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The Yale Endowment 2005


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Endowment Highlights

Fiscal Year

2005 2004 2003 2002 2001

Market Value (in millions) $15,224.9 $12,747.2 $11,034.6 $10,523.6 $10,725.1Return 22.3% 19.4% 8.8% 0.7% 9.2%

Spending (in millions) $ 567.0 $ 502.0 $ 470.1 $ 409.3 $ 337.5Operating Budget Revenues 1,768.0 1,630.8 1,553.7 1,466.6 1,352.9(in millions)Endowment Percentage 32.2% 30.8% 30.3% 27.9% 24.9%

Asset Allocation (as of June 30)

Domestic Equity 14.1% 14.8% 14.9% 15.4% 15.5%Absolute Return 25.7 26.1 25.1 26.5 22.9Foreign Equity 13.7 14.8 14.6 12.8 10.6Private Equity 14.8 14.5 14.9 14.4 18.2Real Assets 25.0 18.8 20.9 20.5 16.8Fixed Income 4.9 7.4 7.4 10.0 9.8Cash 1.9 3.5 2.1 0.3 6.2

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Endowment Market Value 19502005

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Contents

A Message from theYale University President 2

A Message from the Investment

Committee Chairman 31. Introduction 4

2. The Yale Endowment 5

3. Investment Policy 8

4. Spending Policy 30

5. Investment Performance 34

6. Management and Oversight 38

7. Ethical Investment Policy 40

Front cover:Wall carving from west faade, SterlingMemorial Library.

Right:View of the Beinecke Rare Book and ManuscriptLibrary in Hewitt Quadrangle, from thecolonnade of University Commons.


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2

A Message fromthe Yale UniversityPresident

For more than three centuries Yale hasremained at the forefront of higher edu-cation, even as the challenges universi-ties face have intensified and as thescope of operations has expanded fromregional to national to global. To main-tain leadership in this rapidly evolvingsphere requires a far-reaching vision aswell as substantial and reliable sourcesof financial support.

We have been fortunate indeed inrecent decades to have the managementof Yales financial resources in suchcapable hands. The Investment Com-mittee, chaired by Charles D. Ellis, hasprovided guidance from some of ourcountrys most sage and resourcefulfinancial experts. The InvestmentsOffice, under Chief Investment OfficerDavid F. Swensen, has consistently ledthe field of higher education in terms ofinvestment return and growth.

I know that thousands of readerswill appreciate and enjoy, as I have, thisreport on the 2005 Yale Endowment.You will find here a distillation of thethinking that guides us so well and adescription of the policies and disciplinethat have kept the value of the YaleEndowment advancing at unparalleledrates. With the growth in net worth hascome steady progress in support for theoperating budget. In 1990 the Endow-ment furnished 12 percent of Yalesoperating revenues; today the budgetreceives approximately 33 percent of itsfunding from this source. As a conse-

quence, Yale has an ever greater degreeof independence, excellence, andstability.

Superior management of Yalesinvestment portfolio cannot aloneensure the financial growth and stabilitwe need. Crucial to the fortunes of aninstitution with the scope and ambitionof Yale is the role of our alumni andfriends in building the Endowment.Gifts to Yale have remained a funda-mental engine of the Universitys growthroughout the centuries. The reportdiscusses the role of our donors inadvancing Yales pursuit of excellence.

Financial support from Yales assetsrepresents a critical underpinning forthe Universitys aspirationsto buildon the Universitys traditional strengthto intensify our efforts in laboratoryscience, medicine, and engineering, tothink and perform globally, to maintaia student body and faculty second tonone.

It is a pleasure to congratulate ourinvestment team on their remarkableperformance. At the same time, I ex-press heartfelt thanks to all our dedi-cated alumni and friends whose gen-erosity continues to mean so muchto Yale.

Richard C. Levin

President Richard C. Levin (right) withCharles D. Ellis, Chairman of the YaleCorporation Investment Committee.


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As a result of generous support fromalumni and friends and the continuingachievements by the Investments Office,Yales Endowment increased its supportof the Universitys expanding budgetfrom 10 percent of revenues in 1986 to33 percent in 2006. During the pasttwo decades, the Endowments annualsupport for the University has increasedby $564 million, supported in large partby Yales $5.4 billion of value-addedversus its endowment peers.

This extraordinary achievement quitenaturally attracts all the attention, yetclose observers can say that the realsecret to Yales remarkable success isdefense, defense, defense. But how, youmight ask, can defense be so importantto Yales remarkably positive results?Starting with that great truism of long-term success in investingif investorscould just eliminate their larger losses,the good results would take care ofthemselveswe remind ourselves of thegreat advantages of staying out oftrouble.

Yales rigorous defense in investingcombines a series of rational initiativesrooted in the powerful body of invest-ment theory developed at Yale and otheruniversities. The architecture of Yalesportfolio structure is designed to locatethe Endowment portfolio on the efficientfrontier in trade-off between risk andreturn. Utilizing Monte Carlo simula-tions, Yales portfolio is tested usingthousands of possible scenarios, withparticular attention to avoiding disrup-

tive adversity and untoward portfoliooutcomes. Yales Investment Committeedevotes a full meeting each year to chal-lenging every aspect of the portfoliostructure in the classic tradition thatonly the well-tested decision meritsstrong, sustained commitment.

Selection of specific external man-agers adds another powerful defenseand has clearly added significantly toYales superior returns. The obviousrisks in manager selection are two:hiring managers after their best resultsand terminating managers after their

worst. Yale strongly favors long-termcontinuing commitments to very care-fully chosen managers, often at an earlystage in their development. As a result,serial capital additions to each managersmandates are frequent and turnoveramong Yales manager relationships isquite low.

Yales process for selecting managersis unusually rigorous, partly because thInvestments Office staff is so well experenced and so in touch with the marketspartly because extensive due diligencecontacts are made; and partly becauseYale selects only those managers whodemonstrate considerable strength onseveral criteria: investment skills; organzational coherence; clarity of businessstrategy; appropriate fees and incentiveand, most importantly, personal andprofessional integrity.

Each new manager is recommendedthrough a formal memorandum thatdetails all due diligence research;explains the managers record, organization, investment philosophy, and deci-sion-making process; and provides theprofessional record of each principal.Each of these in-depth background brieingstypically 15 to 20 pages longprovides the basis for a thorough discusion with staff professionals. QuarterlyInvestment Committee meetings aremuch like an advanced seminar ininvestment theory and practice, led bytwo Yale Ph.D.s: President RichardLevin and Chief Investment OfficerDavid Swensen.

Committee members are chosen fortheir devotion to Yale, their ability towork unusually well in a small group,and, most particularly, for their capacitto provide effective oversight. Our Uni-versity is indeed fortunate to have suchcapable women and men working soconscientiously with our professional

team in the Investments Office.Consistently superior achievement bany investment organization dependsultimately on the people who do theimportant work. Yale has a remarkableteam of highly skilled investment professionals, each with a different area offocus and expertise, who share objectivity when making qualitative decisions;commitment to teamwork; tenacity topurpose when searching out or nurtur-ing relationships with investment man-agers; and appreciation of the impor-tance of serving Yale unusually well.

Sincerely yours,

Charles D. Ellis

A Message from theInvestment CommitteeChairman


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Yales Endowment produced extraordinarily strong results in fiscalyear 2005, generating returns of22.3 percent and gains of $2.8billion. In an environment of single-digit returns for domestic mar-ketable securities, the Universitys non-traditional asset classes drovportfolio results. Once again, Yale benefited from the Endowmentsequity orientation, broad diversification, and active management.

Over the past ten years, the Endowment grew from $4.0 billionto $15.2 billion. With annual net investment returns of17.4 per-

cent, the Endowments performance exceeded its benchmark andoutpaced institutional fund indices. The Yale Endowments two-decade record of16.0 percent per annum produced a 2005 Endow-ment value of more than ten times that of1985. Yales superb longterm 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$149 million to $567 million, an annual growth rate of14 percent.On a relative basis, Endowment contributions expanded from 15percent of total revenues in fiscal 1995 to 32 percent in fiscal 2005.

Next year, spending will approximate $613 million, or 33 percentof projected revenues. Yales spending and investment policies haveprovided handsome levels of cash flow to the operating budget forcurrent scholars while preserving Endowment purchasing power forfuture generations.

Introduction

4

1

1950

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01955 1960 1965 1970 1975 1980 1985 1990 1995 2000 20

1950Endowment Inflated

Post-1950Endowment Gifts Inflated

EndowmentMarket Value

Endowment Growth Outpaces Inflation 19502005

Billions


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Totaling $15.2 billion on June 30, 2005, the Yale Endowmentcontains thousands of funds with a variety of designated purposesand restrictions. Approximately four-fifths of funds constitute trueendowment, gifts restricted by donors to provide long-term fundingfor designated purposes. The remaining one-fifth represent quasi-endowment, monies that the Yale Corporation chooses to invest antreat as endowment.

Donors frequently specify a particular purpose for gifts, creat-

ing endowments to fund professorships, teaching, and lectureships(23 percent), scholarships, fellowships, and prizes (18 percent),maintenance (4 percent), books (3 percent), and miscellaneous spe-cific purposes (25 percent). The remaining funds (27 percent) areunrestricted. Thirty-four percent of the Endowment benefits theoverall University, with remaining funds focused on specific units,including the Faculty of Arts and Sciences (31 percent), the profes-sional schools (22 percent), the library (7 percent), and other entitie(6 percent).

Although distinct in purpose or restriction, Endowment fundsare commingled in an investment pool and tracked with unit

accounting much like a large mutual fund. Endowment gifts of cashsecurities, or property are valued and exchanged for units that rep-resent a claim on a portion of the whole investment portfolio.

In fiscal 2005 the Endowment provided $567 million, or 32percent, of the Universitys $1,768 million operating income. Othermajor sources of revenues were grants and contracts of $507 millio(29 percent), medical services of $277 million (16 percent), nettuition, room, and board of $234 million (13 percent), gifts of $76million (4 percent), other investment income of $24 million (1 per-cent), and other income and transfers of $83 million (5 percent).

The Yale Endowment

2

Professorships

Unrestricted

MiscellaneousSpecific Purposes

Scholarships

MaintenanceBooks

Endowment Fund AllocationFiscal Year 2005

Endowment

Tuition, Room, Board

Medical Services

GiftsOther Income

Other InvestmentIncome

Operating Budget RevenueFiscal Year 2005

Grants & Contracts


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Strong growth in the Endowmentduring the past two decades raises ques-tions about the sensibility of contribut-ing to Yale given the apparent wealthof the University. In fact, recent assetgrowth simply brought Endowmentcontributions to the operating budget

to the historical trend line. Moreover,had the Endowment not benefited fromgenerous gifts over the years, currentsupport for Yales broad program ofeducation and research would be vastlydiminished. Although the Yale Endow-ment is one of the largest in the world,donor support remains critical to thefuture of the University.

Gifts Support Yales Growth

Over the past century, the growth of theYale Endowment mirrored the dramatic

expansion of the Universitys programs.In 1905, the Yale Endowment totaled$7.4 million and funded 34 percent ofthe budget. One hundred years later, theEndowment amounted to $15.2 billionand provided 33 percent of the Univer-sitys budget. In a surprising commonal-ity with the beginning point of34 per-cent and the end point of33 percent,Endowment support for Yales opera-tions over the last 100 years averaged33 percent of revenues.

In 1905, Yale had 3,138 studentsenrolled in the College and eight gradu-

ate and professional schools; as of June30, 2005, Yale had 11,359 studentsenrolled in the College and twelve post-graduate schools. The expansion wasdramatic across the board. New schoolsfounded in those one hundred yearsinclude the School of Architecture, theSchool of Drama, and the School ofManagement, with the School of Medi-cine expanding its program dramati-cally. The growth of the Yale facultywas even more striking. As of June 30,2005, Yale employed 3,236 facultymembers, approximately seven times

the 1905 figure.With this expansion in the number of

students and faculty at Yale came explo-sive growth in the size of the campus.In 1905, Yales physical plant totaledapproximately one million square feet;one hundred years later, that figure wasaround thirteen million square feet,easily outpacing the growth in studentsand faculty. Most dramatic, though,was the exponential growth of financialaid offered by Yale. In the 1905 fiscal

year, when much of the Universitysstudent body came from affluent back-grounds, financial aid totaled only $1.7million in 2005 dollars. In the yearending June 30, 2005, Yale offered$180.7 million of financial aid, anamazing 109-fold increase from one

hundred years earlier.

Gifts Maintain the EndowmentsRelevance

Examining the experience of Harvard,Yale, and the Carnegie Institution overthe past 95 years provides insight intothe importance of gifts. The Carnegie

Institution of Washington, one ofAndrew Carnegies many philan-thropies, pursues cutting-edge scientificresearch in astronomy, plant biology,embryology, global ecology, terrestrialmagnetism, and earth sciences. Estab-lishing the institution in 1902 with a

$10 million gift, Carnegie made subse-quent gifts to bring the 1910 endow-ment to $22 million, nearly equal toHarvards 1910 fund balance of $23million and vastly exceeding Yales$12 million.

Over the course of the past 95 years,the Carnegie Institution endowment

Gifts and Endowment

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Yale Expands Dramatically 19052005

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1905 1915 1925 1935 1945 1955 1965 1975 1985 1995 2005

University Revenue by Source 19052005

EndowmentIncome

Tuition, Roomand Board

Gifts, Grantsand Contracts

Medical Servicesand Other


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more than kept pace with inflation,with June 30, 2005 assets of $650million comfortably ahead of theapproximately $450 million needed tomatch the rise in price levels. But theformerly comparable Harvard endow-ment, now at $25.9 billion, and the

previously smaller Yale endowment,currently at $15.2 billion, dwarf theCarnegie fund. Because the three institu-tions followed roughly comparableinvestment and spending policies, theabsence of continuing gift inflows con-stitutes the single most importantreason for Carnegies failure to keeppace. The result is that Carnegiesendowment, once one of the largest inthe country, now ranks far lower. Byway of comparison, had the YaleEndowment grown at the same rate asCarnegies, it would total approximately$350 million today; Endowment spend-ing would be an insignificant $14million in fiscal 2006, compared to theactual figure of $613 million.

A more precise understanding of theimportance of gifts to Endowmentcomes from a look at Yales post-1950experience, covering the period forwhich the University has high-qualityfinancial data. Without the benefit ofEndowment gifts to Yale in the last 55years, the 1950 Endowment of $132million would have grown to about$3.7 billion by 2005 rather than $15.2billion. The differencea staggering$11.5 billioncomes from gifts andinvestment performance on those gifts.Yales current academic distinctionwould be unthinkable without thesefinancial contributions. Lookingforward, Yales Endowment will fail tomaintain its level of importance to theUniversity over the long term unlessdonors continue to provide Endowmentsupport.

Gifts Underpin Yales Excellence

Endowments provide the means forinstitutions to establish a superior edu-cational environment. On the margin,endowment income attracts betterscholars, provides superior facilities,

and funds pioneering research. As aresult, the ability of endowment tosupport a large portion of a universitysbudget correlates strongly with institu-tional excellence. As the chart belowindicates, a direct relationship existsbetween endowment support and edu-cational quality. The top quartile ofprivate universities, as ranked by U.S.

News and World Reportin its 2005report Americas Best Colleges, reliedon investment income for 19.1 percentof their fiscal 2004 budgets; the topthreeHarvard, Princeton, and Yaleaveraged 31.2 percent, with investmentincome surpassing all other revenue

sources. In contrast, fourth quartileinstitutions counted on investmentincome for only 6.8 percent of revenues.Maintaining an endowment largeenough to fund a sizable percentage ofa universitys budget clearly correlateswith institutional excellence.

Top Three

First Quartile

Second Quartile

Third Quartile

Fourth Quartile

0 5% 10% 15% 20% 25% 30% 35%

Investment Income Correlates with Qualityof Top Research Universities

Fiscal 2004 Percentage of Budget Supported by Investment Income

Actual Endowment Market Value1950 Endowment without Subsequent Gifts

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

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Gifts Prove Crucial to Endowment Growth 19502005

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Yales 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, both of whom con-ducted work on this important portfolio management tool at YalesCowles Foundation. Using statistical techniques to combineexpected returns, variances, and covariances of investment assets,Yale employs mean-variance analysis to estimate expected risk and

return profiles of various asset allocation alternatives and to testsensitivity of results to changes in input assumptions.

Because investment management involves as much art asscience, qualitative considerations play an extremely important rolein portfolio decisions. The definition of an asset class is quite subjective, requiring precise distinctions where none exist. Returns andcorrelations are difficult to forecast. Historical data provide a guidebut must be modified to recognize structural changes and compen-sate for anomalous periods. Quantitative measures have difficultyincorporating factors such as market liquidity or the influence ofsignificant, low-probability events. In spite of the operational chal-

lenges, the rigor required in conducting mean-variance analysisbrings an important perspective to the asset allocation process.

The combination of quantitative analysis and market judg-ment employed by Yale produces the following portfolio:

June CurrentAsset Class 2005 Target

Domestic Equity 14.1% 14.0%

Fixed Income 4.9 5.0Absolute Return 25.7 25.0Foreign Equity 13.7 14.0Private Equity 14.8 17.0Real Assets 25.0 25.0Cash 1.9 0.0

Investment Policy

8

3

Dean J. Takahashi 80, 83 mppmSenior Director

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


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The target mix of assets produces an expected real (afterinflation) long-term growth rate of6.2 percent with a risk (standarddeviation of returns) of11.9 percent. Primarily because of shortfallrelative to the target in private equity holdings, the actual allocationproduces a portfolio expected to grow at 6.0 percent with a risk of11.4 percent. The Universitys 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-

age point.At its June 2005 meeting, Yales Investment Committee

adopted a number of changes in the Universitys policy portfolioallocations. The combination of valuation increases in energy,timber, and real estate and new commitments to timber and realestate drove the real assets allocation to the upper end of the speci-fied range. Based on strong investment characteristics, the Commit-tee approved an increase in the real assets target from 20.0 percentto 25.0 percent. The 5.0-percentage-point increase was funded by a2.5-percentage-point decrease in fixed income to 5.0 percent, a 1.0-percentage-point decrease in each of domestic equity and foreign

equity to 14.0 percent, and a 0.5-percentage-point decrease inprivate equity to 17.0 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 Universitys vulnerability to inflation further directsthe Endowment away from fixed income and toward equity instru-ments. Hence, 95.0 percent of the Endowment is targeted for investment in assets expected to produce equity-like returns, throughholdings of domestic and international securities, real assets, andprivate equity.

Over the past two decades, Yale reduced dramatically theEndowments dependence on domestic marketable securities byreallocating assets to nontraditional asset classes. In 1985, morethan 80 percent of the Endowment was committed to U.S. stocks,bonds, and cash. Today, target allocations call for less than 20percent in domestic marketable securities, while the diversifyingassets of foreign equity, private equity, absolute return strategies,and real assets dominate the Endowment, representing more than80 percent of the target portfolio.

The heavy allocation to nontraditional asset classes stemsfrom their return potential and diversifying power. Todays actualand target portfolios have significantly higher expected returns andlower volatility than the 1985 portfolio. Alternative assets, by theirvery nature, tend to be less efficiently priced than traditional mar-ketable securities, providing an opportunity to exploit market inefficiencies through active management. The Endowments long timehorizon is well suited to exploiting illiquid, less efficient marketssuch as venture capital, leveraged buyouts, oil and gas, timber, andreal estate.

Alexander C. BankerDirector

Seth D. Alexander 95Director


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0

Yales 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. Thepredominant asset class in most U.S. institutional portfolios, domestic equity, represents a large, liquid, and heavily researched market.While the average educational institution invests 32.0 percent ofassets in domestic equities, Yales target allocation to this asset classis only 14.0 percent. The domestic equity portfolio has an expectedreal return of6.0 percent with a standard deviation of20.0 percentThe Wilshire 5000 Index serves as the portfolio benchmark.

Despite recognizing that the U.S. equity market is highly effi-cient, Yale elects to pursue active management strategies, aspiring to

outperform the market index 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. Over the past five fiscal years, security selection gener-ated extraordinary returns, as the University outperformed themarket by a cumulative 61 percentage points. The efforts of Yalesexternal active managers, aided by a tail wind favoring value-oriented and small-capitalization securities, led to this outstandingresult.

As a consequence of the domestic equity portfolios uncon-

ventional structure, Yale experienced significant underperformancepreceding the recent success. For the five years prior to the marketpeak in March 2000, a period when the market favored large-capitalization growth stocks, the University dropped 16 percentagepoints relative to the market. Only by sticking with an uncomfort-able, contrarian position did the University ultimately benefit fromits unusual portfolio.

In constructing the domestic equity portfolio, Yale pays littleattention to sectoral allocations. In fact, the current portfolio con-sists of a variety of specialists seeking to apply in-depth knowledgeto concentrated portfolios of securities. The aggregation of individ-ual manager portfolios focused on energy, biotechnology, and tech-nology, along with a number of less specialized managers, bearslittle resemblance to broad-based market indices. While such a portfolio almost guarantees short-term deviation from market returns,the focused application of deep knowledge to the security selectionprocess sows the seeds for longer-term investment success.

Yales portfolio typically favors value and small-capitalizatiostocks. Value stocks, securities that are cheap in relation to funda-mental measures such as book value, earnings, or cash flow, gener-ally outperform the market over the long term, albeit with higher

Asset ClassCharacteristics

Domestic Equity

Timothy R. Sullivan 86Director

Alan S. FormanDirector


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volatility of returns. Patient investors reap rewards for takinguncomfortable positions in out-of-favor sectors and securities.Yales overweighting of small-capitalization stocks stems from abelief that larger stocks tend to be better followed and more effi-ciently priced than small-capitalization stocks, offering better opportunities for superior managers to generate excess returns. In addi-tion, studies indicate that, over the very long term, small-capitaliza-tion stocks tend to generate slightly higher risk-adjusted returns

than do large-capitalization stocks. Thus small-capitalization stockshave a prevailing, albeit somewhat unreliable, wind at their back.

When engaging active managers, Yale structures relationshipthat align the Universitys interests with the managers. Too manymoney managers profit by gathering assets at the expense of gener-ating strong investment returns. High levels of side-by-side invest-ment contribute to creating coincidence of interest, as does amanagers ethical desire to serve the clients interest.

Yale often develops new investment management relation-ships with promising young and hungry principals or with anexperienced group working independently for the first time. Newer

organizations typically have small amounts of assets under manage-ment and something to prove. As investment management organizations progress through their life cycle, Yale monitors relationshipscarefully to ensure that interests continue to coincide, that assetsunder management remain at reasonable levels, and that managersstand motivated and capable.

The Investments Office monitors the size of actively managedportfolios, shifting capital both to rebalance market sector exposureand to take advantage of tactical opportunities. Capital allocationto individual managers takes into consideration the sector exposureof the domestic equity portfolio, the degree of confidence Yale pos-

sesses in a manager, and the appropriate asset size for a particularstrategy. When the University perceives compelling undervaluationin a sector of the market, Yale may allocate additional capital toexisting managers and, perhaps, hire new managers to take advan-tage of the opportunity.

Yales domestic equity portfolio contains a group of intelli-gent and dedicated managers with high integrity, sound investmentphilosophies, strong track records, superior organizations, andcompetitive advantages. In spite of the difficulty of identifying mis-priced securities, by employing a sufficiently long time horizon theUniversity expects to benefit from the efforts of its domestic equitymanagers.

Given the efficiency of the U.S. equity market, the Univer-sitys performance in the asset class has been remarkable. Over theten years ending June 30, 2005, Yales domestic equity portfolioreturned 15.7 percent per annum, outperforming the Wilshire 5000by 5.8 percent annually, generating $746 million in value addedrelative to the portfolios benchmark.

Michael E. FinnertyAssociate Director

Kenneth R. Miller 71Associate General Counsel


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Yale College students enjoy an extraor-dinary quality of campus life. Donors toYales Endowment have contributed tothe undergraduate experience by pro-viding permanent support for a widevariety of student activities, whichenrich the learning experience while

encouraging leadership and involvementin social services.

A historical review indicates that theissue of student well-being was not amajor concern of donors in the earlyhistory of Yale College. In the eigh-teenth and nineteenth centuries, acollege education had been more or lessrestricted to the leisure class, with theresult that a students free timeasidefrom intercollegiate athleticsremainedlargely a private matter funded by theindividuals own resources. The notionthat a university should provide stu-dents with a pleasant, stimulating, andwell-rounded experience became morefirmly entrenched in the twentiethcentury, as reflected in the quickeningpace of contributions to the Universityfor extracurricular student activity.With the democratization of higher edu-cation came a sense of responsibility forstudent well-being, as well as a concernfor wholesome, organized activity forundergraduates.

An early endowment for studentactivities, the John W. Hendrie DebatingFund, established in 1900 by Mr.Hendrie, b.a. 1851, supports what maybe the most long-standing extracurricu-lar activity at Yale. Debating, which isclosely associated with political life,suits an institution that aspires to pro-duce leaders as well as scholars. Inaddition to debating, Yale has endowedsupport for many prizes for oratory.

Other early endowments emphasizedcultural pursuits and reinforced Yalesassociation with the arts. A 1907endowment originally funded withcontributions from a number of donorsfinances the Yale Dramatic Association,known as the Dramat. Endowmentfunding placed student drama produc-tions on permanent financial footing,which has helped cement theaters placeas one of the liveliest aspects of Yalesextracurricular life. Yales PhilharmoniaOrchestra, another arts-related extra-curricular activity, benefits from theLucy S. and Henry C. White Fund,which started with a $50,000 bequestby Mrs. White in 1927.

One of the most widely supported

student activities has been the GleeClub, which relies on at least eightdifferent endowed funds. Endowmentsupport for the Glee Club began withthe Joseph Horne Holmes Fund of1936, presented by the brother and sonsof the honoree to assist the Yale GleeClub in meeting expenses. Some fundsthoughtfully provided for travelexpenses so the Glee Club can acceptengagements throughout the world.Other funds support undergraduate

musical performance more broadly,including the Sarah E. Cogan DeansDiscretionary Fund (1978) that providesfunds for singers and their travel andfor instrument maintenance andreplacement, among more generalneeds and the William Weston Bray, Jr.(b.e. 1950e) Undergraduate Music Fund(1994) for the support of undergraduatemusic programs. Performing arts receivefunding from the 2003 David Shaber54 m.f.a. Memorial Fund for Under-graduate Performing Arts.

In 1933, Yale founded the residentialcollege system, which created space oncampus for the growing body of under-graduates (many of whom had previ-ously been forced to live in boardinghouses off campus), divided them intosmall communities, and integratedsocial, extracurricular, and academiclife. From the 1930s forward, studentactivity funds tended to be associatedwith the colleges. Each of Yales twelveresidential colleges boasts a numberof endowments for student activities,which complement funds to supportthe more academic side of residentialcollege life such as seminars, research

travel, and scholarly prizes.The earliest of the residential collegefunds for student activities, the PaulHaviland (b.a. 1927) Memorial Fundestablished in 1935, supports an intra-mural golf tournament among the col-leges. The Haviland fund was unusualfor its time in that it promoted athleticcompetition instead of cultural activity.

A bequest from alumnus Allison V.Armour, b.a. 1884, established a fundin 1941 to enable the master of Daven-

Student Activities

2

The Yale Glee Club in 1888. The man with the long whiskers is Thomas G. Shepard, second director ofthe club. In the back row, last man on the left, is Amos Alonzo Stagg,b.a. 1888, later a famous football andbasketball coach.

A poster announcing the performance on June17,1911 of a Yale Dramatic Association (Dramat) playcalled The Knight of the Burning Pestle. This poster

dates from a few years after the student theater groupreceived endowed funding in 1907.


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port College to acquire books, works ofart, or furnishings for the college, par-ticularly for the Fellows Room. Shortlythereafter the Kent Arnold and HarryLlewelyn Evans, Jr. Memorial Fund(1945) gave the master of Berkeley thewherewithal to encourage student inter-est in natural sciences and music, butwithout indicating how that should be

accomplished on income from a totalgift of $1,740.

A 1936 gift from Hendon Chubb,ph.b. 1895, created the Chubb Fellow-ship in Timothy Dwight College tobring distinguished speakers to campuseach year. In its nearly seven-decadehistory, the Chubb Fellowship enabledstudents to hear talks by nationalfigures including George H.W. Bush,

Jimmy Carter, Gerald Ford, BettyFriedan, John Kenneth Galbraith, andNorman Mailer. The guests often partic-ipate in the Yale institution known as

the Masters Tea, which brings visitorsinto the masters living room for a con-versation with students. Campus visitsby leaders in government, business,sports, the arts, and the media undeni-ably add luster to a Yale College educa-tion, providing a real-world comple-ment to theoretical studies.

Chubb inspired other residential col-leges to follow suit, generating a rangeof funds for guest lectureships andexchanges with prominent nationaland international figures. In 1958 theCharles D. Dickey (b.a. 1916, m.a.h.

1946, ll.d. 1963) Davenport CollegeFund, named for a former fellow of theYale Corporation, established supportfor guest speakers, as did the LovettLectureship Fund of Pierson College.Other colleges followed. A similarendowment for the University as awhole, the John-Christophe SchlesingerVisiting Writer Endowment Fund, 1999,has sponsored campus visits by authorsincluding Tobias Wolff, author ofThisBoys Life.

Increasingly, endowments for studentactivities provide substantial flexibility.

For example, in 1960, several donorscombined forces to create the CalhounCollege Fund to be used at the discre-tion of the Master of Calhoun Collegefor the benefit of the College. Manyyears later, in 2003, the Evelyn and

John McNiff (b.a. 1983) CalhounCollege Fund for Student Activities pro-vided the same flexible student activitysupport. Most colleges have at least onesuch discretionary masters fund thatserves a great range of purposes. The

Abraham Pierson Fund of1991, forinstance, provides for: (1) college break-fasts for graduating seniors and othersresiding on campus until Commence-ment; (2) common room furnishings;(3) maintenance and upkeep of thePierson squash courts; and (4) otherpurposes including emergency loans forstudents and maintenance of the pool

room, TV room, exercise and weightroom, and similar facilities. Discre-tionary funds enable the college mastersto support important activities, includ-ing social events and celebrations.

The Residential Colleges IntramuralsFund, contributed by the William andMartha Ford Fund in 1981, providesongoing support for athletic competi-tion among the residential colleges. Forthose with more artistic inclinations, theLouis Sudler (b.a. 1925) PerformingArts Fund supports performing artsactivities in the residential colleges.

In a more spiritual vein, religiousactivities receive support from theWilliam Sloane Coffin, Jr. (b.a. 1949,b.d. 1956) Fund, established in 1976,while programs of the Slifka Center for

Jewish Life and the St. Thomas MoreChapel have endowments as well. Some

endowments address the needs of par-ticular groups of undergraduates, suchas the Peter Greeman (b.a. 1954) Fundestablished in 1999 to support EthnicCounselors for undergraduates andCultural Connections (a pre-orientationprogram for freshmen).

Endowed funds often reflect thechanging character of Yale, providing

permanent funding for new initiatives.For example, to support the currenteffort to increase international opportu-nities available to Yale students, theRichard G. Corey Fund, established in2003, provides funds for internshipsabroad for Yale undergraduates, so thatthe students may either perform volun-teer services or work in foreign coun-tries. The fund helps to make non-academic activity abroad affordable forall students, increasing internationalinterests and knowledge.

Endowments play a crucial role in

shaping the character and quality ofundergraduate life. Yales generousdonors have provided a wide variety offunds that expose students to provoca-tive ideas, healthy competition, and newexperiences.

The Yale Golf Course, which opened in1926 on land given to the University in1923 by Mrs. Sarah WeyTompkins, occupies about 300 acres. The eighteen-hole course hosts the Yale mens and womens varsity golfteams as well as the annual Yale College intramural golf tournament, which receives support from the Paul

Haviland (b.a. 1927) Memorial Fund.


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Fixed income assets generate stable flows of income, providinggreater certainty of nominal cash flow than any other Endowmentasset class. The bond portfolio exhibits a low covariance with otherasset classes and serves as a hedge against financial accidents orperiods of unanticipated deflation. While educational institutionsmaintain a substantial allocation to fixed income and cash, averag-ing 19.5 percent, Yales target allocation to fixed income constitutesonly 5.0 percent of the Endowment. Bonds have an expected real

return of2.0 percent with risk of10.0 percent. The Lehman Broth-ers U.S. Treasury Index serves as the portfolio benchmark.

Yale is not particularly attracted to fixed income assets, asthey have the lowest historical and expected returns of the six assetclasses making up the Endowment. Still, fixed income plays animportant role in the Endowment by providing a diversifying hedgeagainst financial accidents or periods of unanticipated deflation. Toachieve this hedge, the Endowment invests primarily in high-qualityinstruments backed by the full faith and credit of the U.S. govern-ment. Yales portfolio emphasizes non-callable securities, ensuringthat the Endowment receives the hoped-for protection in periods of

declining interest rates.The government bond market is arguably the most efficiently

priced asset class, offering few opportunities to add significant valuthrough active management. In fact, most fixed income managersplay a cynical game, consciously exposing client assets to greater-than-benchmark risk and claiming that the incremental returns rep-resent superior performance. As the bond managers pocket fees forproviding a disservice, clients lose in more than one way. In additioto the out-of-pocket costs for active management, clients lose theprotection afforded by high-quality, non-callable fixed incomeinstruments.

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

Another method employed by active managers is to increasethe optionality of fixed income holdings. By holding callable corpo-rate or mortgage-backed securities, bond managers again increasereturns under normal circumstances. Yet, when interest ratesdecline, companies and homeowners repay callable debt to refinancexisting obligations at lower rates. In periods of deflation, just whendeclining rates ought to boost bond portfolio value, the presence ofcallable instruments dampens portfolio appreciation and underminethe fundamental reason for holding bonds.

Most active management strategies hurt investors by failingto generate risk-adjusted excess returns and by diluting the hedgingcharacteristics of high-quality, non-callable bond investments.Investors holding pure fixed incomelong-term obligations of the

Fixed Income

Peter H. Ammon 05 mba, 05 maSenior Associate

Randy Kim 98, 04 mbaAssociate Director


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U.S. governmentbest meet the crisis protection and deflationhedging requirements for bond portfolios.

Yale generally engages external managers to make activesecurity selection decisions, operating with the philosophy that superior investment results stem from creating partnerships with top-notch managers around the globe. Fixed income represents theexception that proves the rule. Based on skepticism about activefixed income strategies and belief in the efficacy of a highly struc-

tured approach to bond portfolio management, the InvestmentsOffice chooses to manage Endowment bonds internally. In spite ofan aversion to market timing strategies, credit risk, and call optionsYale manages to add value consistently. Primarily by identifyingoverlooked, illiquid securities, over the past decade the InvestmentsOffice produced returns of7.4 percent per annum, 67 basis pointsper year above the benchmark return. Creative, patient portfoliomanagement leads to superior investment results without impairingthe portfolio protection characteristics of high-quality fixed income

Sensible investors focus on the diversifying characteristics oflong-term government bonds, holding only the amount necessary to

protect portfolios against financial trauma. If portfolios include theminimum allocation necessary to provide insurance against catastrophe, investors free up assets to diversify into alternative assetclasses, achieving volatility reduction without sacrificing return. Alow allocation to high-quality fixed income reduces the costs associ-ated with holding bonds during normal circumstances and periodsof unanticipated inflation, the environments in which fixed incomepositions tend to impair portfolio performance. Tailoring the bondportfolio to emphasize fixed incomes essential diversifying charac-teristics increases expected benefits in time of crisis, while reducingthe long-term costs of holding bonds.

Celeste P. BensonSenior Portfolio Manager

David B. Slifka 01Senior Associate


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security allocations may differ significantly from those of broadglobal indices. Small-capitalization stocks, lying below the radarscreen of large institutional funds, offer particularly compellingopportunities to add value. Although some of Yales managers haveglobal mandates, Yale recognizes the value of managers that specialize regionally. A regional mandate facilitates the conduct of inten-sive company research, creating an edge over less focused globalfunds.

Country allocations heavily influence overall performance inforeign equities. Unfortunately, forecasting country returns provesdifficult in developed markets and provides a generally unreliablesource of value added. In emerging markets, country valuationssometimes move to extremes that offer identifiable top-down opportunities to generate excess returns. In general, however, Yales man-agers focus on identifying bottom-up security-specific investments.

The Investments Office monitors the size of actively managedportfolios, shifting capital to take advantage of tactical opportuni-ties. Capital allocation to individual managers takes into considera-tion the degree of confidence Yale possesses in a manager, the

country allocation of the managers portfolio, and the appropriatesize for a particular strategy. In addition, Yale sometimes exploitscompelling undervaluations in a country, sector, or strategy byhiring a new manager to take advantage of the opportunity.

Although Yales foreign equity managers pursue a broadrange of investment mandates, they share a commitment to funda-mental research. In the developed portfolio, Yale has core alloca-tions to managers that search for undervalued securities, employingproprietary models to identify value. Investment approaches rangefrom using highly sophisticated quantitative modeling techniques, tconducting thorough bottom-up company analysis, to identifying

out-of-favor, asset-rich companies at deep discounts to fair value.Yale manages internally a portfolio of closed-end funds and invest-ment trusts that contain both developed and emerging market equi-ties. Through these vehicles the University can increase or decreaseexposure to foreign markets as needed and add incremental value bpurchasing at wide discounts and selling at narrower discounts.

In the developing markets portfolio, Yale employs a globalemerging markets manager complemented by managers withregional concentrations in Eastern Europe, Russia, Asia, and AfricaThe Universitys managers use fundamental research to understandpotentially attractive companies, often making hundreds of

company visits per year.In general, Yales managers do not hedge currencies, since a

modest amount of exchange rate exposure actually improves overalportfolio diversification. However, managers will occasionally incorporate insights on exchange rates into security selection decisions,such as by favoring exporters in countries with weakening curren-cies. In extreme circumstances, some of Yales managers will selec-tively hedge foreign exchange exposure back to the dollar or toother currencies.

The Universitys performance in foreign equities has beenoutstanding. Over the ten years ending June 30, 2005, Yale foreign

Shuba V. RaghavanSenior Research Associate

Anne MartinSenior Research Consultant


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equities returned 12.7 percent per annum, more than twice theannualized 6.1 percent return of the asset classs composite bench-mark, generating $672 million in value added relative to the portfolios benchmark.

In July 1990, Yale became the first institutional investor to pursueabsolute return strategies as a distinct asset class, beginning with

a target allocation of15 percent. Unlike traditional domestic andforeign equity investments, absolute return investments providereturns largely independent of overall market moves. In contrastwith diversifying investments such as cash and bonds, absolutereturn strategies have excellent prospects of generating high long-term real returns coupled with low risk.

Absolute return investments seek to generate high long-termreal returns by exploiting market inefficiencies. The absolute returnportfolio is managed by investment firms pursuing a wide varietyof strategies, which can be broadly categorized as event-driven orvalue-driven. Event-driven strategies generally involve hedged

positions in mispriced securities and depend on a specific corporateevent, such as a merger or bankruptcy settlement, to achieve tar-geted returns. Value-driven strategies also entail hedged investmentsin mispriced securities, but rely on changing company fundamentalsor increasing market awareness to drive prices toward fair value.

Today, the absolute return portfolio is targeted to be 25.0percent of the Endowment. In contrast, the average educationalinstitution allocates 17.6 percent of assets to such strategies.Absolute return strategies are expected to generate real returns of6.0 percent with risk levels of10.0 percent for event-driven strate-gies and 15.0 percent for value-driven strategies.

An important attribute of Yales investment strategy concernthe alignment of interests between investors and investment man-agers. To that end, absolute return accounts are structured with performance-related incentive fees, hurdle rates, and clawback provi-sions. In addition, managers invest a significant portion of their networth side by side with Yale. In any investment arrangement, whengains are strong, managers benefit and Yale profits. But if losses areincurred, only providers of capital suffer. Significant general partnerco-investment ensures that losses will be felt by both the managerand Yale. By aligning the interests of Yale and its managers, theUniversity avoids many of the potential pitfalls of the principal-

agent relationship.Given the opportunistic aspect of the absolute return asset

class, Yale seeks to vary capital commitments in response to degreeof opportunity. Fluctuations in bankruptcy rates and merger activitas well as changes in regulatory environment and valuation levels aaffect the relative attractiveness of absolute return strategies. Yalestructures accounts to allow timely cash flows (in and out) in orderto match asset size with investment opportunities. The University iswary of dedicated specialist funds that lock up investor assets,encouraging managers to put money to work regardless of theinvestment climate. We prefer to hire managers with the depth,

Absolute Return

Daniel G. Kilpatrick 03Senior Financial Analyst

Jay L. Kang 02Senior Financial Analyst


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Private Equity

scope, and experience to assess and allocate funds across more thanone strategy.

Since June 30, 1990, the absolute return portfolio hasachieved its goal of generating high returns with modest volatilityand low correlation to domestic equity markets. The portfolio hasreturned an annualized 12.7 percent in the fifteen years since itsinception, outperforming its benchmark by 1.7 percent. In additionthe portfolio has outperformed the Wilshire 5000 return of10.8

percent over the relevant time period. The monthly standard devia-tion of the portfolio was a remarkably low 5.1 percent annualized,relative to 14.6 percent volatility exhibited by the Wilshire 5000.The correlation of monthly returns with the Wilshire 5000 has beenexactly zero, highlighting the significant diversification effect of theasset class.

Private equity offers extremely attractive long-term risk-adjustedreturn characteristics, stemming from the Universitys strong stableof value-added managers that exploit market inefficiencies. Yalesprivate equity investments include participations in venture capital

and leveraged buyout partnerships. The Universitys target alloca-tion to private equity of17.0 percent far exceeds the 6.1 percentactual allocation of the average educational institution. In aggregatethe private equity portfolio is expected to generate real returns of11.4 percent with risk of29.0 percent.

Yale was among the first institutional investors to participatein the now widely pursued asset class of private equity, making itsfirst commitment to leveraged buyouts in 1973 and to venture cap-ital in 1976. The University participates in private equity throughpartnerships managed by the nations leading private equity firms,including venture capitalists Greylock, Kleiner Perkins, Sequoia, and

Sutter Hill, and buyout specialists Bain Capital, Berkshire Partners,Clayton Dubilier & Rice, and Madison Dearborn Partners.

Yales private equity program is regarded as one of the bestin the institutional investment community and the University is fre-quently cited as a role model by other investors. Since inception in1973, private equity has generated a 31.0 percent annual return;over the past ten years Yales private equity portfolio has generateda 39.5 percent annual return, including an amazing return of168.5percent in fiscal 2000, when the University made $2.1 billion on itsprivate equity investments. The success of Yales program led to a1995 Harvard Business School case study, Yale University Invest-

ments Office, by Professors Josh Lerner and Jay Light. The populacase study was updated in 1997, 2000, and 2003.

Yales private equity assets concentrate on partnerships withfirms that emphasize a value-added approach to investing. Suchfirms work closely with portfolio companies to create fundamentallmore valuable entities, relying only secondarily on financial engi-neering to generate returns. Investments are made with an eyetoward long-term relationshipsgenerally, a commitment isexpected to be the first of severaland toward the close alignmentof the interests of general and limited partners.

Dennis Hong 05Financial Analyst

Carrie A. AbildgaardFinancial Analyst


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Of particular note has been the success of Yales venturecapital managers, which have started some of the nations leadingcompanies. In the 1970s and 1980s, Yale participated in a numberof start-ups that defined the technology industry, including CompaqComputer, Oracle, Genentech, Dell Computer, and Amgen. Thehigh-flying 1990s included lucrative investments in Amazon.com,Yahoo, Cisco Systems, Red Hat, and Juniper Networks. Yales morerecent investment in Google illustrates the home-run potential of

venture capital investing; the Universitys $300,000 investment gen-erated $75 million of gains after the company went public in 2004.While lacking the dramatic appeal of venture investments,

Yales leveraged buyout investments have delivered high returnswith remarkable consistency. Notable transactions in which Yaleparticipated through its leveraged buyout firms include Snapple Beverage, AutoZone, Lexmark International, Kinkos, Carters, andDominos Pizza.

Increasingly, Yale has invested in private equity abroad. TheEuropean leveraged buyout market has emerged as an appealinginvestment opportunity, as private equity gains more widespread

acceptance. Venture capital in Asia presents intriguing potential,albeit with the increased risks of investing in developing countrieswith less well-established laws and markets.

The successes of Yale and other long-time investors in privatequity have attracted numerous new investors to the field. Vastlylarger sums of capital have been raised, prompting concerns aboutfuture returns. The hallmark of Yales successful private equityprogram has been long-term relationships with the very best venturcapital and leveraged buyout managers. By aligning itself with thesepremier firms, the University hopes to continue to generate attrac-tive returns in an increasingly competitive marketplace.


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Real Assets Real estate, oil and gas, and timberland share common characteris-tics: sensitivity to inflationary forces, high and visible current cashflow, and opportunity to exploit inefficiencies. Real assets invest-ments provide attractive return prospects, excellent portfolio diversfication, and a hedge against unanticipated inflation. Yales 25.0percent long-term policy allocation significantly exceeds the averageendowments commitment of7.5 percent. Expected real returns are6.0 percent with risk of15.0 percent.

Holdings of real assets offer risk and return characteristicswell suited for the Yale Endowment. Real assets represent claims onfuture streams of inflation-sensitive income, supplying protectionagainst unanticipated inflation and playing an important diversify-ing role in the portfolio. Real assets provide relative stability to theEndowment during periods of public market turmoil, at the price oan inability to keep pace during bull markets. In addition to attrac-tive diversifying characteristics, real assets present tremendousopportunities for superior managers to add value and outperformindustry averages. The illiquid nature of real assets and the information-intensive aspects of the transaction processes favor skilled and

experienced investors.To take advantage of inefficient real estate, oil and gas, andtimberland markets, the University seeks talented and motivatedinvestment managers with proven ability to create value indepen-dent of underlying market or commodity price movements. Believ-ing that the basic return from real assets investments can be aug-mented by operational expertise, Yale looks for firms with superioroperating capabilities, as opposed to groups with only financialengineering skills. Yales strong preference is to work with operatorthat focus on a geographic region or property type, or both, believ-ing that specialized managers with deep market knowledge and

experience gain an important edge over more diffuse organizations.Yale attempts to create strong, long-term partnerships in

which the interests of the University and its investment managersare closely aligned. Yale requires investment managers to own ameaningful economic interest in every deal, encouraging thoughtfulacquisitions, careful oversight, and timely dispositions. Yale targetsemployee-owned firms to ensure that incentive compensation bene-fits the individuals doing the work and that general partner co-investment comes principally from the partners of the firm. Yaledemands that its partners maintain reasonable levels of assets undermanagement, encouraging pursuit of only the most attractive oppor

tunities and forcing managers to create wealth through the genera-tion of high returns rather than the collection of large annual man-agement fees.

Yales investment strategy compels the University to supportemerging investment management groups that are not well-known,brand name companies. Even though newly formed groups typicallyinclude several highly experienced and talented founding partners,backing start-ups exposes the University to managerial and organi-zational risk as the individuals attempt to jell as a team and themanagement company seeks a stable financial footing. In spite ofthe risks, the University benefits enormously from the close relation

Xiaoning Wu 04Financial Analyst

Nicholas T. Shalek 05Financial Analyst


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ships forged with organizations that Yale introduced to the institu-tional funds management business.

Yale prefers real assets investments that generate a currentcash yield, whether from property rents, reserve production, or sus-tainable timber harvests. The presence of a substantial cash yieldmakes the total return on investment less sensitive to the length ofthe holding period and reduces valuation risk. Yale garners a margiof safety by paying a low purchase price. In real estate deals, Yale

pursues investments in which asset pricing is at a discount toreplacement cost; in oil and gas, reserve acquisitions at a discountto long-term normalized pricing; and in timber, forestland at a sub-stantial discount to standing timber value.

In the real estate portfolio, Yale developed a deep roster ofinvestment managers focused on multiple property types and geo-graphies. Because local supply and demand play a large role indetermining market returns, much of the real estate portfolio islocated in supply-constrained areas. Reflecting the Universitys biastoward focused managers, the portfolios largest managers are nicheplayers, concentrating on narrowly defined areas, such as prime

office buildings in central business districts of major metropolitanmarkets, retail assets in the Northeast, and office and residentialproperties in the Westside submarket of Los Angeles. Specializedmanagers with excellent market knowledge provide enormous valueadded, supporting the notions that real estate is not a commodityand that values can vary tremendously even between neighboringproperties.

In the oil and gas and timber arenas, price changes in theunderlying commodity strongly influence investment returns. Unfortunately, macroeconomic and political factors drive commodityprices, making them extremely difficult, if not impossible, to fore-

cast. Rather than depend on uncertain future price increases, Yalesnatural resource investments must meet return targets in flat priceenvironments. If commodity prices rise, Yales natural resource portfolio will generate handsome performance even as other parts of thEndowment suffer from the higher costs of basic materials andenergy.

In the oil and gas portfolio, Yale emphasizes the low-riskpurchase of high-quality proven reserves. In finding managers thatevaluate and operate assets more efficiently than large oil and gascompanies, Yale generates substantial returns without depending onhigher-risk exploration strategies. A portion of the energy portfolio

is allocated to private investments in which investment managerstake meaningful stakes in energy exploration, production, or servicecompanies, and attempt to influence the management and growth othe companies.

When investing in timberland, Yale concentrates on the pur-chase and sustainable management of natural forests in the UnitedStates. While generally slower-growing than plantation forests,natural forests tend to be priced less efficiently and to offer moreopportunities for skilled managers to add value through silviculturaactivities, selective harvests, and wood merchandising. Like valuestocks in the marketable securities world, slower-growing forests

Thad C. Brown 92

Matthew L. Ramadanovic


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sometimes can be purchased for overly discounted prices because oflack of interest by other investors.

In real assets, like other asset classes, Yale seeks value andbehaves in a contrarian manner. Investments reflect compellingopportunities and the Universitys ability to find suitable managers,regardless of activity in the broad market. This approach has generated strong investment performance and important diversification tothe Endowment. Over the ten years ending June 30, 2005, the port

folio returned an annualized rate of return of17.7 percent, surpass-ing the benchmark return of9.8 percent. Correlations over the lastten years between real assets and Yales other asset classes have beenextremely low, ranging between a low of -0.04 with the foreignequity asset class and a high of0.29 with the absolute return assetclass.

Yale EducationalUniversity Institution Mean

Domestic Equity 14.1% 32.0%

Fixed Income 4.9 16.3Absolute Return 25.7 17.6Foreign Equity 13.7 17.4Private Equity 14.8 6.1Real Assets 25.0 7.5Cash 1.9 3.2Data as of June 30, 2005

Asset Allocations

The Class of1954 Environmental Science Centeron Sachem Street adjacent to the Peabody Museum.


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Many market participants place anextraordinary value on liquidity. Playersseek the ability to trade out of yester-days loser and acquire todays hotprospect, to sell during a market panicand buy into a bull market. Managersresponsible for large sums of money

focus on heavily traded securities,allowing movement in and out of posi-tions with minimal market impact.However, in pursuing more-liquid secu-rities, investors often miss out on theopportunity to establish positions inilliquid securities at meaningful dis-counts to fair value.

Highly liquid large-capitalizationstocks receive extensive coverage, gener-ating enormous amounts of public data.The widespread availability of informa-tion contributes to an environment inwhich investors have difficulty inobtaining an analytical edge. In con-trast, less liquid small-capitalizationstocks have less available information,creating an opportunity to be rewardedfor uncovering nuggets of data relevantto valuation. Rewarding investmentstend to reside in dark corners, not inthe glare of floodlights.

The liquidity so many investors seektends to disappear when most needed.In the crash of October 1987, marketmakers possessed neither the resourcesnor the willingness to absorb the extra-ordinary volume of selling demand thatmaterialized. The liquidity that

investors paid dearly for evaporatedin the panic selling on October 19, justwhen the ability to make an immediatesale might have had value.

J. M. Keynes argued in The GeneralTheory that of the maxims of ortho-dox finance none, surely, is more anti-

social than the fetish of liquidity, thedoctrine that it is a positive virtue onthe part of investment institutions toconcentrate their resources upon theholding of liquid securities. It forgetsthat there is no such thing as liquidityof investment for the community as awhole.

In fact, less frequently traded assetscan provide good returns relative toliquid ones. pefco bonds, obligationsof the Private Export Funding Corpora-tion, enjoy the full faith and creditbacking of the U.S. government.Because pefco bonds are issued insmaller amounts and receive less atten-tion than more liquid U.S. Treasurybonds, buyers can expect that they willbe more difficult to trade. In return,owners receive higher returns. In May2005 the Investments Office boughtpefco 4.55 percent bonds set to matureon May 15, 2015 at a yield of4.57percent. Compared to U.S. Treasuriesmaturing on the same date, the pefcosprovided an incremental yield of37basis points. Earning a spread overU.S. Treasuries for U.S. Treasury equiv-alent credit makes sense.

Investments in companies backed byventure capital illustrate the rewards ofaccepting illiquidity. In December 1997,eToys, an online retailer, received itsfirst round of private financing, valuingthe company at $15 million. Obviously,as a privately held start-up, shares of

the concern exhibited extreme illiquid-ity. When eToys went public on May20, 1999, quadrupling on the first dayof trading, the companys value sky-rocketed to $7.8 billion, representingan extraordinary gain for the originalprivate investors.

Liquidity of securities tends toincrease and decrease as the popularityof the underlying assets waxes andwanes. On the day when eToys wentpublic, approximately $1 billion worthof shares traded. Not even two yearslater, when eToys filed for bankruptcy,trading volume amounted to only$100,000. Clearly, a mindset thatavoids illiquid start-ups and prefershighly liquid ipos carries a clear setof risks.

Once illiquid private investmentssucceed, liquidity follows as investorsclamor for shares of the hot initialpublic offering. In contrast, if public,liquid investments fail, liquidity driesup as a company falls from favor ordeclares bankruptcy. Investors shouldfear failure, not illiquidity.

Liquidity

Liquid Assets: Marketable Equity, Bonds, and Cash

Quasi-Liquid Assets: Absolute Return

Illiquid Assets: Private Equity and Real Assets

Average Endowment LiquidityJune 30, 2005

Yale Endowment LiquidityJune 30, 2005

Liquid Assets68.9%

Illiquid Assets13.6%

Quasi-Liquid Assets17.6%

Liquid Assets34.6%

Illiquid Assets39.8%

Quasi-Liquid Assets25.7%


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School of Architecture

Yale has an internationally recognizedSchool of Architecture whose alumniare among the most prominent archi-tects of the twentieth century. Endowedfunds have a direct impact on its abilityto attract students and pre-eminentfaculty.

Support for faculty includes such

long-standing endowments as the Archi-tectural Teaching Fund, established in1909 through a gift from alumni HenryFowler English (ll.b. 1874) and JohnDavenport Wheeler (ph.b. 1858). Pro-fessorships at the School, which honordonors, alumni, and distinguishedfaculty, ensure that leaders in the fieldfrom all over the world continue toprovide outstanding teaching at Yale.

Among the Schools endowed chairs,the J.M. Hoppin Professorship ofArchitecture has a particularly distin-guished history. The chair was createdin 1923 through a bequest from JamesMason Hoppin, b.a. 1840, a longtimeYale faculty member (186199). TheHoppin Professorship has been heldby distinguished architects includingEverett Victor Meeks, former Dean ofthe School of Fine Arts (192247),and Architecture Chairs George Howe(195054) and Paul Rudolph (195765). Dean Robert A.M. Stern is thecurrent incumbent.

The Eero Saarinen Visiting Professor-ship, established in 1984 by architectKevin Roche, colleagues, and friends,honors the famous Yale-trained (b.f.a.1934) architect of the David IngallsRink and Morse and Stiles Colleges.The list of architects who came to theSchool as Saarinen Visiting Professorsincluded Pritzker Prize winning archi-tects Philip Johnson (the first PritzkerPrize recipient), Cesar Pelli, ZahaHadid, and Thom Mayne, the 2005Pritzker Prize winner.

Former Professor Louis I. Kahn, whodesigned both the Yale University ArtGallery and the Yale Center for BritishArt, has inspired two separate funds.The Louis I. Kahn Visiting Professor-ship, funded by friends and colleaguesin 1980, has brought to the School suchnoted architects as Peter Eisenman,Frank Gehry, Daniel Libeskind, TodWilliams and Billie Tsien. An anony-mous donor endowed the Kahn VisitingAssistant Professorship in 2003 as wellas the Vincent Scully Visiting Professor-ship in architectural history to honorSterling Professor Emeritus Vincent

Scully, one of Yales most esteemedfaculty members.

Also crucial to the Schools success isfinancial aid from endowed funds. TheEverett Victor Meeks (b.a. 1901, b.f.a.1917, m.a.h. 1919) Graduate Fellow-ship Fund (1956) honors the formerdean and professor. Classmates, friends,and business associates of Eero Saarinenendowed a memorial scholarship in hisname in 1962. The James GambleRogers (Class of1889) Memorial Fel-lowship Fund, endowed by his son in1990, honors the architect whodesigned many Yale buildings in the1920s and 1930s, including SterlingMemorial Library, the Sterling LawBuildings, and residential colleges suchas Berkeley, Branford, and Saybrook.

The School of Architecture has longrecognized the importance of a globalapproach to the training of students,encouraging travel and study abroad.The William Wirt Winchester Fund(1895), the Schools most prestigiousfellowship and its oldest endowment,

was established to provide for studyand travel outside the United States.The Henry Hart Rice Fund in Architec-ture, created in 1999 by the Rice FamilyFoundation, supports teacher-directedterm-time travel for students at theSchool of Architecture.

Endowed discretionary funds providecrucial flexible support. The Schoolsfirst discretionary funds include theGertrude Vanderbilt Whitney Fund andthe Robert W. DeForest Fund, bothestablished in 1927 for general pur-poses, and the Richard Hellmann Archi-tectural Fund (1973) endowed by theRichard Hellmann Foundation to beused by the Dean, at his discretion, totake advantage of educational opportu-nities as they may arise.

Eero Saarinen (top left), one of the leading architects of the international movement in the mid-twentieth century,

designed several Yale buildings including the David S. Ingalls Rink. He taught at the School of Architecture andtoday his name is associated with a lecture series and with the Eero Saarinen Visiting Professorship, endowedin 1962. Among leading architects who have served as Saarinen Visiting Professors was Thom Mayne (above

left), the 2005 winner of the important Pritzker Prize. Shown here (above right) is one of Maynes recent works,the Diamond Bar High School near Pomona, California.


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School of Music

The School of Musics highest profileendowed fund is most likely its newest,an anonymous $100 million five-yearpledge announced in October 2005.The gift, the largest in the Schoolshistory, will allow it to provide freetuition for all students beginning in the20062007 academic year, and toenhance its relationships with conserva-tories across the world.

The tuition subsidy from the newgift builds on a strong existing base ofscholarship support. The Henry (b.a.1900) and Lucy Moses Fellowship Fund(1990) and the Stephen and DeniseAdams Endowed Scholarship Fund forthe School of Music (1999) each makegrants to more then a dozen studentsper year; and the Horatio Parker Schol-arship Fund (1945) in honor of theSchools first dean has been awarded to

a number of outstanding musicians.Individualized music instructionbegan at Yale in 1854 thanks to a giftof $5,000 from Joseph Battell, a mer-chant and music lover, whose familywas generous to Yale in many ways.The School of Music summer programat Norfolk, Connecticut occupies theformer Battell estate, and the Battellfamilys gifts include a professorship inthe Yale Department of Music.

The School of Music, founded in1894, instructs students in performanceand composition, while Yales

Department of Music teaches theory

and history of music. One of manyprominent composers who have beenaffiliated with Yale, the innovativeCharles E. Ives (18741954), b.a. 1898,inspired three different endowments.His widow, relatives, and friendscreated the Charles E. Ives MemorialFund in 1962 for the maintenance andenhancement of the Charles E. Ives Col-lection in the Library of the School ofMusic. The collection contains the Ivespapers, a valuable resource for researchon one of Americas greatest composers.In 1970, a bequest from Harmony T.Ives, the composers widow, establishedthe Charles E. Ives Fund for generalsupport of the School. In 1985, HelenT. Ives (wife of the composers nephew,

Brewster Ives) funded the Charles

Ives Scholarship for School of Musicstudents.

In a more popular musical vein, thecomposer of Broadway musicals includ-ing Man of La Mancha, Mitch Leigh,mus.b.1951, mus.m.1952, and his wifeAbby Leigh have had a considerableimpact on the fortunes of the School.The building housing classrooms and

offices at 435 College Street bears thename of Leigh Hall in honor of theirgenerosity, which includes support forthe Keith L. Wilson Scholarship Fund,established in 1984. The fund honorsMr. Wilson, an award-winning clar-inetist who taught at the School from1946 to 1987 and served as associatedean.

Other great names grace the list ofthe School of Musics endowed funds.Distinguished cellist Aldo Parisotlent his name to a fund created forscholarships in 1995 and donors have

named endowments for legendarypianists Vladimir Horowitz andArtur Rubinstein.

The School of Music enjoys a uniquedistinction among the ten professionalschools at Yale in that Music is the onlyschool that has an endowed deanship.Thanks to a bequest, the dean bearsthe title of the Henry (b.a. 1900) andLucy Moses Dean of the Yale Schoolof Music.

School of Drama

In December 1924, the Yale Corpora-tion recorded the deep gratitude of thePresident and Fellows to Edward S.Harkness, b.a. 1897, for his constantdesire to further the development of theUniversity as evidenced anew by his giftof one million dollars for the establish-ment of a Department of DramaticArt in the School of Fine Arts. Mr.Harknesss largesse permitted Yale topurchase land and erect the buildingfor the University Theatre, besides pro-viding an endowment for the dramadepartment. In 1955, the department

was reorganized to form the YaleSchool of Drama.Endowed funds that supported the

Department of Drama in its earlydecades included the Henry McCormickProfessorship (1953) and the HenriettaHoffman Lord Memorial Scholarship(1929) intended for promising womenstudents. The Oliver Thorndike (Classof1940) Acting Award Fund, estab-lished in 1957, shortly after Drama

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The Horatio Parker Scholarship Fund for students at the School of Music, established in1945, honors theSchools first Dean, composer-conductor Horatio Parker, shown in a portrait by Erica von Kager. Recipients haveincluded noted clarinetist Richard L. Stoltzman (shown above, right); pianist Joan C. Panetti, a long-time faculty

member at the School; baritone Patrick J. Carfizzi of the Metropolitan Opera; and Paul A. Jacobs, chairman ofthe Organ Department at the Juilliard School.

American composer Charles E. Ives, b.a. 1898, iscommemorated in three School of Music endowmentfunds. The photo of Ives in his summer home in

West Redding, Connecticut, is believed to date fromJuly 1950.


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became a full-fledged Yale professionalschool, recognizes outstanding students,including such luminaries as MerylStreep and Stacy Keach. The GeorgePierce Baker (m.a.h. 1925) Memorial

Scholarship Fund (1960) honors thefirst chairman of the Department ofDrama, the countrys then-leadingteacher of playwriting, who joinedthe Yale faculty in 1925.

An endowment from the Ford Foun-dation in 1978 proved helpful to theSchool and its sister institution, theYale Repertory Theatre. The Yale Rep,founded in 1966 as a performancevenue, adds considerably to the theatri-cal life of the School. Another impor-tant unrestricted endowment, theSimsbury Fund, created by Virginia

Brockman and Robert E. Darling, Jr.in 1980, provides financial supportfor the Drama School and the Rep.

Important names in Americantheater and film have strong associa-tions with the School of Dramasendowment. Nobel Prize winning play-wright Eugene ONeill, who received anhonorary Doctor of Letters in 1926,and his widow, Mrs. Carlotta ONeillcreated the Eugene ONeill Scholarshipsthrough a 1970 bequest. At that time,

Yale already had on its books theEugene ONeill (litt.d. hon. 1926)Memorial Scholarship Fund, establishedin 1958 to honor the playwright.

As director of the Rep and deanof the School of Drama from 1979 to1991, Lloyd Richards played an impor-tant role in the history of drama atYale. Under his direction the Repertory

Theatre launched major plays by suchfigures as Lee Blessing, Athol Fugard,and August Wilson. Mr. Richards, whomade history in 1958 as the firstAfrican-American director to work onBroadway, is recognized at the Schoolby the Lloyd Richards ProfessorshipFund (1991), established by a groupof his friends and admirers.

In the field of design, the Schoolreceived an endowment in 1995 for theDonald M. Oenslager Professorship forScene, Costume, and Lighting Design.The late Mr. Oenslager was one of the

original Drama department facultymembers in 1925 and started theDesign department in 1926. He retiredfrom the School in 1970, but his theatercareer continued; he was active as aBroadway designer, producer, and per-former from 1925 to 1975, working indozens of original productions of suchshows as The Man Who Came to

Dinner, Of Mice and Men, and SabrinaFair. Presented to Yale by his widow,Mary P. Oenslager, the professorshiphas been held since its inception bynoted Broadway designer MingCho Lee.

In taking stock on the occasion ofthe Universitys 300th anniversary, in2001, President Richard C. Levinstated, Yale is arguably the premieruniversity in the world in the humani-ties and the arts. Endowments providefunds critical to achieving, maintaining,and enhancing Yales artistic excellence.

Established in 1991, the LloydRichards Professorship at the

School of Drama honors theformer dean of the School andartistic director of the Yale

Repertory Theatre. Richards

directed several works at Yaleby playwright August Wilson

(seen at right, wearing hat, withRichards at the theater), includingThe Piano Lesson. The original

production of the play at Yale in1987 starred Samuel L. Jackson(seen in photo above with

LaJara Henderson).

Meryl Streep was the 1975-76 recipient of the Annie

G. K. Garland Memorial Fellowship Fund whilestudying at the School of Drama. The photographshows her in a Yale Repertory Theatre performanceofThe Idiots Karamazov (by Christopher Durang and

Albert Innaurato) in 1974 with Ralph Redpath.Ms. Streep was associated with another endowmentas winner of the Oliver Thorndike Prize at the

School, a prestigious award that has gone to suchwell-known figures as Stacy Keach, Mark Baker,and Richard Grusin.


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4Spending Policy The spending rule is at the heart of fiscal discipline for an endowed

institution. Spending policies define an institutions compromisebetween the conflicting goals of providing substantial support forcurrent operations and preserving purchasing power of Endowmentassets. The spending rule must be clearly defined and consistentlyapplied for the concept of budget balance to have meaning.

Yales policy is designed to meet two competing objectives.The first goal is to release substantial current income to the operatin

budget in a stable stream, since large fluctuations in revenues are difficult to accommodate through changes in University activities orprograms. The second goal is to protect the value of Endowmentassets against inflation, allowing programs to be supported at todaylevel far into the future.

Yales spending rule attempts to achieve these two objectives busing a long-term spending rate combined with a smoothing rule thaadjusts spending gradually to changes in Endowment market value.The amount released under the spending rule is based on a weightedaverage of the prior years spending adjusted for inflation and anamount determined by applying the target rate to the current

Endowment market value.The spending rule has two implications. First, by incorporating

the previous years spending the rule eliminates large fluctuations,enabling the University to plan for its operating budget needs. Overthe last twenty years, annual changes in spending have been less thana third as volatile as annual changes in Endowment value. Second,by adjusting spending toward the long-term target spending level, thrule ensures that spending will be sensitive to fluctuating Endowmenmarket values, providing stability in long-term purchasing power.

Spending Growth Surpasses Inflation 1950-2005

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Spending from Post-1950 Endowment Gifts Inflated1950 Spending Inflated Actual Spen

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Until the mid 1960s, the Universitylimited the Endowments annual contri-bution to the operating budget toinvestment yield the interest, dividendand rental income generated by theEndowment. In 1967, recognizing thatsimply spending yield could result in

too high or too low a spending rate andcould bias investment decisions towardsecurities with high yield but low appre-ciation potential, Yale adopted a totalreturn spending policy. Under the totalreturn policy, the University supportedoperations with current yield plus aprudent portion of the appreciation ofEndowment market value.

Concurrent with the decision toemploy a total return concept, Yaleinstituted a formal method, called theUniversity Equation, to calculatethe total amount that could responsiblybe spent from the Endowment. Themethod set spending in a given year byadjusting the previous years spendingby the difference between the Univer-sitys long-term investment return (mea-sured over the prior twenty-year period)and the current percentage of theEndowment being spent. Higher long-term returns would lead to higherannual spending, while lower long-term

returns 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 inflationincreased and market returns dropped,the University spent an unsustainably

high portion of the Endowment tosupport current operations.

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) returnfrom the Endowment. The Endow-ments expected real return was takento be 4.5 percent, consistent with his-torical experience.

In 1982, upon bringing the spendinglevel to an appropriate level, the Corpo-ration adopted a spending rule thatattempted to produce substantialincome for current scholars and pre-serve purchasing power of the Endow-ment for future generations. Under thenew rule, Endowment spendingamounted to the weighted average of70percent of the previous years spending,adjusted for inflation, plus 30 percent of

the targeted long-term spending rateof4.5 percent applied to the previousyears Endowments market value. The70 percent weight on prior year spend-ing promised budgetary stability, whilethe 30 percent weight on currentmarket value provided purchasing

power sensitivity.Since 1982, the spending rule has

been 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 the Corpo-ration increased the spending rate to5.25 percent and changed the smooth-ing rule from 70/30 to 80/20. Theincreases in spending rates resultedfrom improvement in Endowment port-folio 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 Yales Spending Policy

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