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Is the ‘Yale Endowment Model’ Obsolete?A Discussion on Lessons Learned from the Financial Meltdown of 2008

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Agenda

1. What is the Endowment Model? How does it add value?

2. How has it changed over time?

3. How does U. Maryland Endowment invest?

4. What’s new since the crisis of 2008?

5. Thematic investing?

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The Endowment Model worked…

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20100%

100%

200%

300%

400%

500%

600%

700%

619%

493%456%

344%

20 year Cumulative Nominal Return:1991- 2010

Over $1bn (10.9% annualized)

Under $500m (9.8% annualized)

80% stocks / 20% bonds (9.4% annual-ized)

CPI+5% (8.2% annualized)

Source: Cambridge Associates LLC. Note: Yale data is for years ending June 30 th and from NACUBO.

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…and worked very well for Yale!

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20100%

100%

200%

300%

400%

500%

600%

700%

800%

900%

1000%

1100%

1200%

1300%

1400%

1084%

619%

493%456%344%

20 year Cumulative Nominal Return:1991- 2010

Yale (13.1% annualized)

Over $1bn (10.9% annualized)

Under $500m (9.8% annualized)

80% stocks / 20% bonds (9.4% annual-ized)

CPI+5% (8.2% annualized)

Source: Cambridge Associates LLC. Note: Yale data is for years ending June 30 th and from NACUBO.

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How does the “Endowment Model” add value?

1. Asset Allocation

2. Risk management

3. Manager Selection

4. Thematic investing

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Traditional vs. Endowment Models

Stocks45%

Bonds40%

Alternatives15%

Traditional “Pension” Model

Stocks35%

Bonds15%

Real Assets15%

Private Equity15%

Hedge Funds20%

“Endowment” Model

Alternatives50%

Growth

Inflation Hedging

Deflation Hedging

Source: Cambridge Associates LLC.

As of 2010

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What are “Alternative” Investments?

Absolute Return• Long/short equity • Arbitrage • Macro-trading • Distressed Credit

Private Equity

• Leveraged buyouts• Venture capital • Growth capital • Mezzanine financing • Turnarounds

Real Assets

• Real estate • Oil & gas properties • Energy infrastructure - pipelines & storage• Timber & Farmland• Mining• Commodities

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The Yale Endowment

28% Real Assets

33% Private Equity

19% Absolute Return9% Int’l. Equity4% Bonds7% US Equity

Source: The Yale Endowment Report 2010.

As ofJune 30,

2010

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Endowment Asset Allocation History

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1990 1995 2000 2005 20100%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

48%40% 34%

26%15%

5%11%

13%21%

18%

4%4%

13%9%

15%4%

5%

6%8% 13%33%

27%19%

13% 11%6% 6% 4% 2% 2%

8% 13%22%

26%

US Equities Int'l. Equities Absolute Return Private Equity Real Assets Bonds Cash

The Current “Over $1 billion” Endowment Universe – Historical Mean Asset Allocation

Source: Cambridge Associates LLC.

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USMF Policy Allocation History

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20100%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

69% 63% 63% 66% 68% 62%53% 50%

43% 37% 36%

4%6% 10% 10%

18%22%

27%26%

28%27% 22%

25% 27% 14% 12%

6% 6% 4% 2% 2% 4% 10%2% 4%

13% 11%2% 4% 7% 5%

1%

7% 9% 15% 20%23%

26%27%

Global Equities Absolute Return Real Assets Bonds Cash

USMF Investment Committee embarked on a new strategy in 2004. Implementation took several years.

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Current Endowment Asset Allocation

Global Equi-ties 49%

Absolute Re-turn 19%

Real Assets 28%

Bonds & Cash 4%

YaleAs of June 30, 2010

U. MarylandAs of Dec. 31, 2010

Source: Cambridge Associates LLC. Note: Real Assets includes real estate, commodities, oil & gas, timber, and other private partnerships.

Global Equi-ties48%

Absolute Re-turn26%

Real Assets13%

Bonds & Cash13%

Over $1 billion UniverseAs of Dec. 31, 2010

Global Equi-ties45%

Absolute Re-turn23%

Real Assets20%

Bonds & Cash12%

Liquid & Quasi-liquid 75%Private 25%

Liquid & Quasi-liquid 66%Private 34%

Liquid & Quasi-liquid 42%Private 58%

Liquidity:

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USMF Allocation by Security Type

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Bonds & Cash24%

Equity & Equity-Like Alternatives

76%

Total Endowment as of 3/31/2011

Note: Represents a look-through to all securities held by endowment managers.

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USMF Allocation by Security Type

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Bonds & Cash24%

Equity-Like76%

Total Endowment

Gov't Bonds15%

Cash25%

Corporate Bonds15%

High Yield & Dis-tressed

15%

Mortgages30%

Bonds & CashSector Breakdown

Note: Represents a look-through to all securities held by endowment managers.

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USMF Allocation by Security Type

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Bonds & Cash24%

Equity-Like76%

Total Endowment

North America50%

Europe15%

Japan5%

Asia ex Japan17%

Latin America5%

Africa & Middle East8%

Equity-LikeRegional Breakdown

30% Emerging Markets

70% Developed

Markets

Note: Represents a look-through to all securities held by endowment managers.

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How does the “Endowment Model” add value?

1. Asset Allocation

2. Risk management

3. Manager Selection

4. Thematic investing

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Risk Management

Enhancements post-2008:

Risk Management Software

Streamline risk exposure data aggregation System provides enhanced stress testing, VaR analysis, risk factor attribution

Formal Liquidity Policy

Tightened limit on outstanding capital commitments (liabilities must be < 20% of endow.)

Placed ceiling on illiquid investments at 50% of endowment

Valuations-based Rebalancing

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“Non-Normal” Markets

1987 Market Crash (Oct 1987)

Bond Market Crash (Feb-May 1994)

Russian Default / LTCM (Jul-Aug 1998)

2002 Credit Crunch (May-Sept 2002)

Lehman Fail (Sept-Nov 2008)

-40%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

-9.7%

-3.1%

-8.6% -8.9%

-21.4%

-28.5%

-7.8%

-15.4%

-23.5%

-36.9%

Sample Stress Test Analysis: Current USMF Endowment vs. S&P 500 Index

USMF En-dowmentS&P 500 Index

USMF Max “1 in 8” Loss: -12.5%

USMF Max Loss: -25.0%

Note: Above stress test estimates the current portfolio’s response to the changes in capital markets during the specified events.

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“Normal markets” – VaR analysis

Jan-07 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11-20%

-15%

-10%

-5%

0%

5%

10%

Value-at-Risk vs. Risk Guard-rails

USMF VaRS&P 500 VaR

Need to reduce risk

Note:

VaR represents the likely one-month loss that might occur every 1 in 20 months, i.e. 95% of all months the portfolio’s returns are likely to be better than the stated VaR amount. This does not capture the “tail events”, and it assumes a normal distribution of returns.

VaRCurre

nt Avg.

USMF -2.6% -5.5%

S&P -5.1% -10.2%

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How does the “Endowment Model” add value?

1. Asset Allocation

2. Risk management

3. Manager Selection

4. Thematic investing

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Value Add via Manager Selection

Source: The Yale Endowment Report 2010.

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How did Yale do it? Right place, right managers

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

26%

41%

9%

28%

-25%

19%

-4%

-20%

Annual Nominal Returns:Periods ending June 30

Yale

Endowments Over $1bn mean

All C&Us mean

Yale’s Real Assets & Private Equity results in high returns, outperformance

Yale’s illiquidity causes high unreal-ized losses…but what happens next?

Source: Cambridge Associates LLC. Note: Yale data is for years ending June 30 th and from NACUBO.

Yale’s Venture Capital results in high returns, outperformance

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How does the “Endowment Model” add value?

1. Asset Allocation

2. Risk management

3. Manager Selection

4. Thematic investing

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What is asset allocation?

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20110%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

176%

15-Year Cumulative Performance through March 31, 2011

60/40

80/20

Debates about 80/20 vs. 60/40 are probably less important…diversification across different asset classes matters far more.

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Not just US stocks/US bonds…

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010-50%

0%

50%

100%

150%

200%

250%

300%

350%

400%

346%

46%22%

Cumulative Return: Jan. 2001 – Mar. 2011

Emerging Markets

Int'l. Developed Markets

S&P 500

Source: Bloomberg

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Thematic Investing

Possible themes for the next several years:

End of the bull market in US govt. bonds

New bilateral relationships in the developing world

Super-cycle wave for commodities

Urbanization and a rising consumer class

High quality multi-national companies ; US technology ; EU luxury brands

Asian Union?

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Emerging Economies Drive Global Growth

2000-2010 2010-2015 2015-20200.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

0.9% 0.8% 0.9%

2.8% 3.3% 3.6%

Contribution to World GDP Growth

Developing Economies

Advanced Economies

Source: The Conference Board, Inc.

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Growing Bilateral Relationships in Developing World

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000Brazil-China Trade

Brazil Exports to China

Brazil Imports from China

Brazil Exports to US

Source: IMF DOT Database, UN COMTRADE

US$millions

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Urbanization

Nearly 1 billion people might urbanize in the next ten years

Source: World Urbanization Prospects

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E.g., in China, the number of cities with large middle-affluent populations will expand dramatically in the next decade.

Source: The Boston Consulting Group, Inc. 2010. “The Keys to the Kingdom – Unlocking China’s Consumer Power”

Rising Consumer Class

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Urbanization

Shanghai 1990 Shanghai 2010

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Asian Demand for Resources

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Urbanization in Africa

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Improved Macro Fundamentals in Africa

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

0%

2%

4%

6%

8%

10%

12%

14%

0%

10%

20%

30%

40%

50%

60%

70%

80%Sub-Saharan Africa External Debt 1980-2015

Total Debt Service % GDP (lhs) Total Debt Service, Interest % Exports (lhs) Ext. Debt % GDP (rhs)

Source: IMF

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Real vs. Financial Assets

1975 1980 1985 1990 1995 2000 2005 20100%

500%

1000%

1500%

2000%

2500%

3000%

3500%

4000%

4500%

5000%Cumulative Return: 1975 – 2011

S&P 500BondsGold

Source: Bloomberg

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Contact Information

University System of Maryland Foundation, Inc.

Michael Barry – Chief Investment Officer301-445-2796

mbarry@usmd.edu