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2012 The Yale Endowment
2012The Yale Endowment
Endowment HighlightsFiscal Year
2012 2011 2010 2009 2008
Market Value (in millions) $19,344.6 $19,374.4 $16,652.1 $16,326.6 $22,869.7Return 4.7% 21.9% 8.9% -24.6% 4.5%
Spending (in millions) $ 994.2 $ 986.8 $ 1,108.4 $ 1,175.2 $ 849.9 Operating Budget Revenues $ 2,851.7 2,734.2 2,681.3 2,559.8 2,280.2(in millions)Endowment Percentage 34.9% 36.1% 41.3% 45.9% 37.3%
Asset Allocation (as of June 30)Absolute Return 14.5% 17.5% 21.0% 24.3% 25.1%Domestic Equity 5.8 6.7 7.0 7.5 10.1Fixed Income 3.9 3.9 4.0 4.0 4.0Foreign Equity 7.8 9.0 9.9 9.8 15.2Natural Resources 8.3 8.7 8.8 11.5 10.4Private Equity 35.3 35.1 30.3 24.3 20.2Real Estate 21.7 20.2 18.7 20.6 18.9Cash 2.7 -1.1 0.4 -1.9 -3.9
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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 façade.
Right:The colonnade, at left, the Alumni War Memorial to Yale men who died in World War i, forms the southfaçade of University Commons. The Beinecke Rare Book and Manuscript Library is seen at right.
Yale’s Endowment generated a 4.7 percent return in fiscal 2012, producingan investment gain of $913 million. Over the past ten years, the Endow-ment grew from $10.5 billion to $19.3 billion. With annual net invest-ment returns of 10.6 percent, the Endowment’s performance exceeded itsbenchmark and outpaced institutional fund indices. For nine of the pastten years, Yale’s ten-year record ranked first in the Cambridge Associatesuniverse. The Yale Endowment’s twenty-year record of 13.7 percent perannum produced a 2012 Endowment value of nearly seven times the 1992value. Yale’s excellent long-term record stems from disciplined and diver-sified asset allocation policies and superior active management results.
Spending from the Endowment grew during the last decade from$409 million to $994 million, an annual growth rate of approximately 9 percent. On a relative basis, Endowment contributions expanded from28 percent of total revenues in fiscal 2002 to 35 percent in fiscal 2012. Next year, spending will amount to $1.03 billion, or 36 percent of pro-jected revenues. Yale’s spending and investment policies provided sub-stantial levels of cash flow to the operating budget for current scholarswhile preserving Endowment purchasing power for future generations.
Introduction1
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Post-1950 Endowment Gifts Inflated1950 Endowment Inflated Endowment Market Value
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Endowment Growth Outpaces Inflation 1950–2012
Beginning in the mid 1980s, the YaleEndowment built a superior track recordon an unconventional foundation. Fromthe late 1980s through the mid 1990s, theEndowment’s revolutionary shift to non-traditional asset classes, coupled with theselection of excellent active managers, ledto outstanding returns in a variety of market conditions.
In the late 1990s, however, Yale’s non-traditional portfolio seemed out of stepwith the markets. Fundamentals decoupledfrom prices, creating a di!cult environ-ment for bottom-up, research-driven man-agers. Diversification did not help returnsas traditional large allocations to domesticequities were rewarded year in and yearout, with the S&P 500 growing at a 20.6percent annualized rate during the seven-year period ending June 30, 2000. Never-theless, in spite of the asset allocationheadwind, the Endowment outperformedits passive and active benchmarks, albeit by modest margins.
In fiscal 2000, the University’s fortuneschanged. Extraordinary returns from ven-
ture capital boosted Yale’s returns far aboveinstitutional averages. The Endowment’soutsized private equity returns o"set thesubstantial underperformance of Yale’svalue-oriented, marketable-security man-agers, which lagged their benchmarks asstocks climbed to unprecedented levels.
After 2000, the University producedsuperior performance based on bothsuperb active management and the Endow-ment’s well-diversified asset allocation. Inthe aftermath of the Internet bubble, withthe S&P 500 declining slightly in the eight-year period ending June 30, 2008, Yale’sinvestment managers had the opportunityto distinguish themselves in an environ-ment without irrational exuberance.
Yale’s fortunes changed for the worseduring the recent financial crisis. Marketsrewarded positions that provided a safehaven, most notably full faith and creditholdings of the U.S. government. Yale’sportfolio, positioned for strong long-termreturns, lacked significant exposure to lowexpected return Treasury securities andsu"ered in the market meltdown. Some
institutions chose to reduce equity expo-sure near the market’s nadir as concernsover portfolio illiquidity and volatilitymounted. Yale sought instead to maintainequity exposure, aggressively managingliquidity and prudently employing debt. As markets rebounded, Yale benefited.Yale’s equity positions, both liquid andilliquid, produced outsized returns as assetprices recovered post-crisis. Endowmentperformance since June 30, 2008 is nowpositive, although the Endowment valueremains below peak because of spendingdistributions to fund University operations.
Yale’s exceptional results have beenachieved by adhering to a fundamentallysound investment program. Instead ofchasing short-term performance, theUniversity invests with a long-term view.Yale consistently generated superior returnsby maintaining discipline, standing byquality managers, and retaining soundinvestments despite su"ering throughoccasional market turbulence.
Disciplined Long-Term Investing
3Afternoon view of the Silliman College courtyard.
Totaling $19.3 billion on June 30, 2012, the Yale Endowment containsthousands of funds with various purposes and restrictions. Approxi-mately three-quarters of funds constitute true endowment, gifts restrictedby donors to provide long-term funding for designated purposes. Theremaining one-quarter of funds represent quasi-endowment, monies that the Yale Corporation chooses to invest and treat as endowment.
Donors frequently specify a particular purpose for gifts, creatingendowments to fund professorships, teaching, and lectureships (24 per-cent); scholarships, fellowships, and prizes (17 percent); maintenance (4 percent); books (3 percent); and miscellaneous specific purposes (27 percent). Twenty-five percent of funds are unrestricted. Twenty-fivepercent of the Endowment benefits the overall University, with remainingfunds focused on specific units, including the Faculty of Arts and Sciences(35 percent), the professional schools (26 percent), the library (7 per-cent), 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 fiscal 2012 the Endowment provided $994 million, or 35 per-cent, of the University’s $2.852 billion operating income. Other majorsources of revenues were grants and contracts of $699 million (25 per-cent); medical services of $541 million (19 percent); net tuition, room,and board of $256 million (9 percent); gifts of $115 million (4 percent);and other income and transfers of $246 million (9 percent).
The Yale Endowment
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Endowment Fund AllocationFiscal Year 2012
Operating Budget Revenue Fiscal Year 2012
Yale’s 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 Yale’s Cowles Foundation. Using statisticaltechniques to combine expected returns, variances, and covariances ofinvestment assets, Yale employs mean-variance analysis to estimateexpected risk and return profiles 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 definition of an asset class is quite subjective, requiringprecise distinctions where none exist. Returns and correlations are di!-cult to forecast. Historical data provide a guide, but must be modified torecognize structural changes and compensate for anomalous periods.Quantitative measures have di!culty incorporating factors such as mar-ket liquidity or the influence of significant, low-probability events. Inspite 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 2012 June 2012Asset Class Actual Target
Absolute Return 14.5% 18.0%Domestic Equity 5.8 6.0Fixed Income 3.9 4.0Foreign Equity 7.8 8.0Natural Resources 8.3 7.0Private Equity 35.3 35.0Real Estate 21.7 22.0Cash 2.7 0.0
Investment Policy3
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The target mix of assets produces an expected real (after inflation) long-term growth rate of 6.3 percent with risk (standard deviation of returns)of 15.2 percent. Because actual holdings di"er from target levels, the actual allocation produces a portfolio expected to grow at 6.2 percent with risk of 15.1 percent. The University’s measure of inflation is based ona basket of goods and services specific to higher education that tends toexceed the Consumer Price Index by approximately one percentage point.
At its May 2012 meeting, Yale’s Investment Committee adopted anumber of changes to the University’s policy portfolio allocations. TheCommittee approved increases in the private equity target from 34 per-cent to 35 percent, in the absolute return target from 17 percent to 18 per-cent, and in the real estate target from 20 percent to 22 percent. Thoseincreases were funded by one-percentage-point decreases in both domes-tic equity and foreign equity targets and a two-percentage-point decreasein the natural resources target.
The need to provide resources for current operations as well as to preserve the purchasing power of assets dictates investing for highreturns, causing the Endowment to be biased toward equity. The Uni-versity’s vulnerability to inflation further directs the Endowment awayfrom fixed income and toward equity instruments. Hence, more than 95percent of the Endowment is targeted for investment in assets expected toproduce equity-like returns, through holdings of domestic and interna-tional securities, absolute return strategies, real estate, natural resources,and private equity.
Over the past two decades, Yale dramatically reduced the Endow-ment’s dependence on domestic marketable securities by reallocatingassets to nontraditional asset classes. In 1992, 51 percent of the Endow-ment was committed to U.S. stocks, bonds, and cash. Today, target allo-cations call for 10 percent in domestic marketable securities, while thediversifying assets of foreign equity, natural resources, private equity,absolute return, and real estate dominate the Endowment, representing90 percent of the target portfolio.
The heavy allocation to nontraditional asset classes stems fromtheir return potential and diversifying power. Today’s actual and targetportfolios have significantly higher expected returns and lower volatilitythan the 1992 portfolio. Alternative assets, by their very nature, tend to beless e!ciently priced than traditional marketable securities, providing anopportunity to exploit market ine!ciencies through active management.The Endowment’s long time horizon is well suited to exploit illiquid, lesse!cient markets such as venture capital, leveraged buyouts, oil and gas,timber, and real estate.
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The Yale Investments O!ce seeks to meetits investment goals through prudent assetallocation and astute manager selection.Beginning in the mid 1980s, Yale’s assetallocation policies, informed by quantita-tive analysis and market insight, shiftedtoward a broadly diversified portfolio witha strong orientation toward investmentsthat promise equity-like returns and strate-gies that exploit market ine!ciencies. Bythe mid 1990s, Yale had achieved most ofthe gains in portfolio e!ciency availablefrom a diversified, equity-orientedapproach. In subsequent years, changes inallocation targets largely reflected attemptsto exploit the most attractive investmentopportunities in the context of sensiblelong-term allocation targets.
As Yale’s asset allocation reached a pointof relative stability and the University’speer institutions began employing similarendowment management models, managerselection became an increasingly importantdi"erentiating factor for Yale. In fact, forthe twenty years ending June 30, 2012,nearly 80 percent of Yale’s outperformancerelative to the average Cambridge Associ-ates endowment was attributable to thevalue added by Yale’s active managers,while only 20 percent was the result ofYale’s asset allocation. Over the past twodecades, the Endowment returned a cumulative 1,204 percent relative to theCambridge median of 413 percent, an out-performance of 5.2 percent per annum. IfYale had employed its actual asset alloca-tion but had earned the rate of return ofthe median manager in each asset class, itwould have outperformed the Cambridgemedian manager by 1.1 percent per year,the value added by Yale’s asset allocation.The remaining 4.1 percent per annum ofthe Endowment’s outperformance resultsfrom Yale’s active management.
Asset Allocation and Active Management
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Yale Moves Toward Risk-Return E!ciency
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Yale Asset Allocation x Median Manager Returns
Yale Returns Cambridge Median
Asset Allocation Value Add 1.1%Manager Value Add 4.1%Total Value Add 5.2%
Cumulative Return for Twenty Years Ending June 30, 2012
International Center for Finance at the Yale School of Management, seen from west.
Yale’s seven asset classes are defined by di"erences in their expectedresponse to economic conditions, such as economic growth, price infla-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 fundamentaldiversification and liquidity constraints.
In July 1990, Yale became the first institutional investor to pursue abso-lute return strategies as a distinct asset class, beginning with a target allo-cation of 15.0 percent. Designed to provide significant diversification tothe Endowment, absolute return investments are expected to generatehigh long-term real returns by exploiting market ine!ciencies. The port-folio is invested in two broad categories: event-driven strategies andvalue-driven strategies. Event-driven strategies rely on a very specific cor-porate event, such as a merger, spin-o", or bankruptcy restructuring, toachieve a target price. Value-driven strategies involve hedged positions in assets or securities with prices that diverge from their underlying eco-nomic value. Today, the absolute return portfolio is targeted to be 18.0percent of the Endowment, below the average educational institution’sallocation of 23.8 percent to such strategies. Absolute return strategies areexpected to generate a real return of 5.25 percent with risk of 12.5 percent.
Unlike traditional marketable securities, absolute return invest-ments have historically provided returns largely independent of overallmarket moves. Over the past ten years, the portfolio exceeded expecta-tions, returning 10.0 percent per year with low correlation to domesticstock and bond markets.
Financial theory predicts that equity holdings will generate returns supe-rior to those of less risky assets such as bonds and cash. The predominantasset class in most U.S. institutional portfolios, domestic equity repre-sents a large, liquid, and heavily researched market. While the averageeducational institution invests 18.5 percent of assets in domestic equities,Yale’s target allocation to this asset class is only 6.0 percent. The domesticequity portfolio has an expected real return of 6.0 percent with a standarddeviation of 20.0 percent. The Wilshire 5000 Index serves as the portfoliobenchmark.
Despite recognizing that the U.S. equity market is highly e!cient,Yale elects to pursue active management strategies, aspiring to outper-form the market index by a few percentage points, net of fees, annually.Because superior stock selection provides the most consistent and reliableopportunity for generating attractive returns, the University favors man-agers with exceptional bottom-up, fundamental research capabilities.Managers searching for out-of-favor securities often find stocks that arecheap in relation to fundamental measures such as asset value, futureearnings, or cash flow.
Asset Class Characteristics
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Domestic Equity
Absolute Return
Fixed income assets generate stable flows of income, providing more cer-tain nominal cash flow than any other Endowment asset class. The bondportfolio exhibits a low covariance with other asset classes and serves as ahedge against financial accidents or periods of unanticipated deflation.While educational institutions typically maintain a substantial allocationto fixed income instruments, averaging 13.3 percent, Yale’s target alloca-tion to fixed income and cash is only 4.0 percent of the Endowment.Bonds have an expected real return of 2.0 percent with risk of 10.0 per-cent. The Barclays Capital 1-5 Year U.S. Treasury Index serves as the portfolio benchmark.
Yale is not particularly attracted to fixed income assets, as theyhave the lowest expected returns of the seven asset classes that make upthe Endowment. In addition, the government bond market is arguablythe most e!ciently priced asset class, o"ering few opportunities to addsignificant value through active management. On the basis of skepticismof active fixed income strategies and belief in the e!cacy of a highlystructured approach to bond portfolio management, the InvestmentsO!ce chooses to manage Endowment bonds internally. Though averse tomarket timing strategies, credit risk, and call options, Yale manages toadd value consistently in its management of the bond portfolio.
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Fixed Income
The rotunda above Memorial Hall, with Sterling Tower (part of She!eld-Sterling-Strathcona Hall) at left.
Yale directs active management e"orts toless e!ciently priced asset classes andemploys less aggressive approaches formore e!ciently priced assets. Given equalexpenditure of time and e"ort, active man-agement promises greater rewards in theinfrequently traded, illiquid world of alter-native assets than in the heavily traded, liquid world of traditional marketable securities.
The distribution of actively managedreturns in a particular asset class serves asan indicator of the degree of opportunityfor active management. Pricing ine!cien-cies allow managers with great skill toachieve great success, while unskilled man-agers post commensurately poor results.Hard work and intelligence only reap richrewards in environments where superiorinformation, skill, deal flow, and long-term time horizon provide an edge. Activemanagers in less e!cient markets exhibitgreater variability in returns.
The accompanying figure shows activemanager returns for various asset classes.The spread in returns between the top andbottom quartiles in collections of activelymanaged portfolios illustrates the notionthat more e!ciently priced assets provideless opportunity for active managers andthat less e!ciently priced assets providemore opportunity.
U.S. Treasury securities, arguably themost e!ciently priced asset in the world,trade in staggering volumes in marketsdominated by savvy financial institutions.The Treasury market provides the bench-mark for all other fixed income trading.Since nobody knows where interest rates
will be, few managers employ interest rateanticipation strategies. Without potentiallypowerful di"erentiating bets on interestrates, institutional portfolios tend to exhibit market-like interest rate sensitivity,or duration. As a result, managers generallylimit themselves to modest security selec-tion decisions, causing returns for mostactive managers to mimic benchmarkresults. The spread between top and bot-tom quartile results for active bond man-agers measures an astonishingly small 0.8 percent per annum for the decade.
Less e!ciently priced securities trade inwider ranges. Stocks provide more di!cultpricing challenges than bonds. Instead ofdiscounting relatively certain fixed incomecash flows, valuation of equities involvesmanager judgment in discounting far-less-certain corporate cash flows. Greater vola-tility in equity markets contributes to thewider active manager spread. Large-capi-talization domestic equities represent thenext rung of the e!ciency ladder, with arange of 1.5 percent per annum betweentop and bottom quartiles.
Domestic small-capitalization stocksshow a larger gap, with a range of 2.3 per-cent per annum between top and bottomquartiles. The progression of degree ofopportunity across types of marketablesecurities makes intuitive sense: smaller-capitalization stocks provide natural limitson the size of stakes investors can take,often precluding larger and more sophisti-cated asset managers from finding andexploiting pricing ine!ciencies.
Many foreign equity markets, particu-larly emerging markets, tend to be less
e!ciently priced than U.S. markets becauseof their lower liquidity, spotty researchcoverage, and smaller local investor bases.These markets present greater opportuni-ties for superior stock selection as demon-strated by the larger range in manager per-formance. The spreads between top andbottom quartile developed and emergingmarket managers are 2.7 percent and 2.8percent per annum, respectively.
Illiquid assets show substantially largerannualized spreads with leveraged buyoutsat 13.8 percent, natural resources at 17.4percent, real estate at 19.1 percent, and ven-ture capital at 19.8 percent. Lacking invest-able benchmarks, managers of illiquidassets succeed or fail by dint of their skillsand abilities, not by the action (positive ornegative) of the market. Furthermore, theoperational, strategic, and company-build-ing skills of private equity and real assetsmanagers can add tremendous value totheir portfolio holdings and di"erentiatethe strongest performers from their lack-luster peers.
Selecting top managers in private mar-kets leads to much greater reward thanidentifying top managers in public mar-kets. On the other hand, poor private man-ager selection can lead to extremely disap-pointing results as a consequence of highfees, poor performance, and illiquid posi-tions. Careful consideration of the degreeof market opportunity when formulatingasset allocation policies and structuringportfolios makes an important contributionto investment performance.
Opportunity for Active Management
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25th Percentile Median 75th Percentile
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Alternative Asset Returns Exhibit Significant DispersionActive Manager Returns by Quartile for Periods Ending June 30, 2012 *
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* Fixed income and marketable equity performance based on annualized ten-year returns of bny Mellon manager universes, adjusted for fees. Venture capital, lbo, real estate, and natural resources returns based on annualized since-inception irrs of Cambridge Associates manager universes.
Foreign equity investments give the Endowment exposure to the globaleconomy, providing diversification and the opportunity to earn outsizedreturns through active management. Yale allocates 3.0 percent of its port-folio to foreign developed markets and 2.0 percent to emerging markets.In addition, Yale dedicates 3.0 percent of the portfolio to opportunisticforeign positions, with the expectation that holdings will be concentratedin markets that o"er the most compelling long-term opportunities, par-ticularly China, India, and Brazil. Yale’s foreign equity target allocation of8.0 percent stands below the average endowment’s allocation of 18.2 per-cent. Expected real returns for emerging equities are 7.5 percent with arisk 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 theMorgan Stanley Capital International (msci) Europe, Australasia, andFar East (eafe) Investable Market Index; (b) emerging markets, meas-ured by a blend of the msci Emerging Markets Investable Market Indexand the msci China A-Share Index; and (c) opportunistic investments,measured by a custom blended index.
Yale’s investment approach to foreign equities emphasizes activemanagement designed to uncover attractive opportunities and exploitmarket ine!ciencies. As in the domestic equity portfolio, Yale favorsmanagers with strong fundamental research capabilities. Capital alloca-tion to individual managers takes into consideration the country alloca-tion of the foreign equity portfolio, the degree of confidence that Yalepossesses in a manager, and the appropriate size for a particular strategy.In addition, Yale attempts to exploit compelling undervaluations in coun-tries, sectors, and styles by allocating capital to the most compellingopportunities.
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Foreign Equity
Yale University Art Gallery.
Equity investments in natural resources—oil and gas, timberland, andmetals and mining—share common risk and return characteristics: pro-tection against unanticipated inflation, high and visible current cash flow,and opportunities to exploit ine!ciencies. At the portfolio level, naturalresource investments provide attractive return prospects and significantdiversification. Yale has a 7.0 percent long-term policy allocation to natu-ral resources with expected real returns of 6.2 percent and risk of 18.2 per-cent. Yale’s current natural resources allocation is in line with that of theaverage endowment.
The natural resources portfolio is a fundamental component ofthe Endowment as it o"ers powerful diversification and promises strongreturns. Superior operators have demonstrated the ability to generateexcess returns over a market cycle. The inception-to-date return of Yale’soil and gas (1986), timber (1996), and mining (2011) portfolio clocks inat an impressive 16.0 percent per annum.
Private equity o"ers extremely attractive long-term risk-adjusted returns,stemming from the University’s strong stable of value-adding managersthat exploit market ine!ciencies. Yale’s private equity portfolio includesinvestments in venture capital and leveraged buyout partnerships. TheUniversity’s target allocation to private equity of 35.0 percent far exceedsthe 10.9 percent actual allocation of the average educational institution. Inaggregate, the private equity portfolio is expected to generate real returnsof 10.5 percent with risk of 26.8 percent.
Yale’s private equity program, one of the first of its kind, isregarded as among the best in the institutional investment communityand the University is frequently cited as a role model by other investors.Since inception in 1973, private equity investments have generated a 30.0percent annualized return to the University.
Yale’s private equity strategy emphasizes partnerships with firmsthat pursue a value-added approach to investing. Such firms work closelywith portfolio companies to create fundamentally more valuable entities,relying only secondarily on financial engineering to generate returns.Investments are made with an eye toward long-term relationships—gen-erally, a commitment is expected to be the first of several—and towardthe close alignment of the interests of general and limited partners.
Investments in real estate provide meaningful diversification to theEndowment. A steady flow of income with equity upside creates a naturalhedge against unanticipated inflation without a sacrifice of expectedreturn. Yale’s 22.0 percent long-term policy allocation significantlyexceeds the average endowment’s commitment of 4.3 percent. Expectedreal returns are 6.0 percent with risk of 17.5 percent.
While real estate markets sometimes produce dramatically cyclicalreturns, pricing ine!ciencies in the asset class and opportunities to addvalue allow superior managers to generate excess returns over long timehorizons. Since inception in 1978, the portfolio has returned 11.6 percentper annum.
Private Equity
Real Estate
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Natural Resources
The illiquid nature of private real estate and the time-consumingprocess of completing transactions create a high hurdle for casualinvestors. A critical component of Yale’s investment strategy is to createstrong, long-term partnerships between the Investments O!ce and itsinvestment managers. In the last two decades, Yale played a critical role in the development and growth of a number of successful real estateinvestment organizations.
Yale Educational University Institution Mean
Absolute Return 14.5% 23.8% Domestic Equity 5.8 18.5Fixed Income 3.9 13.3 Foreign Equity 7.8 18.2 Natural Resources 8.3 8.2Private Equity 35.3 10.9 Real Estate 21.7 4.3 Cash 2.7 2.7Data as of June 30, 2012
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Asset Allocations
Active Management and Career RiskSuccessful active management requires acontrarian focus on ine!cient markets and out-of-favor assets, which present thegreatest opportunity to take advantage ofmispricings and generate outsized returns.In practice, however, such contrarianbehavior is rare—most fund managers herd around popular investment strategiesor hew closely to their benchmarks ratherthan pursue strategies that would likelyproduce greater rewards over the longterm.
Career risk is a significant driver ofmanager behavior. A contrarian manager’sportfolio di"ers markedly from peer port-folios and from market benchmarks. Con-sequently, the contrarian manager producesresults that diverge dramatically from thoseof peers. Although a high-quality activemanager should outperform over the longterm, the manager’s idiosyncratic portfoliois likely to underperform at various pointsalong the way. During those periods ofunderperformance, the manager will likelylose clients. Even if the contrarian invest-ment thesis ultimately proves correct, themanager may already be out of business or
managing a much diminished portfolio.These dire business consequences pushmany managers to hug their benchmarks in the name of career preservation.
Prominent investor Jeremy Grantham of Grantham Mayo Van Otterloo (gmo)notes that “the main driver in risk manage-ment for most investors is, unfortunately,career and business risk. This means thatcontrolling short-term benchmark riskdominates, and not the risk of the actualclient losing real money.” Fund managersare much more likely to be fired for tempo-rary underperformance as their long-terminvestments play out than they are for sus-tained mediocre performance in line withtheir peers. As John Maynard Keyneslamented in The General Theory, “it is better for reputation to fail conventionallythan to succeed unconventionally.”
gmo experienced short-term bench-mark risk first-hand with its InternationalIntrinsic Value Strategy. The strategyattracted investors in the early 1990s as itdramatically outperformed its msci eafebenchmark by 8.7 percent per year from1990 through 1993. Poor relative returns
during the manic markets of 1994 through1999 resulted in a client exodus, however,taking assets from a peak of $2.8 billion in1996 to just $578 million by 2002. Thefund robustly recovered during the 2000through 2005 period, outperforming itsbenchmark by 9.5 percent per annum, butthe majority of its clients were no longeraround to participate in the recovery.Although the International Intrinsic ValueStrategy generated returns of 11.1 percentper year from its 1987 inception throughthe end of 2006, outperforming mscieafe by 4.1 percent per annum, fewinvestors reaped the sustained success of gmo’s active strategy.
Only by building an investor base witha common investment philosophy, timehorizon, resolve, and tolerance for trackingerror can a manager maintain the stablecapital base required to see its contrarianinvestments through to a successful conclu-sion. As many managers and institutionalclients cower in the face of career riskissues, financing and executing a sensibleactive management program is challengingand rare.
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The spending rule is at the heart of fiscal discipline for an endowed insti-tution. Spending policies define an institution’s compromise between theconflicting goals of providing substantial support for current operationsand preserving purchasing power of endowment assets. The spendingrule must be clearly defined and consistently applied for the concept ofbudget balance to have meaning.
The Endowment spending policy, which allocates Endowmentearnings to operations, balances the competing objectives of providing astable flow of income to the operating budget and protecting the realvalue of the Endowment over time. The spending policy manages thetrade-o" 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 year’sspending and 20 percent of the targeted long-term spending rate appliedto the fiscal year-end market value two years prior. The spending amountdetermined by the formula is adjusted for inflation and constrained sothat the calculated rate is at least 4.5 percent, and not more than 6.0 per-cent, of the Endowment’s inflation-adjusted market value two years prior.The smoothing rule and the diversified nature of the Endowment aredesigned to mitigate the impact of short-term market volatility on theflow of funds to support Yale’s operations.
Spending Policy4
Spending Growth Surpasses Inflation 1950–2012
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The spending rule has two implications. First, by incorporatingthe prior year’s spending, the rule eliminates large fluctuations, enablingthe University to plan for its operating budget needs. Over the last twentyyears, the standard deviation of annual changes in spending has been lessthan 65 percent of the standard deviation of annual changes in Endow-ment value. Second, by adjusting spending toward the long-term targetspending level, the rule ensures that spending will be sensitive to fluctu-ating Endowment market values, providing stability in long-term pur-chasing power.
Despite the conservative nature of Yale’s spending policy, distribu-tions to the operating budget rose from $409 million in fiscal 2002 to$994 million in fiscal 2012. The University projects spending of $1.03 billion from the Endowment in fiscal 2013, representing approximately 36 percent of revenues.
Aerial view of Science Hill, with Kroon Hall at center left and Kline Biology Tower at the right.
Yale has produced excellent long-term investment returns. Over the ten-year period ending June 30, 2012, the Endowment earned an annualized10.6 percent return, net of fees, surpassing annual results for domesticstocks of 3.8 percent and domestic bonds of 5.6 percent, and placing itamong the top one percent of large institutional investors. Endowmentoutperformance stems from sound asset allocation policy and superioractive management.
Yale’s long-term superior performance relative to its peers andbenchmarks has created substantial wealth for the University. Over theten years ending June 30, 2012, Yale added $7.3 billion relative to its com-posite benchmark and $7.2 billion relative to the average return of a broaduniverse of college and university endowments.
Yale’s long-term asset class performance continues to be outstanding. Inthe past ten years, nearly every asset class posted superior returns, signifi-cantly outperforming benchmark levels.
Over the past decade, the absolute return portfolio produced anannualized 10.0 percent return, exceeding the passive Barclays 9-12Month Treasury Index by 7.7 percent per year and besting its activebenchmark of hedge fund manager returns by 4.6 percent per year. Forthe ten-year period, absolute return results exhibited little correlation totraditional marketable securities.
For the ten years ending June 30, 2012, the domestic equity port-folio returned an annualized 9.8 percent, outperforming the Wilshire5000 by 3.6 percent per year and the Russell Median Manager return, netof estimated fees, by 4.5 percent per year. Yale’s active managers haveadded value to benchmark returns primarily through stock selection.
Yale’s internally managed fixed income portfolio earned an annu-alized 4.5 percent over the past decade, keeping pace with the Barclays 1-5Year Treasury Index and exceeding the Russell Median Manager returnby 0.4 percent per year. By making astute security selection decisions andaccepting a moderate degree of illiquidity, the Endowment benefited fromexcess returns without incurring material credit or option risk.
Investment Performance5
0
$100
$200
$300
$400
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Endowment Mean of Broad Universe of Colleges and Universities Inflation
Grow
th of
$100
Fiscal Year
Performance by Asset Class
Yale’s Performance Exceeds Peer ResultsJune 30, 2002 to June 30, 2012, 2002=$100
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The foreign equity portfolio generated an annual return of 16.6percent over the ten-year period, outperforming its composite benchmarkby 6.5 percent per year and the Russell Median Manager return by 6.8percent per year. The portfolio’s excess return is due to astute countryallocation and e!ective security selection by active managers.
Yale’s natural resources portfolio produced an annualized return of16.2 percent over the past decade, outperforming its composite passivebenchmark by 4.7 percent per year though lagging the CambridgeAssociates natural resources manager pool by 0.4 percent per year. Yale’sstrong performance results from its partnership with superior operators.
Private equity earned 13.2 percent annually over the last ten years,outperforming the composite passive benchmark by 5.2 percent per yearand outperforming the return of a pool of private equity managers com-piled by Cambridge Associates by 1.4 percent per year. Since inception in1973, the private equity program has earned an astounding 30.0 percentper annum.
Real estate generated a 7.3 percent annualized return over the ten-year period, underperforming the msci reit Index by 1.9 percentper year, but outperforming a pool of Cambridge Associates real estatemanagers by 5.3 percent per year. Yale’s active outperformance is due tosuccessful exploitation of market ine"ciencies and timely pursuit of contrarian investment strategies.
02%
4%
6%
8%
10%
12%
14%
16%
18%
AbsoluteReturn
DomesticEquity
Fixed Income
ForeignEquity
NaturalResources
PrivateEquity
RealEstate
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 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, 2002 to June 30, 2012
*Yale Returns and Active Benchmarks are dollar-weighted
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Since 1975, the Yale Corporation Investment Committee has been respon-sible for oversight of the Endowment, incorporating senior-level invest-ment experience into portfolio policy formulation. The InvestmentCommittee consists of at least three Fellows of the Corporation and otherpersons who have particular investment expertise. The Committee meetsquarterly, at which time members review asset allocation policies, Endow-ment performance, and strategies proposed by Investments O!ce sta".The Committee approves guidelines for investment of the Endowmentportfolio, specifying investment objectives, spending policy, andapproaches for the investment of each asset category.
Management andOversight6Investment Committee Douglas A. Warner, iii ’68
ChairmanFormer Chairman J.P. Morgan Chase & Co.
Byron G. Auguste ’89 DirectorMcKinsey & Company
G. Leonard Baker ’64 Managing DirectorSutter Hill Ventures
Joshua Bekenstein ’80 Managing DirectorBain Capital
Ben Inker ’92Director of Asset Allocationgmo
Paul Joskow ’72 ph.d.PresidentAlfred P. Sloan Foundation
Stefan Kaluzny ’88Managing DirectorSycamore Partners
Richard C. Levin ’74 ph.d.PresidentYale University
Kevin Ryan ’85Founder and ceoGilt Groupe
Carter Simonds ’99Managing DirectorBlue Ridge Capital
Dinakar Singh ’90ceo and Founding Partnertpg-Axon Capital
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Manager selection lies at the heart of Yale’sactive management strategy. The Endow-ment has built longstanding investmentrelationships with talented active managersthat exploit a rich set of investment oppor-tunities across an array of market sectors,strategies, and asset classes. Each year, theInvestments O!ce meets with countlessprospective investment managers, relent-lessly evaluating opportunities to add newhigh-quality managers to Yale’s portfolio.When the Investments O!ce identifies apromising fund manager, it conducts thor-ough due diligence to evaluate the group’sinvestment acumen and strategy, as well asits character and ethics, often spendingseveral months getting to know a teamprior to funding a new investment.
Yale searches for intelligent and dedi-cated managers that have high integrity,sound investment philosophies, strongtrack records, superior organizations, andsustainable competitive advantages. Yalestrives for excess returns by building size-able relationships with firms that have along-term orientation, as well as a rigor-ous investment process and exceptionalbottom-up research capabilities. Successfulmanagers execute a program that providesthe conviction necessary to hold concen-trated portfolios. The University seeksmanagers that exhibit significant disciplinein their investment processes, that deploy
capital only when they have found ine!-ciencies, and that exploit compellingopportunities for attractive returns.
Yale’s marketable managers focus pri-marily on making attractive bottom-up,security-specific investments and frequentlyconcentrate their e"orts on companies withearnings driven by factors that can be rea-sonably forecast, such as production, costs,distribution, and pricing. Yale’s active man-agers tend to be attracted to less widely followed stocks and less e!ciently pricedmarkets, which o"er better opportunitiesfor superior managers to develop di"eren-tiated insights and identify meaningfullymispriced securities.
In Yale’s private equity, real estate, andnatural resources portfolios, the Invest-ments O!ce seeks cohesive and motivatedgroups with a proven ability to create valueindependent of underlying market condi-tions. Ideal real estate partners possesssuperior operating and financial capabilitiesand focus on specific geographies or prop-erty types. Similarly, Yale seeks privateequity firms that work closely with theirportfolio companies to create fundamen-tally more valuable entities, relying onlysecondarily on financial engineering togenerate returns.
A critical component of Yale’s invest-ment strategy is the creation of long-termpartnerships with strong alignments of
interest. The Investments O!ce targetsemployee-owned firms to ensure thatincentive compensation appropriatelybenefits the investment team. Yale looks for a substantial co-investment from thegeneral partners, which helps foster pru-dent decision-making and risk assessment.Yale aims to partner with firms that strivefor investment excellence and that are will-ing to limit assets under management,ensuring flexibility to exploit attractiveopportunities.
Yale often looks to develop close rela-tionships with firms early in their lifecycles. As an investment managementorganization progresses through its lifecycle, Yale monitors the relationship care-fully to ensure that interests continue tocoincide, that assets under managementremain at reasonable levels, and that themanager remains motivated and capable ofearning substantial returns. The Universityfrequently supports emerging investmentgroups that are not well-known, brand-name players. In some cases Yale createsproprietary opportunities by helping a firmenter the world of institutional fund man-agement. The University seeks to buildlong-term relationships with high-qualityinvestment managers, as evidenced by theaverage tenure of eleven years for managersin the Endowment portfolio.
Manager Attributes
North façade of Branford Court.
The Investments O!ce manages the Endowment and other Universityfinancial assets, and defines and implements the University’s borrowingstrategies. Headed by the Chief Investment O!cer, the O!ce currentlyconsists of twenty-six professionals.
Investments O!ce David F. Swensen ’80 ph.d.Chief Investment O!cer
Dean J. Takahashi ’80, ’83 mppmSenior Director
Peter H. Ammon ’05 m.b.a., ’05 m.a.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
Celeste P. BensonSenior Portfolio Manager
Matthew S. T. Mendelsohn ’07Senior Associate
John V. Ricotta ’08Senior Associate
Cain P. Solto" ’08Senior Associate
David S. Katzman ’10Senior Financial Analyst
Nilesh V. Vashee ’09Senior Financial Analyst
Xinchen Wang ’09Senior Financial Analyst
Philip J. Bronstein ’12Financial Analyst
Florence R. Dethy ’11Financial Analyst
Sebastian K. Serra ’11Financial Analyst
Kaiyuan Wang ’11Financial Analyst
David Y. Zhang ’12Financial Analyst
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Sources
Financial and Investment InformationEducational institution asset allocations andreturns from Cambridge Associates.Much of the material in this publication isdrawn from memoranda produced by theInvestments O!ce for the Yale CorporationInvestment Committee. Other material comesfrom Yale’s financial records, Reports of theTreasurer, and Reports of the President.Pages 8-13Educational institution asset allocations andreturns from Cambridge Associates.
Page 10Returns from bny Mellon and CambridgeAssociates.Page 13Jeremy Grantham quotation from gmo,Letters to the Investment Committee vii, April 2006. International Intrinsic ValueStrategy data provided by gmo.John Maynard Keynes quotation from The General Theory of Employment, Interest and Money (Harcourt and Brace, 1964).
This section draws on David Swensen’sPioneering Portfolio Management(Simon and Schuster, 2009).
Photo Credits
Front coverSteve Dunwell Photography, Inc., BostonAdditional photographsMichael Marsland, Yale O!ce of PublicA"airs and CommunicationsDesign
Strong Cohen/D. Pucillo
Silliman College tower.
Berkeley College
Sterling Memorial Library Pierson College
Calhoun College School of Medicine
Hall of Graduate StudiesDavenport College
Silliman College
Timothy Dwight College
