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The Endowment

Annual Investment Report for the Fiscal Year Ending June 30, 2003

Rochester's preliminary net return for the fiscal year ending June 30, 2003 was approximately +4.1%. While this result is below the 8% goal contained in the University's financial plan, it compares favorably with the benchmark return of +1.8% (comprised of 60% Wilshire 5000, 20% Lehman Aggregate and 20% EAFE). The endowment value at the end of the fiscal year was approximately $1.1 billion, roughly the same value as reported at the beginning of the year. The relatively unchanged endowment value was attributable to an investment gain of $53 million, gifts and additions of $22 million and spending of $74 million. Early reports from Rochester's peers suggest that the mean return achieved by large endowments in fiscal year 2003 will range from modestly negative to positive single digits. Rochester's five-year average annual return through June 30, 2003 is +6.0% vs. -0.1% for the benchmark, while the University's ten-year average annual return through June 30, 2003 is +9.9% vs. +7.6% for the benchmark. Major asset classes generated the following performances in fiscal year 2003:

Domestic equity managers returned +1.7% compared to +1.3% for the domestic equity benchmark (Wilshire 5000). Selection of active and "index agnostic" investment firms, using fundamental valuation models, helped domestic equity performance in 2003, albeit in a very difficult environment during the first half of the fiscal year. Rochester's lower exposure to domestic equities was a positive influence on performance.

The domestic fixed income return of +10.4% matched the +10.4% return for the benchmark (Lehman Aggregate). Duration on the University's fixed income portfolio was lowered to 3.9 years in fiscal 2003, as managers adjusted for increased price risk in long bonds. The University halved its bond allocation during the year, to approximately 10%, to reflect this increase in risk.

International equities returned -0.3% compared to -6.4% for the benchmark (EAFE).

The alternative investment program generated a net return of +6.7%. Hedge funds (including managers of distressed securities) returned +8.5%, private equity returned a negative 7.1% and real estate, oil & gas and timber returned +9.2%. An underweight position in private equity, specifically in venture capital funds with vintage years of 1998 to 2000 helped Rochester avoid the large write-downs in value experienced by peer schools. The negative return in private equity is largely a result of the "J" curve on funds deployed in the 2001 to 2003 fiscal years.

The investment office continues to pay close attention to asset allocation and strategies of Rochester's peers. The investment office expects that these monitoring efforts will maintain an allocation and investment approach that does not drastically differ from peers. The release of fiscal 2003 peer asset allocation data, expected in November, will assist in the discussions and strategic planning at the Investment Committee's March, 2004 annual review.

The University's 4.1% investment return in fiscal 2003 was generated through the efforts of many talented managers, investment committee members and investment office staff. It is the consensus of these groups that, over time, the University of Rochester's target return of 8% is achievable. We anticipate a return to the targeted return as domestic economic conditions improve.

The 2003 return was attributable to the following asset classes and allocations:

Domestic Equities (30.3% allocation): +1.7% (vs. Wilshire 5000 return of +1.3%)
Int'l Equities (14.7% allocation): -0.3% (vs. EAFE return of -6.4%)
Fixed Income (8.5% allocation): +10.4% (vs. Lehman Aggregate return of +10.4%)
Cash (8.2% allocation): +1.1%
Balanced Funds (5.0% allocation): +6.5% (vs. Lipper Balanced Index return of +3.5%)
Hedge/Distressed (22.6% allocation): +8.5% (vs. various benchmarks)
Private Equity (5.7% allocation): -7.1% (vs. various benchmarks)
Real Assets (5.0% allocation): +9.2% (vs. various benchmarks)
Total Fund 7/1/02 to 6/30/03: +4.1% (vs. Policy Benchmark* of +1.8%)
  * 60% Wilshire 5000, 20% MSCI EAFE, 20% LB Aggregate

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