The 2000-2001 fiscal year was one of retrenchment in the securities markets, as investors sought to minimize the loss of wealth created in the extraordinary but unsustainable bull market of the past decade. The University's pooled endowment returned 2 percent during the fiscal year, an average annual return of 20.2 percent over the past three years, and an annualized 18.4 percent over the past five years. All are top-quartile performance levels among the largest university and college endowments.

In 2000-2001, the Board of Visitors made the decision to reduce the endowment's investments in conventional long-only domestic and international equity markets and to place greater emphasis on alternative investments, primarily hedge funds. In addition to reducing its long-only positions, the University sold as soon as possible all distributions from its venture capital portfolio, thereby locking in the exceptional gains of the previous year. These assets were redeployed into hedge fund positions.

The hedge fund portfolio primarily consists of long/short equity managers. Based on analysis of individual company fundamentals, these managers purchase stock in companies that they believe to be undervalued by the market and sell stock short in companies that their research shows cannot sustain their market value. The return on these hedge fund portfolios is determined, for the most part, by the spread between the returns on the long portfolio versus the return on the short portfolio and much less by the direction of the overall stock market. Because the return is dependent upon manager skill, the Board of Visitors and the staff are carefully selecting managers for the portfolio. By year-end, 39 percent of the endowment was invested in hedge funds (more than double the previous year), 23 percent in non-marketable alternatives including private equity and real estate, 15 percent in domestic long-only equity, 4 percent in international long-only equity, and 19 percent in fixed income.

Going forward, the road appears treacherous, but the endowment's long time horizon and predictable and fairly low spending rate allow for investments in less liquid areas where the potential reward appears to be greater than in the traditional markets. The University will continue to identify promising hedge fund and private equity managers. While always hopeful for a robust market, we do not wager on its overall direction, choosing instead to emphasize areas that have the potential to yield positive returns under both favorable and unfavorable conditions.