UTIMCO Overview

The Texas Constitution and various state statutes designate The University of Texas System Board of Regents (UT Board) as the fiduciary for the management of certain public endowment and operating funds dedicated to the support of higher education. The UT Board is the governing body of The University of Texas System (UT System), a state supported university system consisting of 15 academic and health-related institutions with an enrollment base of approximately 171,000 students. The UT System's general academic institutions enroll one-third of the students at Texas public universities and its health-related institutions enroll two-thirds of the students at Texas public health institutions. Members of the UT Board are officers of the State of Texas and are appointed by the Governor with the advice and consent of the State Senate.

Effective March 1, 1996, the UT Board entered into an Investment Management Services Agreement delegating investment management responsibility for all investments to UTIMCO. UTIMCO is a 501(c)(3) investment management corporation dedicated solely to the management of investment assets controlled by the UT Board. It is the first external investment corporation formed by a public university system. A board of directors consisting of three UT System regents, the Chancellor of the UT System, and five outside directors with experience in investment management governs UTIMCO. This structure is designed to preserve ultimate regental control of investments for fiduciary purposes and to increase the level of investment expertise in the governance of investments.

The UT Board delegates investment management responsibility to UTIMCO subject to compliance with UT Board approved investment policies. Day-to-day management of funds is further delegated to UTIMCO management, which provides a comprehensive range of investment management services. UTIMCO employees include investment professionals, accountants, information technology specialists, operations and administrative personnel, all of whom work together to provide total investment support.

UTIMCO invests the endowment and operating assets designated by the UT Board primarily through internal mutual funds with distinct time horizons and risk adjusted return characteristics.

UTIMCO allocates each endowment or operating fund's assets to internally and externally managed portfolios in accordance with approved asset allocation policies.

Investing for Real Returns

UTIMCO manages over 6,000 endowment funds established by the State of Texas, individuals, corporations, and foundations, some of which date back to 1876. UTIMCO attempts to supplement the original endowment corpus by increasing the purchasing power of endowments through time. In so doing, UTIMCO increases the endowment resources available to fund the teaching, research, and health care programs specified by the donor. UTIMCO attempts to achieve this objective by earning real economic returns on its investment of endowment assets.

A Focus on Value-Added Investing

In the difficult financial markets anticipated over the next several years, the ability to increase endowment assets at a rate sufficient to both maintain current distributions and maintain purchasing power of the endowment funds will very likely hinge on our ability to earn returns in excess of those generally available in the traditional financial markets. In order to earn above market returns, we have sharpened our focus on several asset categories categorized by complex, illiquid, and mispriced securities where proprietary information and sophisticated investment strategies offer the opportunity for value-added returns. These asset categories have an additional important advantage. Because these assets typically provide returns which have a low correlation with those of the more traditional exchange-traded equities and fixed income securities in the UTIMCO portfolios, they offer the additional advantage of reducing the overall risk level at the total fund level. We generally refer to these asset categories as high potential value-added assets:

Non-Marketable Alternative Investments
This category consists of investments in special equity, mezzanine, venture capital, oil and gas, real estate, distressed debt, and other investments that are privately held and which are not registered for sale on public exchanges. These investments are held through limited partnerships or as direct ownership interests and are often held for extended periods of time. This program was originated by the UT System in 1981 and has expanded considerably under UTIMCO's management. Over the past 10 year period, UTIMCO has invested more than $1,923.9 million in this asset category. The PUF and GEF have enjoyed annually compounded returns of 15.1% and 16.2%, respectively. (The GEF's return was combined with the LTF to obtain the 10 year history.) This result was considerably better than the 10.4% annual return posted by the "blue-chip" Standard and Poor's 500 Index. At year-end, non-marketable investments constituted 13.0% of PUF and GEF combined assets.

Marketable Alternative Investments
This category consists of investments in true hedge funds with low net exposure to market risk, arbitrage and special situation funds, distressed debt, market neutral, and other non-traditional investments whose underlying securities generally are traded on public exchanges. This asset category has been one of the top performing portions of UTIMCO funds in the recent past. We plan to continue to seek the top managers in this area and rely on their skills to gain superior returns. At year-end, alternative marketable investments comprised 12.5% of the PUF and GEF combined assets.

Specialized Public Markets Investments
Although much of the publicly traded fixed income and equity markets are efficiently priced and therefore offer minimal opportunities for value-added approaches, certain segments such as small capitalization equities and sophisticated fixed income strategies do offer value-added opportunities for highly skilled managers. The UTIMCO staff screens a large number of possible external managers in these publicly traded asset categories to find a small number of creative, highly skilled managers capable of adding value in this very competitive arena. These specialized investment opportunities comprised 22.7% of the combined PUF and GEF assets at year end.

Risk Control
Superior returns are earned by the intelligent assumption of risk. Investment risk is multidimensional and very difficult to quantify with any great precision. However, sophisticated risk management tools are now available which allow UTIMCO to pursue value-added investment strategies with the confidence that we are achieving the best returns available for each increment of risk assumed. These tools also help us more precisely define the limits of risk we should assume in the endowment and operating fund portfolios. At UTIMCO, the measurement and anticipation of risk is central to portfolio construction and monitoring. We manage the assumption of risk through a process very similar to budgeting capital in a business or a family. UTIMCO uses current industry-standard risk management techniques including Value at Risk, or VAR. VAR measures a portfolio's predicted maximum loss over a specified future time period. Keeping a close watch on changes in VAR with changes in portfolio holdings allows us to seek value-added returns while avoiding unpleasant investment surprises.

Use of Economies of Scale
UTIMCO incurs expenses associated with strategy and analysis, portfolio management, custody and safekeeping, accounting, and other investment related functions. Fund expenses are paid from fund assets. UTIMCO's management of $13.3 billion of assets provides for exceptional economies of scale in the management of the investment assets. To provide for even greater efficiencies and cost savings, the investments of the Permanent Health Fund and the Long Term Fund were contributed to the General Endowment Fund in exchange for General Endowment Fund ownership in March of 2001. Fiscal year expenses for all funds were 0.19% of average asset value.

Emphasis on Client Satisfaction
UTIMCO continues to pursue and enhance its Internet-based reporting system using proven technology that reaches its broad base of higher education clients and the public at large.

Among the major reporting services provided by UTIMCO are:

• Secured Internet access for quarterly and annual investment reports utilizing interactive solutions tailored to the individual users' preferences
• Daily online investment information regarding over 6,000 endowment, charitable trust, and other accounts under management
• Annual and quarterly information available to the public via UTIMCO's website: www.utimco.org