F 9 STANDING COMMITTEES. B. Finance and Asset Management Committee. Investment Program Annual Update. This item is for information only.

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1 VII. STANDING COMMITTEES F 9 B. Finance and Asset Management Committee Investment Program Annual Update This item is for information only. Attachment Investment Program Update: A Report to the Board of Regents, May 8, 014 F 9/05-14

2 Investment Program Update A Report to the Board of Regents May 8, 014 Treasury Office University of Washington ATTACHMENT

3 Investment Program Update A Report to the Board of Regents May 8, 014 Table of Contents Executive Summary...3 Roles and Responsibilities Governance...4 Capital Global Capital Market Composition...5 Relative Performance and Valuations...6 Historical 10-Year Treasury Yields...7 Consolidated Endowment Fund CEF Characteristics...8 CEF s and Risk...9 Annual s by CEF Asset Class...10 Contributors of Endowment Growth...11 Invested Funds Invested Funds Characteristics...1 Invested Funds: Projected Pool Allocations...13 Appendices Spending and Inflation...14 CEF Distributions...15 CEF Activity...16 CEF Policy Asset Allocation...17

4 Regents perspective is requested on the following : Active Management Favoring public over private strategies which may result in greater performance volatility. Maintaining the level of differentiation relative to policy benchmark and peers allocation. Tactical Positioning Leaning into value relative to policy targets. Highlights of the UW investment program include: Executive Summary Overview The Consolidated Endowment Fund (CEF) and Invested Funds (IF) are reviewed annually with the Board of Regents. While no policy changes are proposed this year for the CEF, a revised asset allocation is recommended for the IF. Performance CEF returned 14.9% and IF returned 3.1% for the year ending December 013. Longer-term performance has also been solid, with the two portfolios returning 7.8% and 4.4%, respectively, over the last ten years. Consolidated Endowment Fund (CEF) The portfolio remains overweight equities, highlighted by meaningful exposure to emerging markets relative to both peer institutions and global market indices. markets represent the CEF s primary driver of growth required to meet the targeted nominal return and spending hurdle. Although emerging markets underperformed in recent years and tend to be volatile, high returns are projected relative to other asset classes over the next 5 7 years. Invested Funds (IF) The portfolio consists of government-backed securities and CEF units to provide diversification and growth. Steps are being taken to further increase CEF exposure to mitigate interest rate risk and enhance diversification of the fund. Creation of a fourth pool is also being recommended to fund University capital assets. 3

5 Roles and Responsibilities

6 Governance Board of Regents Investment Committee (UWINCO) Chief Investment Officer (CIO) Sets Investment Policy Spending rate Strategic asset allocation Delegations Appoints Investment Officer/Advisors Chief Investment Officer (CIO) UWINCO members Investment consultants Reviews Program Program oversight/accountability Advises CIO Investment planning Asset allocation Manager identification Market trends Advises the Board of Regents Investment program oversight CIO oversight Implements Investment Program Day-to-day management Tactical asset allocation Manager appointments Manager terminations Risk management Research Monitors Results Performance reporting Governance of the investment program is defined around clearly established roles and responsibilities. 4

7 Capital

8 Global Market Composition Share of GDP Share of Capital 38.4% 61.6% EM: 5% DM: 95% EM: 13% DM: 87% DM: 81% EM: 19% DM: 69% EM: 31% China 1.% Brazil 3.0% Russia.9% India.4% Mexico 1.8% Remaining 16.1% Total 38.4% United States.8% Japan 6.8% Germany 4.9% France 3.7% United Kingdom 3.4% Remaining 0.0% Total 61.6% DM EM North America Europe Other (DM) Other (EM) Brazil, India, Russia China Source: International Monetary Fund, World economic Outlook database as of October, 013 Sources: Factset, IMF, Worldbank, World Federation of Exchange, Goldman Sachs Global ECS Research estimates markets share of global capital markets is anticipated to rise substantially over the next two decades. 5

9 Relative Performance and Valuations Rolling 1-Month Relative Performance (UW EM versus ACWI) MSCI EM Forward PE 70% 60% 50% 40% 30% 0% 10% 0% -10% -0% -30% SD Excess Average -1 SD 4x x 0x 18x 16x 14x 1x 10x 8x 6x 4x SD Average -1 SD Source: Morgan Stanley Research, March 014 markets performance has lagged developed markets over the past three years, but current valuations are attractive. 6

10 Historical 10-Year Treasury Yields Average Year Treasury Yield Source: Wellington Management Co. Historically low interest rates present risk of owning longer maturity US Treasuries. 7

11 Consolidated Endowment Fund

12 CEF Characteristics CEF Profile Asset Allocation as of 1/31/13 Description A permanent fund established through private gift funds to support the program specified by the donor. Composition 4,069 individual endowments which are commingled for investment purposes similar to a mutual fund. Primary Objective To preserve the purchasing power of each endowed gift over time. This objective drives the discussion on spending policy, return requirements, long-term asset allocation and risk tolerance. Secondary Objective To provide a steady stream of income to support individual programs. This objective influences the spending formula used in calculating the income distribution. Current Allocation ($ =M) 1 Percentages may not sum due to rounding. Target $46 17% 17% $958 38% 8% $300 1% 15% $186 7% 7% Opportunistic $46 % 3% Policy Range Capital Appreciation $1,916 76% 70% 55% 85% $457 18% 19% $161 6% 11% Capital Preservation $618 4% 30% 15% 45% Total CEF 1 $, % 1 Geographic Exposure 1 as of 1/31/13 Sector Exposure 1 as of 1/31/13 North America 65% Dev. Asia ex. Japan: % EM Latin America: % Europe 11% EM Asia 11% Japan: 4% EM EMEA: 5% Utilities: % Telecom: 4% Materials: 3% Financials 18% Consumer Staples 10% Health Care 11% Consumer Discretionary 15% Energy 11% Industrials 14% Information Technology 1% 1 At 1/31/13 foreign currency exposure: 34% 1,,, and The CEF risk/return objectives are achieved through broad diversification by strategy, sector and geography. 8

13 CEF s and Risk As of December 31, Year 3 Year 10 Year 0 Year Total CEF 14.9% 8.3% 7.8% 9.4% RETURN Policy Benchmark % 9.% 8.% 9.3% Passive Benchmark 15.1% 8.3% 7.0% 7.% Peer Quartile Ranking 3 nd 3rd nd 1st Contribution ($M) 4 $335 $540 $1,351 $,033 CEF Sharpe Ratio RISK Policy Benchmark Sharpe Ratio Policy Benchmark is a blend of market indices weighted to reflect the strategic asset allocation of the CEF. 70% MSCI ACWI plus 30% BC Government Bonds. 3 Cambridge Associates Public Colleges and Universities reporting with endowments currently between $1B & $5B. 4 Represents the cumulative dollars generated by CEF investment returns. 5 The higher the Sharpe ratio, the better the fund s historical risk-adjusted performance. The Sharpe ratio is calculated using standard deviation and excess return over the risk-free rate to determine reward per unit of risk. CEF performance was solid during the past year. Longer-term performance is improving. 9

14 Annual s by CEF Asset Class Best Performance 004 For Calendar Years Ending December Years (Annualized).0% 30.7% 36.0% 57.4% -.9% 71.4% 6.5% 10.7% 1.1% 9.0% 14.4% 1 Opportunistic 1 Opportunistic 0.5% 6.0% 17.4% 8.8% -4.4% 5.9% 1.9% 9.4% 18.9% 5.7% 11.5% 15.0% 1.4% 16.0% 16.% -.9% 4.% 10.7% 1.6% 16.1% 15.0% 7.5% 1.5% 13.5% 15.% 15.3% -3.0%.% 10.1% 1.5% 15.9% 1.1% 7.5% 1 Opportunistic 11.9% 10.0% 14.9% 9.0% -38.3% -7.%.5% -0.6% 6.8% 9.5% 5.8% 3.4% 4.0% 5.8% 8.9% -5.0% -13.% 0.1% -4.6% 4.9% 5.1% Worst Performance 1 Opportunistic investment strategy added 7/1/010 Prior to 008 absolute return included long / short equity investments -15.3% 1.4% 1.0%.7% strategy drove CEF performance over the past ten years. 10

15 Contributors of Endowment Growth As of December 31, 013 $.5 $.5 Market Value ( $=B) Add: Active Investment Management Add: Active Advancement Management $1.8 $ Baseline: Passive Management Fiscal Years Assumptions Baseline CEF passively invested 70% MSCI ACWI and 30% U.S. Government bonds 5% of actual gift activity No administrative fees to advancement or investments $1.1 billion CEF ending market value Add: Active Advancement Management CEF passively invested 70% MSCI ACWI and 30% U.S. Government bonds 100% of actual gift activity, invested passively 80 bps administrative fee to advancement $1.8 billion CEF ending market value Add: Active Investment Management CEF actively managed with actual results shown 100% of actual gift activity 80 bps administrative fee to advancement & 0 bps administrative fee to investments $.5 billion CEF ending market value Successful fundraising efforts, coupled with an active approach to investment management, have resulted in significant growth in the CEF over the past 16 years. 11

16 Invested Funds

17 IF Profile Description Locally generated operating and capital reserves of the University. Composition Institutional funds (57%) and funds on deposit by campus departments (43%). Financial and Liquidity Objectives To meet the day-to-day financial obligations of the University. Access to funds on demand under normal conditions. Maintain strong liquidity to permit cost effective debt issuance. Investment Objective To achieve investment returns above those of money market instruments. Invested Funds Characteristics IF Allocation by Pool Fund Allocation at 1/31/13 ($=M) Range Duration in Years Actual Maximum Cash Pool $78 36% 10% 40% Liquidity Pool $818 40% 30% 60% Total Cash & Liquidity Pool $1,545 76% Diversified Investment Pool 1 $497 4% 15% 40% Total Invested Funds $,04 100% 1 DIP consists of CEF units held by IF IF Mix of Investments at 1/31/13 IF Risk and at 1/31/13 CEF Units 4% 1 Year 3 Years 10 Years 0 Years Total IF including DIP 3.1% 3.% 4.4% 6.0% Policy Benchmark 3.1% 3.3% 4.6% 6.0% Treasuries & Agencies 50% Cash Equivalents: % Mortgage- Related 17% Asset-Backed Securities: 7% Total IF excluding DIP -0.4% 1.7% 3.1% 4.7% Policy Benchmark -0.6% 1.4% 3.1% 4.6% Three Month T-Bill 0.1% 0.1% 1.6%.9% DIP Contribution $66 $108 $87 $513 IF Sharpe Ratio Policy Benchmark Sharpe Ratio IF liquidity remains strong with the Diversified Investment Pool adding significantly to total return over the past decade. 1

18 Invested Funds: Projected Pool Allocations Policy Pool Allocation Current Proposed Target Range Target Range Cash Pool 0% 10 40% 15% 10 40% Liquidity Pool 50% 30 60% 40% 5 60% Diversified Investment Pool 30% 15 40% 35% 15 45% Capital Pool 10% 0 15% 1 1 The Capital Asset Pool is capped at 10% while the range of 0 15% allows for market fluctuations. Increasing exposure to the Diversified Investment Pool will mitigate interest rate risk and enhance diversification. Creation of a Capital Pool requires a change to policy and will have a nominal impact on liquidity

19 Appendices 18

20 Spending and Inflation Total Nominal * Required to Meet the Long-Term Spending Target Endowment Distributions 4.0% Long-Term Policy Rate Advancement Office 0.8% Investment Office 0.% Expected Inflation 3.0% Consumer Price Index Total Required 8.0% Administrative Fees * is assumed net of investment fees (manager, consulting, custodial and legal) of approximately 50 basis points. Required Nominal Matrix Distribution Rate plus Administrative Fees Inflation 3.0% 4.0% 5.0% 6.0% 7.0% 1.0% 4.0% 5.0% 6.0% 7.0% 8.0%.0% 5.0% 6.0% 7.0% 8.0% 9.0% 3.0% 6.0% 7.0% 8.0% 9.0% 10.0% 4.0% 7.0% 8.0% 9.0% 10.0% 11.0% 5.0% 8.0% 9.0% 10.0% 11.0% 1.0% 6.0% 9.0% 10.0% 11.0% 1.0% 13.0% 7.0% 10.0% 11.0% 1.0% 13.0% 14.0% 8.0% 11.0% 1.0% 13.0% 14.0% 15.0% Long-Term spending plus inflation rate estimate. Program distributions, administrative fees and inflation are critical factors in defining a sustainable level of program support

21 CEF Distributions As of June 30, 013 Endowed Program Support Principal by Purpose Endowment Distributions ($=M) As a Percentage of Total UW Revenues Research Activities 8% Scholarships & Fellowships 9% Fiscal Years Total UW Annual Revenues* CEF Distributions Percent 010 $3,93 $59 1.5% 011 $4,304 $76 1.8% Academic Support 17% Other University Activities 1% Professorships & Chairs 5% 01 $3,94 $85.% 013 $4,541 $87 1.9% * Excludes discrete component units Principal by School & College Distributions by Fiscal Year Office of the President Student Life Foster School of Business Engineering 5% 7% Centrally Administered 5% 4% 8% Academic Medical Affairs 3% Operating Funds 0% Other Colleges, College Schools & of Arts & Programs Sciences 16% 1% $59 $76 $85 $87 $9* Interim Policy * Projected Distributions to schools and colleges have been steadily increasing post-financial crisis. 15 0

22 CEF Activity As of December 31, 013 ($=M) 1 Year 3 Year 10 Year 0 Year Beginning Balance $,6 $,088 $1,177 $377 Gifts ,04 Transfers Operating Funds Purchases Total Additions $84 $9 $967 $1,41 Net Investment $335 $540 $1,351 $,033 Distributions (90) (59) (778) (1,068) Administrative Fees (4) (13) (37) (51) Advancement Support (18) (5) (147) (170) Ending Balance $,533 $,533 $,533 $,533 CEF investment returns support endowment distributions, program management, and Advancement funding while generating overall CEF growth. 16 1

23 CEF Policy Asset Allocation Opportunistic 60 Percent Over the past twenty-five years, the CEF grew significantly in size and complexity. The portfolio today is diversified across many dimensions: asset classes, countries, sectors, investment styles and managers. 17