F–7 STANDING COMMITTEES Finance and Asset Management Committee

F–7/205-20 5/14/20

Annual UWINCO Report INFORMATION This is an annual report, presented for information only. Attachment Investment Program Annual Review: Report to the Board of Regents

Investment Program Annual ReviewReport to the Board of Regents (Updated)

May 14, 2020

University of Washington Investment Management Company

ATTACHMENTF-7.1/205-20 | 5/14/20 Page 1 of 22

Table of Contents

Executive Summary…………………….……………………………………………………. 3-5UWINCO’s Guiding Principles……………………………………………………………. 6Governance ………..………….. ………………………………………………………...…… 7Consolidated Endowment Fund

Profile, Asset Allocation, Exposures …….................................................................. 8Performance …………………….…………………………………………………….. 9

Invested FundsProfile, Asset Allocation, Mix of Investments, Risk and Returns……................... 10

Update – COVID-19 Impact………………………………………………………………… 11Equity Markets………………………………………………………………………... 12Historical 10-Year Treasury Yields………………………………………………….. 13CEF Crisis Comparison………………………………………………………………. 14

Appendices……………………………………………………………………………………. 16-22

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Overview

The Consolidated Endowment Fund (CEF) and Invested Funds (IF) are reviewed annually with the Board of Regents. UWINCO staff completed an analysis of CEF asset allocation and the capital markets for the UWINCO Board in March 2020. However, market conditions quickly changed with the spread of COVID-19.

No changes to the strategic policy targets for the CEF are recommended this year. The CEF and IF have sufficient liquidity to weather this crisis. During this market correction, focus has shifted to protecting liquidity and rebalancing the portfolio by selectively upgrading managers and capitalizing on market dislocations.

Performance

The CEF and IF returned +16.1%% and +1.7%, respectively, for calendar year 2019. Annualized CEF returns over longer periods range from 7.4% to 9.8%.

CEF performance relative to peers has been solid and UWINCO has generated excess returns over a passive 70/30 benchmark in all periods except the one-year.

Executive Summary CEF Asset Allocation - $3.7 BillionAs of December 31, 2019

Capital Preservation

27%

Capital Appreciation

73%

Emerging Markets Equity

19%

Developed Markets Equity

35%

Opportunistic 2%

Private Equity

13%

Absolute Return

18%

Fixed Income

9%

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Market Outlook

The effect of the current COVID-19 crisis on return forecasts is uncertain and dependent upon the pace of recovery. Over the next 5–7 years, UWINCO Board, UWINCO staff, and other market participants continue to project a low return environment. Pre-crisis, the CEF was forecast to have a nominal return of 5.2%, which remains below the spending hurdle (4.5% spending rate plus 2.0% inflation).

The February 2019 spending policy rate change from 5.0% to 4.5% has a three-year phase in period. This, along with the 5-year rolling average spending formula, should help smooth the impact of the market downturn on campus distributions.

Asset Class Return / Risk

Options to increase prospective returns remain limited. Emerging Markets (EM) and Private Equity (PE) represent the only asset classes forecasted to deliver returns in excess of the CEF’s 6.5% spending hurdle, but with greater volatility. Risks have increased under current crisis conditions, placing a premium on liquidity and downside protection. Therefore, we are more cautious on adding riskier assets at this time.

Executive Summary

CEF Forecasted 5 – 7 Year Return vs Spending Hurdle

Fore

cast

ed R

etur

ns

MCTR (Volatility)

Asset Class 5-7 Year Return / Risk Projection

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Campus Support

The CEF and IF contribute meaningfully to campus funding. Solid performance has translated into steadily higher dollar distributions over time.

CEF Long-term Growth

The CEF has grown more than 4x over the last 20 years, excluding campus support. Consistent with other endowments, the CEF’s equity orientation can lead to periods of short-term volatility and UW focuses on long-term risk-adjusted returns.

.

Executive Summary

CEF Twenty Year Growth: 1999 – 2019

$ = Millions 1 Year 5 Year 10 Year 20 Year

CEF Distributions to Unit Holders $133 $598 $1,021 $1,659

Advancement Support from CEF $27 $120 $206 $308

Invested Funds Distributions (in June) $46 $230 $422 $903

Total Campus Support $206 $947 $1,649 $2,870

Campus Support from InvestmentsAs of December 31, 2019

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UWINCO’s Guiding Principles

MissionOur mission is to preserve and grow the University’s

investments through superior investment returns

VisionOur vision is to support UW’s global leadership in

research and education

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Board of Regents UWINCO Board Chief Investment Officer (CIO)

Sets investment policy• Spending rate• Strategic asset allocation• Delegations

Appoints investment officers/advisors• Chief Investment Officer• UWINCO Board Members• Investment consultants

Reviews program• Program oversight / accountability

Advises the CIO• Investment planning• Asset allocation• Manager identification• Market trends

Advises Board of Regents/President• 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

Key Roles and Responsibilities

Governance

Governance of the investment program is defined around clearly established roles and responsibilities.

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As of December 31, 2019Asset Allocation

Equity Sector ExposureGeographic Exposure

Profile

Consolidated Endowment Fund (CEF)

Target Range Emerging Markets Equity $703 19% 17% Developed Markets Equity 1,296 35% 30% Private Equity 501 13% 15% Real Assets 159 4% 5% Opportunistic 73 2% 3%

$2,733 73% 70% 55% - 85% Absolute Return 687 18% 19% Fixed Income 328 9% 11%

$1,014 27% 30% 15% - 45%$3,747 100%

($ = Millions)

Capital Appreciation

Capital Preservation Total CEF

Current Allocation PolicyDescription: A permanent fund established through private gift funds to support the program specified by the donor.

Composition: 5,034 individual endowments (as of January 1, 2019) which like a unitized mutual fund are commingled for investment purposes.

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.

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CEF Performance

In addition to the CEF market value of $3.7 billion, cumulative distributed investment returns (purple area) over the past 20 years total $2.1 billion.

Campus Distributions & Contributors of Endowment Growth over Last 20 YearsAs of December 31, 2019

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As of December 31, 2019

Profile Fund Allocation By Pool ($ = Millions)

Risk and ReturnMix of Investments

Invested Funds (IF)

Description: Locally generated operating and capital reserves of the University.

Composition: Institutional funds (~40%) and funds on deposit by campus departments (~60%).

Financial Objective: To meet the day-to-day financial obligations of the University as they come due. Access to funds on demand under normal conditions.

Investment Objectives: To achieve investment returns above those of money market instruments.

Liquidity Objective: Provide strong liquidity levels to maintain flexibility and permit cost effective issuance of debt.

MV % Range Actual MaximumShort-term Pool1 $1,192 48% 10%-50% 2.1 3.0Intermediate-term Pool 502 20% 15%-60% 2.4 5.0

Long-term Pool2 667 27% 15%-45%IF excluding CAP $2,361 95%

Capital Assets Pool3 133 5% 0%-15%Total Invested Funds $2,493 100%1 Short-term Pool excludes $334m of restricted Supplemental Retirement Funds.2 Long-term Pool consists of CEF units and are included in the CEF market value.3 Capital Assets Pool (CAP) consists of UW internally financed projects.

Fund Allocation Duration (yrs)

10

1 Year 3 Year 10 Year 20 Year

IF Return including LTP1 7.0% 4.3% 3.5% 4.3%Money Market Funds2 2.2% 1.6% 0.6% 1.7%Policy Benchmark 8.4% 4.3% 3.3% 4.3%

IF Return excluding LTP 3.7% 2.3% 1.9% 3.5%Policy Benchmark 4.1% 2.0% 1.7% 3.5%

LTP Return Contribution ($M) $95 $176 $426 $578

1 Long-term Pool consists of CEF units and are included in the CEF market value.2 Money Market Funds represented by the 3 month Tbill

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Update – COVID-19 Impact

Economic crisis different than 2008-09. Corporations now over leveraged, not households.

UWINCO focused on rebalancing, upgrading managers and capitalizing on market dislocations.

Performance down Jan-Mar 2020; neutral-to-favorable compared to broader markets:

CEF declined -12.7% during quarter and -5.6% this past year

IF fell –2.5% in 1Q and rose +1.5% over last 12 months

Both portfolios are well positioned. CEF has enhanced liquidity access compared to pre-2008-09 crisis.

Markets remain volatile. Broader range of possible economic outcomes. All suggest lower returns.

CEF phased spending rate reduction to 4.5% in process. Spending policy will smooth decline in FY 2020. Impact increasing through FY 2021-22.

UWINCO Board and staff benefit from 15+ years working together and even greater industry experience facing market corrections (Asian Economic Crisis, Dot.com bubble, 9/11, SARS, Global Financial Crisis 2008-09).

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Equity Markets12

Q1 2020 Apr‐20

‐12.7% n/a

‐13.8% 7.6%

‐19.6% 12.8%

‐22.1% n/a

n/a n/a

5.2% 0.3%

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Historical 10-Year Treasury Yields13

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CEF Crisis ComparisonCEF 2008 2020

Performance • -14.5% 4Q 2008• -23.9% FY 2009

• -12.7% 1Q 2020• -8.2% FYTD

Positioning • 8.5% Fixed Income 6/30/2008• 39.0% total monthly liquidity• 14.3% unfunded commitments

• 10.0% Fixed Income 1/31/2020• 49.0% total monthly liquidity• 14.7% unfunded commitments

Liquidity • Forced seller of equities to cover liabilities = losses

• Dry powder to upgrade managers and capitalize on dislocations

Borrowing Capacity

• None • Interfund Loan (capacity tbd)

Spending Policy

• Froze spending• Reduced spending rate from

6.0% to 5.0%• Increased from 3 to 5-year

rolling average

• Phased spending rate reduction to4.5% (currently 4.9%)

• 5-year rolling average

Distributions • ~50% cut from FY 2008 level • Down est. -10% by 6/2021

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Appendices

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Appendix – CEF Cash FlowsCEF Activity and Campus Support

As of December 31, 2019

16

($ Millions)

FYTD 2020 2019 2018 3 Year 5 Year 10 Year 20 Year

Beginning Balance $3,588 $3,407 $3,144 $2,904 $2,889 $1,840 $1,085Endowment Gifts 50 135 101 342 483 798 1,422Transfers 9 7 14 34 69 103 187Operating Funds 0 0 (0) (0) (107) 146 299Total Additions $59 $142 $114 $376 $445 $1,047 $1,909Net Investment Return 184 202 301 937 1,160 2,140 2,799Distributions to Unit Holders (67) (130) (121) (376) (598) (1,021) (1,659)Internal Fees Advancement Support (13) (26) (24) (75) (120) (206) (308) Investment Administration (3) (7) (6) (19) (30) (52) (79)Ending Balance $3,747 $3,588 $3,407 $3,747 $3,747 $3,747 $3,747

Net Investment Return $184 $202 $301 $937 $1,160 $2,140 $2,799 Less: Passive Return1 (236) (224) (228) (932) (1,070) (1,901) (2,253) Less: Investment Administration (3) (7) (6) (19) (30) (52) (79)Net Active Management ($55) ($29) $67 ($14) $60 $187 $467

CEF Distributions to Unit Holders $67 $130 $121 $376 $598 $1,021 $1,659Advancement Support from CEF 13 26 24 75 120 206 308Invested Funds Distributions2 0 46 49 137 230 422 903Total Campus Support $80 $202 $195 $588 $947 $1,649 $2,870 1 70% MSCI ACWI & 30% Bloomberg Barclays (BB/BC) Intermediate Government Bond Index 2 Invested Funds Distributions are made annually in June. Note: Numbers may not sum due to rounding.

Campus Support From Investments

Fiscal Years Rolling Years

Active Management Contribution

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Appendix – Endowment Impact

Distributions supporting campus unit holders totaled $1,021 million over the past decade. Despite representing a small percentage of total UW operating revenues, distributions remain a critical funding source for beneficiaries.

FY 2019 Endowment Impact

Faculty Support

23%

Academic Support

18%

Research Activities

7%

Operating Funds and

Other23%

Student Support

29%

1,652 Scholarships/ 4,643 students

802 Fellowships/ 1,462 students

283 Awards / Prizes 773 students

256 Research Endowments

6 Deanships

163 Chairs

317 Professorships

173 Instruction

1,240 Academic

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FY 2019 Endowment Support by Unit and Purpose

Appendix – Endowment Impact 18

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Appendix – Endowment Impact

The generous $100,000 gift from William and Ruth Gerberding invested in 1996 provided a powerful impact, distributing $155K in fellowship support and still having a market value of nearly double its original value.

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Gerberding Beneficiary HighlightsEndowment value creation since inception in 1996

As of December 31, 2019

First year in Speech & Hearing Sciences

3rd year MD/PhD in Genome Sciences

4 Professors1 Resident

4 Professors1 ResearchDirector

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Appendix – SpendingCEF Spending Update

CEF spending has steadily increased over the past several years at a rate comparable to peers.

As of June 30, 2019

FY 2015 FY 2016 FY 2017 FY 2018 FY 2019

Beginning Market Value 2,832,753 3,076,226 2,968,013 3,143,790 3,407,264Distributions to Unit Holders1 105,279 112,880 112,818 121,306 130,391Distributions as a % of UW Revenues2 2.9% 3.0% 2.9% 3.1% 3.0%

Effective Spending Rate excluding Fees 3.7% 3.7% 4.0% 3.9% 3.8%Administrative Fees3 5,303 5,644 5,641 6,065 6,520UW Effective Spending Rate including Fees 4.6% 4.6% 5.0% 4.8% 4.8%Peer Effective Spending Rate including Fees4 4.6% 4.8% 5.0% 4.8% 4.7%

Total CEF Return 6.8% -1.6% 13.6% 9.6% 5.8%

PeriodAdditions Excluding

LTP Purchases

Additions as a % of Beginning Market Value

PeriodAnnual Payout

% Change from Prior Year

FY 2015 59,978 2.1% FY 2015 $3.21 -5%FY 2016 112,686 3.7% FY 2016 $3.31 3%FY 2017 101,629 3.4% FY 2017 $3.38 2%FY 2018 114,264 3.6% FY 2018 $3.52 4%FY 2019 141,904 4.2% FY 2019 $3.63 3%

1 Actual distributions are administrered on a quarterly and per unit basis. New gifts are added quarterly and receive payouts at the next distribution date. 2 UW Revenues excludes discrete component unit including health care.3 Administrative fees support Advancement and Investments. 4 Data collected by Cambridge Associates Colleges and Universities Annual Survey for Public Institutions with endowments between $1 billion to $7 billion.

Fiscal Year Additions

($ = 000's)

Per Unit Distributions

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Appendix – SpendingAs of December 31, 2019

The February 2019 approved spending rate reduction to 4.5% meaningfully reduced long-term impairment risk. Short-term spending risk remains elevated.

Spending Level

Short-term Spending

Risk

Long-term Impairment

Risk

5.0% 52% 42%

4.5% 49% 32%

4.0% 44% 23%

Spending and Impairment Risk

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$-

$2

$4

$6

$8

$10

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Additions Maturities

Standard Unitrusts

62% Endowment 7%

Gift Annuities

24%

Other 7%

As of December 31, 2019

Profile Portfolio Type

Deferred Gift Assets ReturnsAdditions and Matured Gifts ($ = Millions)

Appendix – Deferred Gift Assets Program

Description: UW planned giving and outside endowment portfolios managed by TIAA Kaspick & Co, a leading provider in gift administration and Life Income Trust asset management*.

Composition: 108 separately managed donor portfolios totaling $106.9 million. Six types of investment allocations balance growth and income.

Primary Objective: To meet the payout requirement of the gift instrument.

Secondary Objective: To maximize the expected real value of the residual trust to benefit the University with an appropriate level of risk given the primary objective.

Investment Objective: To achieve competitive risk-adjusted returns as measured against both multi-asset and traditional benchmarks.

* Excludes Outside Trusts and miscellaneous assets not managed by TIAA Kaspick.

1 Year 3 Year 10 Year 20 YearKaspick Growth UW 20.1% 9.1% 8.1% 7.3%Multi-asset Benchmark 20.7% 9.4% 8.5% 6.4%60/40 Benchmark 21.3% 10.5% 9.5% 5.7%1 Out of the 6 investment allocations offered by UW through TIAA Kaspick, the Growth Composite Portfolios are the most common representing 65% of the total UW donor assets managed and 71% of the 103 UW donor portfolios.2 60% S&P 500 and 40% Bloomberg Barclays Intermediate Government / Credit

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