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The Endowment

Annual Investment Report for the Fiscal Year Ending June 30, 2002

The investments of the Rochester endowment produced a respectable negative 3.8% total return, net of all fees, during the fiscal year ended June 30, 2002. This was the first negative return by the endowment in over a decade. The loss of the past year should be taken in context—it was the third consecutive year of double digit declines in the value of domestic and international equity markets, marking the worst performance by equities since the mid-1970s, and, according to some measures, the worst period of domestic equity performance since 1929-1930. It was a year, though, when Rochester's active investment managers and diversification worked in tandem to preserve capital, quite a feat considering nearly one-half of the endowment is invested in publicly-traded equities.

The 2002 return was attributable to the following asset classes and allocations:

Domestic Equities (31.2% allocation): -12.8% (vs. Wilshire 5000 return of -16.6%)
Int'l Equities (14.9% allocation): +2.5% (vs. EAFE return of -9.5%)
Fixed Income (17.8% allocation): +6.9% (vs. Lehman Aggregate return of +8.6%)
Balanced Funds (4.7% allocation): +3.4% (vs. Lipper Balanced Index
return of -1.0%)
Hedge/Distressed (21.1% allocation): +3.2% (vs. various benchmarks)
Private Equity (4.7% allocation): -34.7% (vs. various benchmarks)
Real Assets (5.7% allocation): +2.5% (vs. various benchmarks)
Total Fund 7/1/01 to 6/30/02: -3.8% (vs. Policy Benchmark* of -10.3%)
  * 60% Wilshire 5000, 20% MSCI EAFE, 20% LB Aggregate
   

During the past ten years, the total value of Rochester's endowment increased by 77%, from $620 million to $1.1 billion, primarily a result of the ten-year average annual net investment return of 11%. Rochester's ten-year investment return ranked third among the eight members the University Athletic Association. For the most recent five-year period Rochester's average annual investment return of 8.3% placed second in this peer group.

The increased use of alternative strategies, particularly hedge funds, was an important factor in improving the endowment's performance during the past decade. Rochester's increase in alternative strategies was accomplished by reducing exposure to both domestic equities and domestic fixed income. Alternative strategies now represent approximately 30% of the endowment. Rochester's asset allocation policy, which emphasizes the use of ranges rather than fixed allocation targets, also helped performance. These ranges allowed the Investment Office and the Trustees' Investment Committee to deemphasize asset classes that were judged to be overvalued (leading to relatively small positions in growth stocks, venture capital and, very recently, additional and significant reductions in domestic fixed income) and to overweight asset classes, strategies or styles that may be out of favor or under-priced (examples include value-oriented stocks, hedge funds, distressed debt and real estate). This flexible approach has served Rochester well over the past decade and we believe it will continue to do so.

Despite the improved investment returns, endowment growth through charitable giving remains a significant challenge. The University's five-year and ten-year endowment growth rates are among the lowest in its peer group, primarily a result of consistently below-average charitable giving to the endowment. Endowment growth is also constrained by Rochester's relatively high endowment spending rate and, recently, the temporary use of endowment funds for litigation to protect the value of the University's intellectual property.

To reflect the realities of a weaker investment and economic environment, the University's financial planning model now contains an average annual endowment return target of 8%, a full 2 percentage points lower than the 10% return target of 2001 and earlier years. A long-term annual investment return of at least 8% is necessary for Rochester's endowment to maintain the level of support it now provides to the University's academic programs.

Prudent investors must always "expect the unexpected" and constantly guard against complacency, which is the primary reason for conducting detailed annual in-depth reviews of the University's investments.

We thank all donors and Investment Committee members for volunteering their time, wisdom and financial resources to the perpetuation of the Rochester endowment—which has enabled tens of thousands of students to further their education at this wonderful and robust institution.

Sincerely,

Robert M Osieski signature        Douglas W. Phillips signature
Robert M. Osieski
Trustee, Chairman of the
Investment Committee
       Douglas W. Phillips
Senior Vice President for
Institutional Resources