2013The Yale Endowment

Endowment HighlightsFiscal Year

2013 2012 2011 2010 2009

Market Value (in millions) $20,780.0 $19,344.6 $19,374.4 $16,652.1 $16,326.6Return 12.5% 4.7% 21.9% 8.9% -24.6%

Spending (in millions) $1,024.0 $994.2 $ 986.8 $ 1,108.4 $ 1,175.2 Operating Budget Revenues $2,968.6 $2,851.7 $2,734.2 $2,681.3 $2,559.8(in millions)Endowment Percentage 34.5% 34.9% 36.1% 41.3% 45.9%

Asset Allocation (as of June 30)Absolute Return 17.8% 14.5% 17.5% 21.0% 24.3%Domestic Equity 5.9 5.8 6.7 7.0 7.5Fixed Income 4.9 3.9 3.9 4.0 4.0Foreign Equity 9.8 7.8 9.0 9.9 9.8Natural Resources 7.9 8.3 8.7 8.8 11.5Private Equity 32.0 35.3 35.1 30.3 24.3Real Estate 20.2 21.7 20.2 18.7 20.6Cash 1.6 2.7 -1.1 0.4 -1.9

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Contents

1. Introduction 22. The Yale Endowment 43. Investment Policy 54. Spending Policy 145. Investment Performance 166. Management and Oversight 18

Front cover:Window of Sterling Memorial Library, east faade.Right:Detail of gate leading to Old Campus from Elm Street.

Yales Endowment generated a 12.5 percent return in fiscal 2013, produc-ing an investment gain of $2.29 billion. Over the past ten years, theEndowment grew from $11.03 billion to $20.78 billion. With annual netten-year investment returns of 11.0 percent, the Endowments perform-ance exceeded its benchmark and outpaced institutional fund indices. For nine of the past ten years, Yales ten-year record ranked first in theCambridge Associates universe. The Yale Endowments twenty-year recordof 13.5 percent per annum produced a 2013 Endowment value of over sixtimes the 1993 value. Yales excellent long-term record stems from dis-ciplined and diversified asset allocation policies and superior active man-agement results.

Spending from the Endowment grew during the last decade from$470 million to $1.02 billion, an annual growth rate of approximately 8 percent. On a relative basis, Endowment contributions expanded from 30 percent of total revenues in fiscal 2003 to 34 percent in fiscal 2013. Next year, spending will amount to $1.05 billion, or 35 percent of pro-jected revenues. Yales spending and investment policies provide substan-tial levels of cash flow to the operating budget for current scholars whilepreserving Endowment purchasing power for future generations.

Introduction1

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Endowment Growth Outpaces Ination 19502013

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The Yale model of endowment investinghas come under intense scrutiny for its per-formance during the recent financial crisis.Skeptics suggest that the Yale Endowment,with its emphasis on diversification andactive management of equity-oriented,often-illiquid assets, failed to deliver on its promise.

Critics argue that Yales model lackeddiversification in times of crisis, evidencedby the Endowments 24.6 percent declinefor the fiscal year ending June 30, 2009. In the global financial crisis, as in the 1998Asian financial crisis and the 1987 stockmarket crash, global markets exhibitedconcurrent broad-based declines. Correla-tions of risky assets increased markedly asmarket participants expressed extremepreferences for liquidity and quality. Whilethese were painful periods for equity-ori-ented investors, they were short lived asindividual countries and markets soonreverted to fluctuating in response to coun-try- and asset-specific drivers of perform-ance. During the bleak period of poor per-formance and high correlation, full faithand credit holdings of the U.S. governmentprovided the only safe harbor. The short-term protection to investor portfolios pro-vided by U.S. Treasury securities comes ata high long-term price, however. Expectedreturns for fixed income instruments fallshort of expected returns for equity-

oriented investments and, over long peri-ods of time, fail to generate the returnsrequired to support current Universityoperations while preserving the purchasingpower of assets.

Yales portfolio, positioned for stronglong-term returns, lacked significant expo-sure to low-expected-return Treasury secu-rities and suffered in the market meltdown.The Endowments decline of 24.6 percentunderperformed peer returns of -22.0 per-cent and a classic 60 percent U.S. equityand 40 percent Treasury bond portfolioreturn of -13.2 percent. Critics presentedYales short-term underperformance as validation of traditional asset allocationsfocused heavily on public equities and fixed income. Although the Endowmentproduced painful losses in fiscal 2009, theresults of any one-year period tell very little about the efficacy of a long-terminvestment strategy. Performance overlonger horizons demonstrates the strengthof Yales investment program.

While Yales diversified, equity-orientedportfolio underperformed during thefinancial crisis, it handsomely outper-formed a traditional U.S. stock and bondportfolio over the past twenty-five years. If Yales assets had been invested in the 60percent equity/40 percent bond portfoliosince 1988, the Endowment would be val-ued at only $9.11 billion today, less than

half of its current value of $20.78 billion.Furthermore, the spending distribution tofund University operations during fiscal2013 would have totaled approximately$440 million, significantly below Yalesactual spending distribution of $1.02 billion. Cumulative spending over the twenty-five-year period would have beenapproximately 40 percent below actualspending levels, which surpassed $11.60billion for the period.

In periods both before and after the crisis, Yales Endowment performedadmirably. In nine of the past ten years, theUniversitys ten-year returns stood atop theCambridge Associates universe. In fiscal2004, when Yale failed to post the top ten-year return, the University placed second.Even in an environment that included anextraordinary financial crisis, the Yalemodel excelled.

While traditional asset allocations heldup well during fiscal 2009 and in theimmediate aftermath of the crisis, thatshort-term outperformance came at a heavycost to the growth of a portfolios valueover the long term. During periods whentraditional portfolios outperform, criticsare quick to cast aspersions on the Yalemodel, but traditional 60 percent equity/40percent bond portfolios are not diversified,not equity-oriented, and not appropriatefor long-term investors.

The Yale Model

3

Aerial view showing Yale Divinity School (top), Betts House and Greenberg Conference Center (middle), and Leitner Observatory and Planetarium (bottom right).

Totaling $20.78 billion on June 30, 2013, the Yale Endowment containsthousands of funds with various purposes and restrictions. Approximately85 percent of funds constitute true endowment, gifts restricted by donorsto provide long-term funding for designated purposes. The remainingfunds represent quasi-endowment, monies that the Yale Corporationchooses to invest and treat as endowment.

Donors frequently specify a particular purpose for gifts, creatingendowments to fund professorships, teaching, and lectureships (24 per-cent); scholarships, fellowships, and prizes (17 percent); maintenance (4 percent); books (3 percent); and miscellaneous specic purposes (27 percent). Twenty-ve percent of funds are unrestricted. Twenty-twopercent of the Endowment benets the overall University, with remainingfunds focused on specic units, including the Faculty of Arts and Sciences (37 percent), the professional schools (26 percent), the library (7 percent),and other entities (7 percent).

Although distinct in purpose or restriction, Endowment funds are commingled in an investment pool and tracked with unit accountingmuch like a large mutual fund. Endowment gifts of cash, securities, orproperty are valued and exchanged for units that represent a claim on aportion of the total investment portfolio.

In scal 2013 the Endowment provided $1.02 billion, or 34 per-cent, of the Universitys $2.97 billion operating income. Other majorsources of revenues were grants and contracts of $680 million (23 per-cent); medical services of $616 million (21 percent); net tuition, room,and board of $272 million (9 percent); gifts of $135 million (5 percent);and other income and transfers of $241 million (8 percent).

The Yale Endowment

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Miscellaneous Specific Purposes

Professorships

Scholarships

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Endowment Fund AllocationFiscal Year 2013

Operating Budget Revenue Fiscal Year 2013

Endowment

Grants and Contracts

Medical Services

Tuition, Room, and Board

Gifts

Other Income and Transfers

Yales portfolio is structured using a combination of academic theory andinformed market judgment. The theoretical framework relies on mean-variance analysis, an approach developed by Nobel laureates James Tobinand Harry Markowitz, both of whom conducted work on this importantportfolio management tool at Yales Cowles Foundation. Using statisticaltechniques to combine expected returns, variances, and covariances ofinvestment assets, Yale employs mean-variance analysis to estimateexpected risk and return proles of various asset allocation alternativesand to test sensitivity of results to changes in input assumptions.

Because investment management involves as much art as science,qualitative considerations play an extremely important role in portfoliodecisions. The denition of an asset class is quite subjective, requiringprecise distinctions where none exist. Returns and correlations are dif-cult to forecast. Historical data provide a guide, but must be modied torecognize structural changes and compensate for anomalous periods.Quantitative measures have difculty incorporating factors such as market liquidity or the inuence of signicant, low-probability events. In spite of the operational challenges, the rigor required in conductingmean-variance analysis brings an important perspective to the asset allocation process.

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

June 2013 June 2013Asset Class Actual TargetAbsolute Return 17.8% 20.0%Domestic Equity 5.9 6.0Fixed Income 4.9 5.0Foreign Equity 9.8 11.0Natural Resources 7.9 8.0Private Equity 32.0 31.0Real Estate 20.2 19.0Cash 1.6 0.0

Investment Policy3

5Berkeley College, a winter view of the windows of the Common Room.

The target mix of assets produces an expected real (after ination) long-term growth rate of 6.3 percent with risk (standard deviation of returns)of 14.8 percent. Because actual holdings differ from target levels, the actual allocation produces a portfolio expected to grow at 6.2 percent withrisk of 14.8 percent. The Universitys measure of ination is based on abasket of goods and services specic to higher education that tends toexceed the Consumer Price Index by approximately one percentage point.

At its June 2013 meeting, Yales Investment Committee adopted anumber of changes to the Universitys policy portfolio allocations. TheCommittee approved increases in the absolute return target from 18 per-cent to 20 percent, in the foreign equity target from 8 percent to 11 per-cent, in the natural resources target from 7 percent to 8 percent, and inthe xed income target from 4 percent to 5 percent. Those increases werefunded by a three percentage point decrease in the real estate target and afour percentage point decrease in the private equity target.

Over the longer term, Yale seeks to allocate approximately one-half of the portfolio to the illiquid asset classes of private equity, realestate, and natural resources. The Endowment has made signicantprogress on this dimension over the past ve years.

Providing resources for current operations and preserving the purchasing power of assets dictate investing for high returns, causing the Endowment to be biased toward equity. The Universitys vulnerability to ination further directs the Endowment away from xed income andtoward equity instruments. Hence, 95 percent of the Endowment is targeted for investment in assets expected to produce equity-like returns,through holdings of domestic and international securities, absolute returnstrategies, real estate, natural resources, and private equity.

Over the past two decades, Yale dramatically reduced the Endow-ments dependence on domestic marketable securities by reallocatingassets to nontraditional asset classes. In 1993, 47 percent of the Endow-ment was committed to U.S. stocks, bonds, and cash. Today, target allo-cations call for 11 percent in domestic marketable securities, while thediversifying assets of absolute return, foreign equity, natural resources,private equity, and real estate dominate the Endowment, representing 89 percent of the target portfolio.

The heavy allocation to nontraditional asset classes stems fromtheir return potential and diversifying power. Todays actual and targetportfolios have signicantly higher expected returns than the 1993 portfo-lio with similar volatility. Alternative assets, by their very nature, tend tobe less efciently priced than traditional marketable securities, providingan opportunity to exploit market inefciencies through active manage-ment. The Endowments long time horizon is well suited to exploit illiquid, less efcient markets such as venture capital, leveraged buyouts,oil and gas, timber, and real estate.

6

Since market participants routinely overpayfor liquidity and since less liquid marketsexhibit more inefficiencies than their liquidcounterparts, illiquid markets create oppor-tunities for astute investors to identify mis-pricings and generate outsized returns.Furthermore, operational, strategic, andcompany-building skills of control-orient-ed, illiquid asset managers can add tremen-dous value to portfolio holdings. Investorswilling to accept less liquid alternativesenhance the opportunity to outperform themarket. Intelligent pursuit of illiquidity iswell suited to endowments, which operatewith extremely long time horizons.

Yales belief in the attractive marketopportunity among less liquid assets ledthe University to allocate a significant portion of the Endowment to the illiquidassets of private equity, real estate, and natural resources. Yale maintains a reason-able allocation to marketable asset classes,however, in order to preserve sufficient liquidity to support current Universityoperations, satisfy capital commitments toinvestment partnerships, take advantage ofattractive investment opportunities, andprovide support for the Universitys financing activities.

The evaporation of liquidity during thefinancial crisis highlighted the importanceof prudent liquidity management. BecauseYale had long recognized the necessity ofunderstanding and monitoring the Endow-ments liquidity profile, the University hadsubstantial internal and external sources ofliquidity at its disposal. Even a portfoliocharacterized by high percentages of illiq-uid, long-term assets contains more liquidi-ty than might be immediately apparent.Yales holdings generate a fair amount ofnatural liquidity: bonds pay interest, stocks

pay dividends, real estate produces rents,energy reserves provide both returns oncapital and returns of capital (throughdepletion), and private equity partnershipsdistribute proceeds from realizations. TheInvestments Office carefully forecasts howthese distributions will behave under arange of economic scenarios.

Holdings of marketable securities pro-vide a source of non-disruptive liquidity,namely liquidity generated in a mannerthat does not change the Endowmentsasset class exposure. For example, bondsand stocks can serve as collateral for repur-chase agreements (repos) and securitylending, respectively. The owner of thesecurities generates liquidity through proceeds produced by the repo and secur-ity lending activity, while retaining the economic exposure associated with thesecurities.

External borrowing represents anothersource of non-disruptive liquidity. As aresult of Yales planning well before theadvent of the crisis, the University hadaccess to nearly $2 billion of commercialpaper funding, a level substantially inexcess of the Universitys crisis-relatedneeds. In November 2009, after the crisissubsided, Yale issued $1 billion of five-yearfixed-rate taxable bonds with attractivepricing to refund the commercial paperdraws. That debt is now largely repaid.

In the late 1990s, Yale developed a flexi-ble and responsive model for projectingilliquid fund contributions, distributions,and net asset values based on the levels of future fund commitments, asset classinvestment returns, the pace of fund com-mitment calls and fund distributions, andoverall Endowment returns. Yale Invest-ments Office Senior Director Dean

Takahashi and former Director SethAlexanders article, Illiquid AlternativeAsset Fund Modeling, published in theJournal of Portfolio Management in winter2002, described Yales illiquid asset model.

Yale continues to use the same basicmodel, albeit with some improvements and modifications. The Investments Officeperiodically revises model parameters toreflect historical experience and incorpo-rates adjustments reflecting current marketconditions. For instance, during the finan-cial meltdown, the model was adjusted todepress Endowment growth rates andreflect the anticipated slower pace of capi-tal calls and distributions. Furthermore, the Investments Office employs the illiquidasset model to stress-test Yales liquidityposition under a range of economic scenarios.

High-quality forecasting tools eluci-dated the Endowments liquidity position during the financial crisis and enabled Yaleto steer the Endowment through the crisiswith sufficient liquidity. The Endowmentmet all of its liquidity requirements, includ-ing private equity, real estate, and naturalresources capital calls; spending distribu-tions for University operations; and debtrepayments.

Economic and financial market turbu-lence during 2008 and 2009 highlightedthe importance of monitoring and manag-ing Endowment liquidity. Fortunately,Yales careful forecasting and in-place liquidity mechanisms enabled the Univer-sity to meet its cash needs. Although thefinancial crisis has passed, liquidity man-agement and monitoring remain ongoingEndowment priorities and the InvestmentsOffice continues to refine and test its liq-uidity model.

Liquidity

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Education, 1890, by Louis Comfort Tiffany and Tiffany Studios, a stained-glass window created for Yales Linsly-Chittenden Hall.

Yales seven asset classes are dened by differences in their expectedresponse to economic conditions, such as economic growth, price ina-tion, or changes in interest rates, and are weighted in the Endowmentportfolio by considering their risk-adjusted returns and correlations. The University combines the asset classes in such a way as to provide thehighest expected return for a given level of risk, subject to fundamentaldiversication and liquidity constraints. In July 1990, Yale became the rst institutional investor to dene absolutereturn strategies as a distinct asset class, beginning with a target alloca-tion of 15.0 percent. Designed to provide signicant diversication to theEndowment, absolute return investments are expected to generate highlong-term real returns by exploiting market inefciencies. The portfolio isinvested in two broad categories: event-driven strategies and value-drivenstrategies. Event-driven strategies rely on a very specic corporate event,such as a merger, spin-off, or bankruptcy restructuring, to achieve a tar-get price. Value-driven strategies involve hedged positions in assets orsecurities with prices that diverge from their underlying economic value.Today, the absolute return portfolio is targeted to be 20.0 percent of theEndowment, below the average educational institutions allocation of 24.4 percent to such strategies. Absolute return strategies are expected to generate a real return of 5.25 percent with risk of 12.5 percent.

Unlike traditional marketable securities, absolute return invest-ments have historically provided returns largely independent of overallmarket moves. Since its 1990 inception, the portfolio exceeded expecta-tions, returning 11.2 percent per year with low correlation to domesticstock and bond markets. Financial theory predicts that equity owners should expect to receivereturns superior to those expected from less risky assets such as bondsand cash. The predominant asset class in most U.S. institutional portfo-lios, domestic equity represents a large, liquid, and heavily researchedmarket. While the average educational institution invests 20.1 percent of assets in domestic equities, Yales target allocation to this asset class is only 6.0 percent. The domestic equity portfolio has an expected realreturn of 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 highly efcient,Yale elects to pursue active management strategies, aspiring to outper-form the market index by a few percentage points, net of fees, annually.Because superior stock selection provides the most consistent and reliableopportunity for generating attractive returns, the University favors man-agers with exceptional bottom-up, fundamental research capabilities.Managers searching for out-of-favor securities often nd stocks that arecheap in relation to fundamental measures such as asset value, futureearnings, or cash ow. Over the past twenty years, Yales domestic equityportfolio has posted returns of 13.1 percent per year.

Asset Class Characteristics

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Domestic Equity

Absolute Return

Fixed income assets generate stable ows of income, providing more certain nominal cash ow than any other Endowment asset class. Thebond portfolio exhibits a low covariance with other asset classes andserves as a hedge against nancial accidents or periods of unanticipateddeation. While educational institutions typically maintain a substantialallocation to xed income instruments, averaging 10.1 percent, Yales target allocation to xed income and cash is only 5.0 percent of theEndowment. Bonds have an expected real return of 2.0 percent with riskof 8.0 percent. The Barclays Capital 1-3 Year U.S. Treasury Index servesas the portfolio benchmark.

Yale is not particularly attracted to xed income assets, as theyhave the lowest expected returns of the seven asset classes that make upthe Endowment. In addition, the government bond market is arguablythe most efciently priced asset class, offering few opportunities to add signicant value through active management. Based on skepticism ofactive xed income strategies and belief in the efcacy of a highly struc-tured approach to bond portfolio management, the Investments Ofcechooses to manage Endowment bonds internally. Though averse to market timing strategies, credit risk, and call options, Yale manages toadd value consistently in its management of the bond portfolio. Over the past twenty years, the xed income portfolio has generated returns of 5.6 percent per annum.Foreign equity investments give the Endowment exposure to the globaleconomy, providing diversication and the opportunity to earn outsizedreturns through active management. Yale allocates 5.0 percent of its port-folio to foreign developed markets and 2.0 percent to emerging markets.In addition, Yale dedicates 4.0 percent of the portfolio to opportunisticforeign positions, with the expectation that holdings will be concentratedin markets that offer the most compelling long-term opportunities, par-ticularly China, India, and Brazil. Yales foreign equity target allocation of11.0 percent stands below the average endowments allocation of 20.1 percent. Expected real returns for emerging equities are 7.5 percent with a risk level of 22.5 percent, while developed equities are expected to return6.0 percent with risk of 20.0 percent. The portfolio is measured against acomposite benchmark of (a) developed markets, measured by the MorganStanley Capital International (MSCI) Europe, Australasia, and Far East(EAFE) Investable Market Index; (b) emerging markets, measured by ablend of the MSCI Emerging Markets Investable Market Index and theMSCI China A-Share Index; and (c) opportunistic investments, meas-ured by a custom blended index.

Yales investment approach to foreign equities emphasizes activemanagement designed to uncover attractive opportunities and exploitmarket inefciencies. As in the domestic equity portfolio, Yale favorsmanagers with strong fundamental research capabilities. Capital allo-cation to individual managers takes into consideration the country allo-cation of the foreign equity portfolio, the degree of condence that Yalepossesses in a manager, and the appropriate size for a particular strategy.In addition, Yale attempts to exploit compelling undervaluations in countries, sectors, and styles by allocating capital to the most compellingopportunities. The twenty-year return of Yales foreign equity portfolio is14.1 percent per year.

9

Fixed Income

Foreign Equity

As endowments, foundations, and otherinstitutional investors have increasinglyshifted into private equity, real assets,and hedge funds over the past decade,these alternative assets have becomemore mainstream. Some market observ-ers contend that as alternative asset class-es have become more crowded and com-petitive, the ability to outperform hasessentially disappeared.

Yale has never viewed the mean returnfor alternative assets as particularly com-pelling. The attraction of alternatives liesin the ability to generate top quartile ortop decile returns. As long as individualmanagers exhibit substantial dispersionof returns and high-quality investmentfunds dramatically outperform their lessskilled peers, Yale enjoys the opportunityto produce attractive returns for theEndowment and to demonstrate thatmanager alpha (excess return) is aliveand well.

The figure below shows the disper-sion in returns between the top and bottom quartiles in collections of activelymanaged illiquid asset portfolios withvintage years ranging from 1993 through2012. Top quartile venture capital, lever-aged buyout, natural resources, and real estate managers have consistently surpassed their bottom quartile peers by substantial margins, with annualizedspreads averaging double-digit percent-ages. With the exception of dispersion in

venture capital (inated by the 1990stechnology bubble), a comparison of the most recent decade with the decadebefore shows roughly comparable performance spreads. The operational,strategic, and company-building skills ofprivate equity and real assets managershave the potential to add tremendousvalue to portfolio holdings, creatingalpha and differentiating the strongestperformers. Investors with the ability to select top managers can certainly generate outsized returns.

In asset classes such as venture capitaland private equity, elite firms create avirtuous cycle in which investment success begets investment success.Because franchise firms have demon-strated exceptional judgment, strategicinsight, and company-building skills,entrepreneurs and owner-managers seekto partner with them. Top-tier managersbenefit from extraordinary deal flow, astronger negotiating position, and supe-rior access to capital markets, and thusare well positioned to outperform theirpeers. Academic research supports thenotion of franchise firm performancepersistence in venture capital and, to alesser extent, in leveraged buyouts.*Although new fund entrants certainlycan and do post impressive returns, theyface significant challenges in breakinginto the top tier. Furthermore, becauseelite venture capital firms limit assets

under management and are consistentlyoversubscribed, they rarely, if ever,accept new investors. As a result, institu-tions that are new to alternative assetsface difficulties in accessing top man-agers. While alpha is not dead, opportu-nities to access it may not be available toall investors.

Yale has consistently demonstrated itsability to identify high-quality activemanagers. For the twenty years endingJune 30, 2013, 57 percent of Yales outperformance relative to the medianCambridge Associates endowment wasattributable to the value added by Yalesactive managers. Over the past twodecades, the Endowment returned acumulative 1,152 percent relative to theCambridge median of 402 percent, anoutperformance of 5.1 percent perannum. If Yale had employed its actualasset allocation, but had earned the rateof return of the median manager in eachasset class, it would have outperformedthe Cambridge median manager by 2.2percent per year, the value added byYales asset allocation. The remaining 2.9percent per annum of the Endowmentsoutperformance results from Yales activemanagement. The Endowment was ableto generate alpha even as alternativeassets became increasingly capitalizedand competitive. Manager selectionremains an important differentiating factor for Yale.

The Death of Alpha?

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U.S. Leveraged Buyouts Natural Resources Real Estate

Alternative Asset Returns Exhibit Signicant Dispersion Source: Cambridge Associates

*Steven N. Kaplan and Antoinette Schoar, Private Equity Performance: Returns, Persistence, and Capital Flows, Journal of Finance, no. 4 (August 2005): 1791.

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1994 1995 1996 1997

Asset Allocation Value Add: 2.2% Manager Value Add: 2.9%

Total Value Add: 5.1%

1998 1999 2000 2001 2002 2003 2004 2005 2006

2007 2008 2009 2010 2011 2012 2013

13.5% per annum

8.4% per annum

10.6% per annum

Yale Asset Allocation x Median Manager Returns Yale Returns Cambridge Median

Cumulative Return for Twenty Years Ending June 30, 2013

Fiscal Year

Sheffield-Sterling-Strathcona Hall, viewed from courtyard.

Source: Yale, Cambridge Associates

Equity investments in natural resources oil and gas, timberland, andmetals and mining share common risk and return characteristics: pro-tection against unanticipated global ination, high and visible currentcash ow, and opportunities to exploit inefciencies. At the portfoliolevel, natural resource investments provide attractive return prospects and signicant diversication. Yale has an 8.0 percent long-term policyallocation to natural resources with expected real returns of 6.35 percentand risk of 20.3 percent. Yales current natural resources allocation is inline with that of the average endowment.

Superior operators have demonstrated the ability to generateexcess returns over a market cycle. The inception-to-date return of Yalesoil and gas (1986), timber (1996), and mining (2011) portfolio clocks inat an impressive 16.0 percent per annum.Private equity offers extremely attractive long-term risk-adjusted returns,stemming from the Universitys strong stable of value-adding managersthat exploit market inefciencies. Yales private equity portfolio includesinvestments in venture capital and leveraged buyout partnerships. TheUniversitys target allocation to private equity of 31.0 percent far exceedsthe 9.5 percent actual allocation of the average educational institution. In aggregate, the private equity portfolio is expected to generate realreturns of 10.5 percent with risk of 26.8 percent.

Yales private equity program, one of the rst of its kind, isregarded as among the best in the institutional investment community,and the University is frequently cited as a role model by other investors.Yales private equity strategy emphasizes partnerships with rms thatpursue a value-added approach to investing. Such rms work closely with portfolio companies to create fundamentally more valuable entities,relying only secondarily on nancial engineering to generate returns.Investments are made with an eye toward long-term relationships generally, a commitment is expected to be the rst of several andtoward the close alignment of the interests of general and limited part-ners. Since inception in 1973, the private equity program has earned anastounding 29.9 percent per annum.Investments in real estate provide meaningful diversication to theEndowment. A steady ow of income with equity upside creates a natural hedge against unanticipated ination without a sacrice ofexpected return. Yales 19.0 percent long-term policy allocation signi-cantly exceeds the average endowments commitment of 4.2 percent.Expected real returns are 6.0 percent with risk of 17.5 percent.

While real estate markets sometimes produce dramatically cyclical returns, pricing inefciencies in the asset class and opportunitiesto add value allow superior managers to generate excess returns over long time horizons. Since inception in 1978 the portfolio has returned 11.6 percent per annum.

Private Equity

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Natural Resources

Real Estate

The illiquid nature of private real estate and the time-consumingprocess of completing transactions create a high hurdle for casual investors.A critical component of Yales investment strategy is to create strong, long-term partnerships between the Investments Ofce and its investment man-agers. Over the past two decades, Yale played a critical role in the develop-ment and growth of a number of successful real estate investment organi-zations.

Yale Educational University Institution Mean

Absolute Return 17.8% 24.4% Domestic Equity 5.9 20.1Fixed Income 4.9 10.1 Foreign Equity 9.8 20.1 Natural Resources 7.9 8.3Private Equity 32.0 9.5 Real Estate 20.2 4.2 Cash 1.6 3.2Data as of June 30, 2013

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Asset Allocations

Architectural detail, stone carving from the entrance to the Hall of Graduate Studies.

The spending rule is at the heart of scal discipline for an endowed insti-tution. Spending policies dene an institutions compromise between theconicting goals of providing support for current operations and preserv-ing purchasing power of endowment assets. The spending rule must beclearly dened and consistently applied for the concept of budget balanceto have meaning.

The Endowment spending policy, which allocates Endowmentearnings to operations, balances the competing objectives of providing astable ow of income to the operating budget and protecting the realvalue of the Endowment over time. The spending policy manages thetrade-off between these two objectives by combining a long-term spend-ing rate target with a smoothing rule, which adjusts spending in anygiven year gradually in response to changes in Endowment market value.

The target spending rate approved by the Yale Corporation cur-rently stands at 5.25 percent. According to the smoothing rule, Endow-ment spending in a given year sums to 80 percent of the previous yearsspending and 20 percent of the targeted long-term spending rate appliedto the scal year-end market value two years prior. The spending amountdetermined by the formula is adjusted for ination and constrained sothat the calculated rate is at least 4.5 percent, and not more than 6.0 per-cent, of the Endowments ination-adjusted market value two years prior.The smoothing rule and the diversied nature of the Endowment aredesigned to mitigate the impact of short-term market volatility on theow of funds to support Yales operations.

Spending Policy4

14

Lessons from the Crisis The financial crisis highlighted a numberof important issues and lessons that invest-ors would be wise to heed. The crisis madeclear the importance of a long-term orien-tation and underscored the need to supporta diversified, equity-oriented, active-man-agement strategy with adequate organiza-tional resources and capabilities.

Organizations, investment teams, and committees that lack commitment to a longtime horizon make sub-optimal decisionsduring periods of tumult and uncertainty.During 2008 and 2009, for example, someinstitutions overreacted to short-term concerns surrounding portfolio perform-ance and volatility, choosing to reduceequity exposure near the markets nadir.Yale instead sought to maintain equityexposure, aggressively managing liquidityand prudently employing debt. Similarly,after the October 1987 stock market crash,Yale made a rebalancing purchase of nearly$100 million of equities (representing morethan 5% of Endowment value) funded by a corresponding sale of nearly $100 millionof bonds. In the context of crisis-inducedgloom, Yales actions appeared rash, partic-ularly as many institutions responded to

market declines by further reducing theiralready diminished equity exposure. Inboth cases, however, as markets rebound-ed, Yales equity positions produced out-sized returns. Those that chose an untimelyreversal of strategy missed the benefits ofthe recovery.

The crisis emphasized that the Yalemodel is only appropriate for organizationswith a strong, dedicated, and skilled invest-ment staff. Although the fundamentalprinciples of the Yale model are straightfor-ward, execution of an active managementstrategy demands a significant commit-ment of resources, particularly duringchaotic and uncertain times. Identifyinghigh-quality active managers with the abil-ity to generate alpha consistently requiresdedicated sourcing, researching, and moni-toring of investment funds. Demands onmanagement are amplified during marketdislocations when sensibly reallocatingfunds between managers and making chal-lenging rebalancing decisions depend uponthe knowledge and input of experiencedinvestment staff. Establishing and main-taining an unconventional investment pro-file require acceptance of uncomfortably

idiosyncratic portfolios, which can, attimes, appear imprudent. Unless institu-tions maintain contrarian positionsthrough difficult times, the resulting dam-age of buying high and selling low imposessevere financial and reputational costs.

The financial crisis highlighted theimportance of understanding, forecasting,and managing portfolio liquidity, whichcan change dramatically during periods of turmoil. Investors with large allocations toilliquid assets must possess a sophisticatedunderstanding of the liquidity tools at theirdisposal and must dedicate sufficient orga-nizational resources to modeling, tracking,and stress-testing portfolio liquidity.

The Yale model of endowment investing is not appropriate for everyone. Investorsmust address the particular investment policy needs of their institutions and takeinto consideration their resources and temperament. Only those organizationswith a true long-term perspective and sufficient staff resources should pursue anactive, equity-oriented, alternatives-focusedinvestment strategy. The costly game ofactive management guarantees failure forthe casual participant.

15

The spending rule has two implications. First, by incorporatingthe prior years spending, the rule eliminates large uctuations, enablingthe University to plan for its operating budget needs. Over the last twentyyears, the standard deviation of annual changes in actual spending hasbeen approximately 66 percent of the standard deviation of annualchanges in Endowment value. Second, by adjusting spending toward the long-term target spending level, the rule ensures that spending willbe sensitive to uctuating Endowment market values, providing stabilityin long-term purchasing power.

Despite the conservative nature of Yales spending policy, distribu-tions to the operating budget rose from $470 million in scal 2003 to$1.02 billion in scal 2013. The University projects spending of $1.05 billion from the Endowment in scal 2014, representing approximately 35 percent of revenues.

The most important distinction in theinvestment world does not separate indi-viduals and institutions; the most impor-tant distinction divides those investorswith the ability to make high-quality active management decisions from thoseinvestors without active managementexpertise. Few institutions and even fewerindividuals exhibit the ability and committhe resources to produce risk-adjustedexcess returns.

The correct strategies for investors withactive management expertise fall on the

opposite end of the spectrum from theappropriate approaches for investors with-out active management abilities. Asidefrom the obvious fact that skilled activemanagers face the opportunity to generatemarket-beating returns in the traditionalasset classes of domestic and foreign equity,skilled active managers enjoy the moreimportant opportunity to create lower-risk,higher-returning portfolios with the alter-native asset classes of absolute return, realassets, and private equity. Only thoseinvestors with active management ability

sensibly pursue market-beating strategiesin traditional asset classes and portfolioallocations to nontraditional asset classes.

No middle ground exists. Low-cost pas-sive strategies suit the overwhelming num-ber of individual and institutional investorswithout the time, resources, and ability tomake high-quality active managementdecisions. The framework of the Yalemodel applies to only a small number ofinvestors with the resources and tempera-ment to pursue the grail of risk-adjustedexcess returns.

Institutions versus Individuals

0

$200

$400

$600

$800

$1,000

$1,200

$1,400

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

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

Spending Growth Surpasses Ination 19502013

Fiscal Year

Millio

ns

Yale has produced excellent long-term investment returns. Over the ten-year period ending June 30, 2013, the Endowment earned an annualized11.0 percent return, net of fees, surpassing annual results for domesticstocks of 8.1 percent and domestic bonds of 4.5 percent, and placing itamong the top one percent of large institutional investors. Endowmentoutperformance stems from sound asset allocation policy and superioractive management.

Yales long-term superior performance relative to its peers andbenchmarks has created substantial wealth for the University. Over theten years ending June 30, 2013, Yale added $7.19 billion relative to itscomposite benchmark and $7.01 billion relative to the average return of a broad universe of college and university endowments.

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

Over the past decade, the absolute return portfolio produced anannualized 9.7 percent return, exceeding the passive Barclays 9-12 MonthTreasury Index by 7.6 percent per year and besting its active benchmarkof hedge fund manager returns by 4.2 percent per year. For the ten-yearperiod, absolute return results exhibited little correlation to traditionalmarketable securities.

The domestic equity portfolio returned an annualized 10.8 percentfor the ten years ending June 30, 2013, outperforming the Wilshire 5000by 2.7 percent per year and the Russell Median Manager return, net ofestimated fees, by 3.3 percent per year. Yales active managers have addedvalue to benchmark returns primarily through stock selection.

Yales internally managed xed income portfolio earned an annu-alized 3.4 percent over the past decade, keeping pace with the Barclays 1-5Year Treasury Index and exceeding the Russell Median Manager returnby 0.2 percent per year. Because the xed income portfolio serves as theUniversitys primary source of liquidity, the Endowment forgoes opportunities to generate excess returns.

Investment Performance5

0

$100

$200

$300

2003 2004 2005 2006 2007 2008 2009

Gro

wth

of $

100

Endowment Mean of Broad Universe of Colleges and Universities

2010 2011 2012 2013

Inflation

Fiscal Year

Performance by Asset Class

Yales Performance Exceeds Peer ResultsJune 30, 2003 to June 30, 2013, 2003=$100

16

17

* Yale Returns and Active Benchmarks are dollar-weighted.

0

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

Absolute Return

Domestic Equity

Fixed Income

Foreign Equity

Natural Resources*

Private Equity*

Real Estate*

Yale Return Active Benchmark Passive Benchmark

Active BenchmarksAbsolute Return: Dow Jones Credit Suisse CompositeDomestic Equity: Frank Russell Median Manager, U.S. EquityFixed Income: Frank Russell Median Manager, Fixed IncomeForeign Equity: Frank Russell Median Manager Composite,

Foreign EquityNatural Resources: Cambridge Associates Natural ResourcesPrivate Equity: Cambridge Associates Private Equity CompositeReal Estate: Cambridge Associates Real Estate

Passive BenchmarksAbsolute Return: Barclays 9-12 Mo TreasuryDomestic Equity: Wilshire 5000Fixed Income: Barclays 1-5 Yr TreasuryForeign Equity: Blend of msci eafe Investable Market

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

Natural Resources: Blend of Custom Timber reit Basket, s&p o&g Exploration & Production Index, hsbc Global Mining Index

Private Equity: Blend of Russell 2000, Russell 2000 Technology, msci acwi ex-US Small-Cap Index

Real Estate: msci reit Index

Yale Asset Class Results Beat Most BenchmarksJune 30, 2003 to June 30, 2013

The foreign equity portfolio generated an annual return of 19.3percent over the ten-year period, outperforming its composite benchmarkby 8.4 percent per year and the Russell Median Manager return by 8.2percent per year. The portfolios excess return is due to astute countryallocation and effective security selection by active managers.

Yales natural resources portfolio produced an annualized return of 15.6 percent over the past decade, surpassing its composite passivebenchmark by 2.4 percent per year and the Cambridge Associates naturalresources manager pool by 0.3 percent per year. Yales strong performanceresults from partnership with superior operators.

Private equity earned 14.4 percent annually over the last ten years, outperforming the composite passive benchmark by 4.4 percent per yearand outperforming the return of a pool of private equity managers com-piled by Cambridge Associates by 1.0 percent per year.

Real estate generated a 7.2 percent annualized return over the ten-year period, underperforming the MSCI REIT Index by 2.4 percentper year, but outperforming a pool of Cambridge Associates real estatemanagers by 3.2 percent per year. Yales active outperformance is due tosuccessful exploitation of market inefciencies and timely pursuit of contrarian investment strategies.

Since 1975, the Yale Corporation Investment Committee has been respon-sible for oversight of the Endowment, incorporating senior-level invest-ment experience into portfolio policy formulation. The Investment Com-mittee consists of at least three Fellows of the Corporation and other per-sons who have particular investment expertise. The Committee meetsquarterly, at which time members review asset allocation policies, Endow-ment performance, and strategies proposed by Investments Oce staff.The Committee approves guidelines for investment of the Endowmentportfolio, specifying investment objectives, spending policy, and app-roaches for the investment of each asset category.

Management andOversight6Investment Committee Douglas A. Warner, iii 68

ChairmanFormer Chairman J.P. Morgan Chase & Co.

G. Leonard Baker 64 Managing DirectorSutter Hill Ventures

Francis Biondi 87 Managing MemberKing Street Capital Management

Ben Inker 92Partnergmo

Paul Joskow 72 ph.d.PresidentAlfred P. Sloan Foundation

Stefan Kaluzny 88Managing DirectorSycamore Partners

Kevin Ryan 85Founder and ceoGilt Groupe

Peter Salovey 86 ph.d.PresidentYale University

Carter Simonds 99Managing DirectorBlue Ridge Capital

Dinakar Singh 90ceo and Founding Partnertpg-Axon Capital

18Peabody Museum tower, springtime view.

19

Two YaleUniversityprofessorswere rec-ognizedwith NobelPrizes in 2013, joining six otherdistinguished members of the Yale community who received the prestigiousaward in prior years. Yale is delighted to count among the members of theUniversity community the 2013 winnersJames E. Rothman and Robert J. Shiller.

Nobel Prize Winners at Yale

Robert J. Shiller The Nobel Prize in Economic Sciences, 2013.Shiller, a behavioral economist, was recognized with Eugene F. Fama and LarsPeter Hansen for their empirical analysis of asset prices.

James E. Rothman The Nobel Prize in Physiology or Medicine, 2013.Rothman, Randy W. Schekman, andThomas C. Sdhof were honored for their contributions to cell physiologythrough their discovery of machinery regulating vesicle traffic, a major cellulartransport system.

Thomas A. Steitz The Nobel Prize in Chemistry, 2009.Steitz, with Venkatraman Ramakrishnanand Ada E. Yonath, was lauded for hisscholarship of the structure and function of the ribosome.

Sidney Altman The Nobel Prize in Chemistry, 1989.Altman and Thomas R. Cech shared the Nobel Prize for their discovery of the catalytic properties of ribonucleic acid.

James TobinThe Nobel Prize in Economic Sciences, 1981.Tobin was honored for his theory of financial markets and their relation to consumption, investment, expenditures,employment, production, and prices.

Tjalling C. Koopmans The Nobel Prize in Economic Sciences, 1975.Koopmans and Russian economist LeonidVitaliyevich Kantorovich shared the prize for their independent analyses of the opti-mal allocation of scarce resources.

George E. PaladeThe Nobel Prize in Physiology or Medicine, 1974. Palade redefined the field of cell physiology. He, Albert Claude, andChristian de Duve were acknowledged for their influential findings on structuraland functional cell organization.

Lars OnsagerThe Nobel Prize in Chemistry, 1968.Onsagers discoveries of reciprocal relations in chemical thermodynamics were recognized for their importance in the thermodynamics of irreversible processes.

The Investments Ofce manages the Endowment and other Universitynancial assets, and denes and implements the Universitys borrowingstrategies. Headed by the Chief Investment Ofcer, the Ofce currentlyconsists of twenty-six professionals.

Investments Oce David F. Swensen 80 ph.d.Chief Investment Ocer

Dean J. Takahashi 80, 83 mppmSenior Director

Alexander C. BankerDirector

Alan S. FormanDirector

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

Timothy R. Sullivan 86 Director

Kenneth R. Miller 71 Senior Associate General Counsel

Stephanie S. Chan 97Associate General Counsel

Deborah S. ChungAssociate General Counsel

J. Colin SullivanAssociate General Counsel

Carrie A. AbildgaardAssociate Director

Michael E. FinnertyAssociate Director

R. Alexander Hetherington 06Associate Director

Matthew S. T. Mendelsohn 07Associate Director

Celeste P. BensonSenior Portfolio Manager

John V. Ricotta 08Senior Associate

Patrick K. Sherwood 13 m.b.a.Senior Associate

Cain P. Solto 08Senior Associate

Xinchen Wang 09Senior Associate

David S. Katzman 10Senior Financial Analyst

Sebastian K. Serra 11Senior Financial Analyst

Philip J. Bronstein 12Financial Analyst

Timothy H. Hillas 13Financial Analyst

Daniel J. Otto 12 Financial Analyst

E. Benjamin VanGelder 13Financial Analyst

David Y. Zhang 12Financial Analyst

20

Back cover: Edward P. Evans Hall, named for the late Edward P. Evans 64, the recently completed home of the School of Management.

In recognition of Chief Investment OfficerDavid F. Swensens contributions to YaleUniversity over the past twenty-eightyears, a group of ninety colleagues, friends,and family donated more than $36 millionin Swensens honor. The gifts raisedthrough the Swensen Initiative will beinvested in Yales Endowment.

A portion of the funds will establish achair in the Economics Department, whereSwensen was a student and then taught for more than thirty years. Nothing could be a more appropriate recognition of [Swensens] devotion to Yale and its academic mission than a professorship in his name, said William C. Brainard,Arthur M. Okun Professor Emeritus ofEconomics.

A second fund will endow the Swensen-McMahon Head Coach ofWomens Tennis, named in honor ofSwensen and Meghan R. McMahon 87, a former standout Yale athlete and tenniscoach. In assuming her title as theSwensen-McMahon Head Coach ofWomens Tennis, Danielle L. McNamaraexpressed honor and gratitude, noting thatit would be difficult to find two peoplewho love Yale and Yale Tennis more.Director of Athletics Thomas A. Beckettpraised Swensens work as transformativefor Yale.

The Initiative creates a fund for innova-tive teaching in Yale College and builds onthe existing David Swensen ScholarshipFund, while the remainder providesendowment funding for teaching andresearch across the University.

Finally, Swensen has been recognized inBerkeley College where he is a longtimeFellow with the masters residence nowcalled Swensen House. Berkeley CollegeMaster Marvin M. Chun was honored toacknowledge Swensen in the collegesmost beautiful space in which we welcome

freshman parents, congratulate the seniors,and host countless events to enhanceBerkeley spirit.

The outpouring of support for Yalesacademic and athletic programs both over-whelms and humbles me, Swensen said.And to have the masters house at BerkeleyCollege named for me is far more than Iever dreamed possible.

Yale Investments Office Senior DirectorDean Takahashi highlighted Swensensvision of integrity and excellence thatinspires us to aim higher. On the person-al front, Takahashi added, he leads byexample. He chooses to serve the greatergood over his personal gain. Dave notonly makes the world better, he makes us,his friends, better.

Yale Provost Benjamin Polak wrote that Swensen is the de facto professor offinance to a generation. And what he hastaught us what he has taught me is notjust finance. It is ethics. It is humanity. It is

the core values of the University, the corevalues that David embodies.

University President Peter Salovey said,Donors have directed their contributionsto some of Yales most important priorities support for great teaching and greatcoaching as well as unrestricted funds thatcan be directed wherever they are neededmost. I am so thankful that our alumni andfriends have come together to recognize aYale leader in a way that will do so muchgood for the University.

Over the last two decades, Yale movedfrom being a national leader to an institu-tion of global scope and eminence, formerPresident Richard C. Levin said. Thiswork required substantial investment infaculty, students, and infrastructure.Davids extraordinary investment returnsgave us the resources we needed to expandthe Universitys reach and influence. I amdeeply grateful for his achievements, hisunfailing integrity, and his friendship.

Yale Rallies Behind Its Financial Steward

David F. Swensen, Chief Investment Officer, and Dean J. Takahashi, Senior Director of the Yale InvestmentsOffice, acknowledge applause at the announcement of the Swensen Initiative.

Sources

Financial and Investment InformationEducational institution asset allocations and returnsfrom Cambridge Associates.Much of the material in this publication is drawn frommemoranda produced by the Investments Oce forthe Yale Corporation Investment Committee. Othermaterial comes from Yales nancial records, Reports of the Treasurer, and Reports of the President.Page 3 The Yale Model: David F. Swensen, Pioneering Portfolio Management: An Unconventional Approach toInstitutional Investment (Simon and Schuster, 2009),pp. 163, 170.Page 7Liquidity: Swensen, Pioneering Portfolio Management,pp. 54-55.

Pages 8-13Educational institution asset allocations and returnsfrom Cambridge Associates.Pages 10-11The Death of Alpha: Swensen, Pioneering PortfolioManagement, pp. 238-240.Page 14Lessons from the Crisis: Swensen, Pioneering PortfolioManagement, pp. 2-8 and 315-317.Page 15Individuals versus Institutions: Excerpted fromSwensen, Pioneering Portfolio Management, pp. 2-3.Page 19Nobel Prize Winners at Yale: The Ofcial Web Site of the Nobel Prize.http://www.nobelprize.org/

Photo Credits

Front cover. Steve Dunwell Photography, Inc., Boston.Page 19: Manuscripts and Archives, Sterling Memorial Library (Koopmans, Onsager);University of California-San Diego (Palade).Back cover: Nigel Young (top photos), Chuck Choi (center), Tom Strong (bottom left), Tony Rinaldo (bottom right).Additional photographs: Michael Marsland, Yale Ofce of Public Affairs and Communications.DesignStrong Cohen/L. Feher