weight) and the amount that would have beenspent using 5.25 percent of current Endowment market value (20 percent weight).

Spending Policy

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Spending Growth vs. Inflation 1950–2004

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The spending rule has two implications. First, byincorporating the previous year’s spending the rule eliminates largefluctuations, enabling the University to plan for its operating budgetneeds. Over the last twenty years, annual changes in spending havebeen less than a third as volatile as annual changes in Endowmentvalue. Second, by adjusting spending toward the long-term rate of5.25 percent of Endowment, the rule ensures that spending levelswill be sensitive to fluctuating Endowment levels, providing stabilityin long-term purchasing power.

Spending from the Endowment increased at a hearty paceduring the past decade despite the conservative nature of Yale’sspending policy, with distributions rising from $132 million in fiscal1994 to $502 million in fiscal 2004. Consequently, Endowmentspending plays an ever-greater role in the budget, having risen from14 percent of expenditures in 1994 to 31 percent in 2004.

Tower in Timothy Dwight College

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5Investment Performance Yale has produced excellent investment returns. Over the ten-year

period ending June 30, 2004, the Endowment earned an annualized16.8 percent return, net of fees, placing it in the top one percent oflarge institutional investors. Endowment outperformance isattributable to sound asset allocation policy and superior activemanagement.

Yale’s long-term superior performance relative to its peersand benchmarks created substantial wealth for the University. Overthe ten years ending June 30, 2004, Yale added $5.4 billion relativeto its composite benchmark and an estimated $5.6 billion relative tothe average return of a broad universe of college and universityendowments.

Yale’s long-term asset class performance continues to beoutstanding. In the past ten years every asset class posted superior returns, in almost every case significantly outperformingbenchmark levels.

For the decade ending June 30, 2004, the domestic equityportfolio returned an annualized 17.0 percent, outperforming theWilshire 5000 by 5.5 percent per year and the Russell MedianManager return by 5.3 percent per year. Yale’s active managers haveadded value to benchmark returns primarily through stock selection.

Yale’s internally managed fixed income portfolio earned anannualized 7.8 percent over the past decade, exceeding the LehmanBrothers U.S. Treasury Index by 0.7 percent per year and theRussell Median Manager return by 0.6 percent per year. By makingastute security selection decisions and accepting illiquidity, theEndowment benefited from excess returns without incurringmaterial credit or option risk.

Over the past decade, the absolute return portfolio producedan annualized 12.2 percent, exceeding its passive benchmark of theOne-Year Constant Maturity Treasury plus 6 percent by 1.2 percentper year and matching its active benchmark of hedge fund manager

Performance by Asset Class

16

$4,720

$2,836

$1,417

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returns. For the ten-year period, absolute return results exhibitedessentially no correlation to traditional marketable securities.

The foreign equity portfolio generated an annual return of10.1 percent over the ten-year period, outperforming its compositebenchmark by 5.9 percent per year and the Russell MedianManager return by 5.4 percent per year. The portfolio’s excessreturn is due to effective security selection and country allocation byactive managers.

Results from Yale’s non-marketable assets demonstrate thevalue of superior active management. Private equity earned 37.6percent annually over the last ten years, outperforming the return ofa pool of private equity managers compiled by CambridgeAssociates by 14.7 percent per year. Since inception in 1973, theprivate equity program has earned an astounding 30.6 percent perannum.

Real assets generated a 16.8 percent annualized return overthe ten-year period, outperforming an active benchmark of realassets manager returns by 2.1 percent per year. Yale’soutperformance is due to the successful exploitation of marketinefficiencies and timely pursuit of contrarian investment strategies.

Asset Class Returns Relative to Benchmarks1994–2004

Active Benchmarks

Domestic Equity: Frank Russell Median Manager, U.S. Equity

Fixed Income: Frank Russell Median Manager, Fixed Income

Absolute Return: csfb Composite

Foreign Equity: Frank Russell Median Manager Composite,

Foreign Equity

Private Equity: Cambridge Associates Composite

Real Assets: ncreif and Cambridge Associates Composite

Passive Benchmarks

Domestic Equity: Wilshire 5000

Fixed Income: Lehman Brothers U.S. Treasury Index

Absolute Return: 1-year Constant Maturity Treasury +6%

Foreign Equity: 50% msci eafe Index, 50% msci em Index

Private Equity: University Inflation +10%

Real Assets: University Inflation +6%

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Yale Corporation Investment Committee

The Yale Investment Committee playsan integral part in the management of the Endowment. With ultimateauthority over the University’sinvestment policy, the eleven-membercommittee consists of the President ofthe University, members of the YaleCorporation, and leaders from thecorporate, financial, and non-profitsectors. Yale’s Investment Committeealso plays a critical role in spendingpolicy deliberations.

Investment Committee meetingsfollow a regular cycle. In the fall theCommittee reviews the previous fiscalyear’s investment results, at levelsranging from the overall Endowment to

individual asset classes to specificinvestment managers. In the winter andspring the Committee focuses attentionon a single asset class or a particularinvestment opportunity. In the summerthe Committee engages in a review ofthe University’s policy portfolio.

Since beginning its oversight of theEndowment in 1975, the InvestmentCommittee has brought togetherremarkable men and women fromvarious backgrounds, united in theirsupport of the mission of the University.The diversity of the Committee servesas a source of strength in themanagement of the Endowment. Corporate executives, investment

managers, educators, and non-profitleaders provide disparate viewpointsand specialized knowledge that informthe decision-making process. Healthydebate and discussion set the stage forconsensus decisions. As Hume noted,“Truth springs from argument amongstfriends.”

By challenging the Investments Officestaff to operate at the highest level, theInvestment Committee plays a criticalrole in Yale’s investment process. Asounding board as well as an oversightbody, the Investment Committee hasbeen an important driver of theexemplary investment performanceachieved by the University.

SUTTER HILL VENTURES

FALCON

Donaldson,Lufkin& Jenrette,Inc.

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Management andOversight

6Since 1975, the Yale Corporation Investment Committee has beenresponsible for oversight of the Endowment, incorporating senior-level investment experience into portfolio policy formulation. The Investment Committee consists of at least three Fellows of theCorporation and other persons who have particular investmentexpertise. The Committee meets quarterly, at which time membersreview asset allocation policies, Endowment performance, andstrategies proposed by Investments Office staff. The Committeeapproves guidelines for investment of the Endowment portfolio,specifying investment objectives, spending policy, and approaches for the investment of each asset category. Eleven individualscurrently sit on the Committee.

Investment Committee Charles D. Ellis ’59, ChairmanFormer Managing Partner Greenwich Associates

G. Leonard Baker ’64Managing Director Sutter Hill Ventures

Joshua Bekenstein ’80Managing Director Bain Capital

Roland W. Betts ’68Chairman Chelsea Piers Management

James Leitner ’75President Falcon Investment Management

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

Henry F. McCance ’64President Greylock Management

Jane L. Mendillo ’80, ’84 mbaChief Investment Officer Wellesley College

William I. Miller ’78Chairman Irwin Financial Corporation

Theodore P. Shen ’66Former Chairman DLJ Capital Markets

Douglas A. Warner iii ’68Former Chairman of the Board J.P. Morgan Chase

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The Investments Office manages the Endowment and otherUniversity financial assets, and defines and implements theUniversity’s borrowing strategies. Headed by the Chief InvestmentOfficer, the Office currently consists of sixteen professionals.

David F. Swensen ’80 ph.d.Chief Investment Officer

Dean J. Takahashi ’80, ’83 mppmSenior Director

Seth D. Alexander ’95Director

Alexander C. BankerDirector

Alan S. FormanDirector

Timothy R. Sullivan ’86Director

Kenneth R. Miller ’71Associate General Counsel

Michael E. Finnerty Associate Director

Randy Kim ’98, ’04 mbaSenior Associate

Robert F. Wallace ’02Senior Associate

Celeste P. BensonSenior Portfolio Manager

Shuba V. RaghavanSenior Research Associate

David B. Slifka ’01Senior Financial Analyst

Jay L. Kang ’02Senior Financial Analyst

Daniel G. Kilpatrick ’03Financial Analyst

Carrie A. Abildgaard Financial Analyst

Investments Office

Windows in Berkeley College

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At University Commencement,hundreds of graduates come away withmore than a coveted Yale diploma. Torecognize exceptional performance inacademics, athletics, community service,and other extracurricular fields ofendeavor, Yale awards a vast array ofprizes. The University bestows so manyprizes, in fact, that it takes a series ofceremonies throughout Commencementweekend to confer them.

Yale’s Endowment provides financialsupport for many of the awards,whether they take the form of a book, a stipend, cash, or a certificate.Endowed funds earmarked for specificawards have existed for nearly two centuries.

Early Prizes and the Role of Oratory

In 1823, David C. DeForest of NewHaven, one of Yale’s most generousnineteenth-century donors, established ascholarship and a prize that still bearhis name. Ranking as the longest-standing Yale award, the David C.DeForest Prize goes each year to thesenior “who shall write and pronouncean English Oration in the best manner.”

Despite the role of oratory anddebating in U.S. presidential campaigns,none of the Yale-educated U.S.presidential candidates won theDeForest Prize. Instead, the best-knownDeForest winners include: presidentialadvisers William P. Bundy (1939) andMcGeorge Bundy (1940); Bay of Pigsnegotiator Henry D. Harfield, Jr. (1934);and two Yale academics, H. BradfordWesterfield (1947), the Damon WellsProfessor Emeritus of International

Studies and Political Science, andStephen Kellert (1985), the Tweedy/Ordway Professor of Social Ecology.

Prominent names populate the list of winners for another of Yale’s earlyawards, created in 1843 by the Isaac H.Townsend Fund in honor of a Yale lawprofessor. The Townsend Prize,bestowed for oratory, honored U.S.Supreme Court Justice Potter Stewart(1937), U.S. Senator David L. Boren ofOklahoma (1963), and U.S. SenatorJohn F. Kerry of Massachusetts (1966).

An oratorical prize at the LawSchool, the John Fletcher Caskey Prize,lists among its winners U.S. SenatorJohn C. Danforth (1963), civil rightsleader and Chief Judge of the ThirdCircuit Court of Appeals A. LeonHigginbotham, Jr. (1952), and NewYork City Mayor John V. Lindsay(1948). Senator Arlen Specter won the

Law School’s John Currier GallagherPrize in 1956 for excellence in thepreparation of cases. In 1941, CharlesL. Black, Jr., the attorney who arguedBrown v. Board of Education in 1954,was honored in the Gallagher Prizecompetition.

Attorney General Edwin Meese wonthe Thacher Memorial Prize in 1951–53for “prowess in extemporaneousdebate,” as did Yale President Kingman Brewster (1941) and frequentprizewinners William P. Bundy (1939),McGeorge Bundy (1940), columnist and author William F. Buckley, Jr.(1948, 1949), John F. Kerry (1964–66),and author and columnist David Frum(1981).

Among several awards for oratoryand debating, Senator Kerry won firstplace in the Henry J. TenEyck, B.A.1879 Prize competition in 1965; this

Endowed Funds for Prizes

David C. DeForest

Henry J. TenEyck

Kingman Brewster

Justice Potter Stewart (standing, third from left), on the Supreme Court, 1962.

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award, created by Members of theKingsley Trust Association (Scroll andKey Society of Yale College), recognizesdistinguished work by juniors.Honorees include poet Stephen VincentBenet (1918), William F. Buckley, Jr.(1949), and legal scholar and authorDeborah Rhode (1973).

Former Senator Gary Hart took the Law School’s Colby TownsendMemorial Prize in 1963 for “the besthonors work done by a second-yearstudent in the School of Law.”Recognizing distinction in publicservice, the Frank Miner Patterson Prize went in 1964 to U.S. SenatorJoseph I. Lieberman.

The Arts and Humanities

Yale awards more prizes in the arts andhumanities than in any other category.

Attorney General John D. Ashcroftwon the John Addison Porter Prize inAmerican History in 1964 during hissenior year at Yale. John E. Pepper, Jr.,former CEO of Procter and Gamble,

now Yale Vice President for Financeand Administration, received the prizein 1960.

An interdepartmental honor, theJohn Addison Porter University Prize,rewards the “best work of scholarship—presented in such literary form as tomake the product of general humaninterest.” George W. Pierson, later anoted Yale historian, received the prizein 1933. Other winners include:distinguished drama critic and scholarEric R. Bentley (1941); authors HughKenner (1950) and Richard D. Ellmann(1947); noted critic and Sterling

Professor of the Humanities HaroldBloom (1956); School of Managementprofessor and author William H.Goetzmann (1957); and SterlingProfessor of History Jonathan D.Spence (1965). The Porter Prize wasestablished by the Kingsley TrustAssociation (Scroll and Key Society ofYale College).

The Donald Annis Prize, recognizing“that student who has made the bestrecord in English and German duringFreshman and Sophomore years,”honored individuals who became well-known writers and scholars, includingYale History Professor George W.Pierson (1924–25), Yale College DeanRichard H. Brodhead (1967), andauthor and New Yorker magazinecontributor Elizabeth R. Kolbert(1983).

Novelist Louis S. Auchincloss in1937 won the Henry W. Scott Prize,which is awarded each year, in the formof a book, for excellence in modernlanguages (mainly French and German).

The John Hersey Prize, endowed in1985 by students of the late author,goes “to a senior or junior for a bodyof journalistic work reflecting the spiritand ideals of John Hersey: engagementwith moral and social issues,responsible reportage and consciousnessof craftsmanship.” Winners includeDavid M. Halbfinger (1990) andMotoko Rich (1991), both New YorkTimes reporters, and an author oncurrent events, Jacob Weisberg (1985).

History of Art graduate studentsaspire to the Frances BlanshardFellowship Prize for scholarlydistinction. Winners include feministauthor Naomi Wolf (1981), Vincent

Scully Professor of the History of ArtMary E. Miller (1981), and HolcombeT. Green Curator of American Paintingsand Sculpture Helen A. Cooper (1986).

Since its inception in 1981, the LouisSudler Prize in the Performing andCreative Arts recognized Yale studentswho have pursued active and successfulartistic careers, from filmmaker JennieM. Livingston (1983) to violinistHaldan Dai Tung Martinson (1994).The prize takes its name from LouisSudler, B.A. 1925, who was a generoussupporter of arts programs at theUniversity. The Thorndike Oliver ActingAward recognized the achievements ofwell-known actors Walter S. (Stacy)Keach, Jr. (1964), Meryl Streep (1975),and Mark Lynn Baker (1979).

Prizes in a Range of Disciplines

In the nineteenth century, Yale’s prizesemphasized oratory. Since the earlytwentieth century, as the Yalecurriculum expanded into new fields, so have the subjects for prizes.

The George Beckwith Medal,established with an endowed fund in 1926, commemorates the publisher ofBeckwith’s Almanac and recognizes theundergraduate most proficient in somebranch of astronomy or mathematics. The 1981 prize was won by Charles E.Bailyn, the Thomas E. DonnelleyProfessor and Chair of the YaleAstronomy department.

For more than a century, Yalehonored students for “excellence inbiological and geological studies” byconferring the William R. BelknapPrize, established in 1872 by a graduateof the Sheffield Scientific School. The1937 Belknap laureate, entrepreneur

John Addison Porter

Mary E. Miller

Paul R. Krugman

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and philanthropist Perry RichardsonBass, of Fort Worth, Texas, fatheredfour sons who also attended Yale. Hisgifts to the University include fundingfor the Nancy Lee and Perry R. BassCenter for Molecular and StructuralBiology. The 1987 winners of theBelknap Prize included Miranda S.Fram, who became a prominentgeologist at the University of California(Davis), and Daniel R. Feikin, anepidemiologist with the Centers forDisease Control, whose studies of SARS

have attracted considerable attention.The Charles Heber Dickerman

Memorial Prize for the best senior essayin economics was awarded to Princetoneconomist and New York Times

columnist Paul R. Krugman (1974) andauthor and professor of managementJeffrey A. Rosensweig (1979). The prizealso went to a series of non-economists,including sculptor Daniel J. Cline(1978), Harvard surgeon and transplantspecialist Hugh D. Auchincloss, Jr.(1971), and Federal Judge GuidoCalabresi (1953).

The Law School awards theBenjamin Scharps Prize to “a memberof the third-year class for the mostmeritorious essay or research on somelegal subject designated by the faculty,under prescribed regulations.” The listof winners includes Victor S. Navasky(1959), author and editor of TheNation, and David Boies (1966), anattorney noted for work ranging fromthe Microsoft antitrust lawsuit to Bush v. Gore.

The versatility of Yale studentsbecomes apparent in the list ofrecipients of the Benjamin F. Barge

Mathematical Prize, whose ranksinclude Edward B. Rothstein (1970,1971), the author and music critic ofThe New York Times. The prize,endowed by Benjamin F. Barge, agraduate of the class of 1857, has alsobeen awarded to Robert S. Rubin(1950), former managing director ofSmith Barney; robotics expert Hillel J.Chiel (1972); mathematician and authorJonathan D. Rogawski (1974); andvideo game creator Nathaniel Glasser(1982, 1983).

Prizes for High Scholarship or Character

The Alpheus Henry Snow Award ranksamong the most important “prizes forhigh scholarship or character” that areawarded annually as a traditional partof Class Day ceremonies. Honoring Mr.Snow, B.A. 1879, the prize recognizes“the senior who, through thecombination of intellectual achievement,character, and personality, shall beadjudged by the faculty to have donemost for Yale by inspiring classmateswith an admiration for scholarship.”

Winners of the Snow Award havegone on to distinguished careers in avariety of fields. A world-of-letterssampling includes: authors Francis OttoMatthiessen (1923), Jan G. Deutsch(1955), and Andre Schiffrin (1957);literary agent Arthur M. Klebanoff(1969); and New Republic editor PeterA. Beinart (1993). From government,the prize winners include presidential

advisers Eugene V. Rostow (1933) andMcGeorge Bundy (1940) as well as N.Strobridge (Strobe) Talbott III (1968),former deputy secretary of state, nowpresident of the Brookings Institution.Snow laureates headed ColumbiaUniversity Law School (Lance M.Liebman, 1962) and the New YorkParks Commission (August Heckscher,1936). Snow honoree GaylordDonnelley (1931) was a conservationistand philanthropist affiliated with theYale School of Forestry &Environmental Studies; Maynard Mack(1932) became a Yale faculty memberand literary historian; John E. Ecklund,Jr. (1938) left his mark as the Yale

McGeorge Bundy

Benjamin Scharps

The McKim Prize recognizes a graduating senior or seniors majoring in political science,economics, history, or a related field, who have shown marked improvement in their academicstanding in upperclass years and who have made a significant contribution in one or moreactivities outside the classroom. Adam Schemp, Annette Saunooke, and Allison Phinney shared theaward at the 2003 Class Day ceremonies.

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Sources

Much of the material in this publication isdrawn from memoranda produced by theInvestments Office for the Yale CorporationInvestment Committee. Other material comesfrom Yale’s financial records, Reports of theTreasurer, and Reports of the President.

Pages 6–11Educational institution asset allocations from Cambridge Associates.

Page 16The Endowment’s annual return for the tenyears ending June 30, 2004 ranks in the topone percent of institutional funds as measuredby the SEI Large Plan Universe.

Photo Credits

Front cover: Tom Strong

Pages 1, 15, 20, 22 (top), 23 (bottom), 24 (left),inside back cover Michael Marsland, Yale Office of Public Affairs

Page 18

Logos and trademarks courtesy of therespective institutions

Page 21 (bottom left) Painting of David C. DeForest by Samuel F. B.Morse, Yale University Art Gallery, gift of Mrs. Pastora Jacoba DeForest Griffin

Page 22 (bottom right)Photo of P. Krugman by Dan Deitch

Pages 21–23 (except where indicated above)Sterling Memorial Library Manuscripts andArchives

Page 24 (right)

Photo of John Madden courtesy of Brown Brothers Harriman & Co.

DesignStrong Cohen

Treasurer in the 1960s and 1970s; andCord Meyer, Jr. (1942) gained renownas a CIA operative and author.

The Hart Lyman Prize recognizes “a junior for character andachievement.” Kurt L. Schmoke, mayor of Baltimore and a YaleCorporation member in the 1990s, won the Lyman Award in 1970.

Prize Winners and Yale’s Endowment

The annals of Yale student prizewinners contain the names of severalmembers of the Yale CorporationInvestment Committee, past andpresent. Former Committee ChairmanJohn Madden, who was ManagingPartner of Brown Brothers Harrimanand Company, had the distinction ofwinning two undergraduate prizes, theAlpheus Henry Snow Award in 1941and the Hart Lyman Prize in 1940.

In 1956, H. Edward Woodsumreceived the Law School’s C. LaRueMunson Prize, which was endowed in1921 by Mr. Munson, an 1875graduate of the school, to recognize“excellence in the investigation,preparation, and (where permitted)presentation of cases.” The IsaacTownsend Prize was awarded in 1963to former Investment Committeemember and later U.S. Senator David Boren, and in 1959 to currentCommittee Chairman Charles D. Ellis.

Two other current Committeemembers received distinguished awards:G. Leonard Baker won the Benjamin F.Barge Mathematical Prize in 1961 andagain in 1962, and Joshua Bekenstein

received the F. Wilder Bellamy, Jr.,Memorial Prize in 1979. Among staffmembers, Chief Investment OfficerDavid F. Swensen was awarded aBerkeley Master’s Prize in 1980 andRobert F. Wallace received the E.Francis Riggs Memorial Prize in 1999for outstanding performance in SpecialCourses in the Humanities forFreshmen.

John Madden

Kurt L. Schmoke

Opposite: Architectural detail, Branford College

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