Letter from the President

The UTIMCO 2003 fiscal year was one of the most unusual and challenging years of my investment career. It was a year of remarkable contrasts as well. The first half of the year, through March 11, 2003, was a period of self-doubt in the United States. Many doubted our ability to achieve acceptable growth in the economy despite historically low interest rates. The doubts were manifested in risk aversion in business decision making, which led to job losses and further self-doubt. Compounding the economic malaise were the lingering gloom of the September 11th terrorist attacks and the imminent conflict in Iraq. Our national psyche seemed to reach the low point during the first weekend of the liberation of Iraq as the troop advances slowed and the ever negative press started to use that famous Viet Nam term "quagmire" in many reports from the front. Glued to our television sets over that weekend watching Fox News Channel, who could have imagined the transformation in psyche that was literally only several days away? As the Saddam statue toppled in Bagdad, spirits soared and the stage was set for the remarkable recovery in the economy, in financial markets, and most importantly, in our confidence in ourselves. I am very pleased to report that The University of Texas System endowment portfolios were well positioned to take full advantage of the turnaround and enjoyed very favorable returns in the 2003 fiscal year.

The Permanent University Fund and General Endowment Fund achieved returns of 12.02% and 12.81% respectively in fiscal 2003, a welcome relief from the negative returns of the prior two years. With better capital market conditions providing positive momentum, the favorable results for the fiscal year were due to a rich mix of assets in the endowment portfolios and significant value-added in several asset categories. All asset categories enjoyed positive returns last year, with benchmark returns ranging from 13.58% in inflation hedge assets including real estate and commodities, to a low of 3.69% in fixed income assets. The UTIMCO staff and our external investment managers were able to expand these favorable returns even more by making successful value-added decisions in most asset categories. For example, the actual return in our absolute return hedge fund portfolio was 21.28% in the Permanent University Fund, significantly better than the 5.49% benchmark return for that asset category. In aggregate, marketable assets in the Permanent University Fund and the General Endowment Fund advanced by 15.12% and 15.51% respectively, well ahead of the 11.56% benchmark return for all marketable assets. While our non-marketable private capital assets suffered another loss in the fiscal year as the after shocks of the collapse of the internet/technology bubble continued to reverberate in the venture capital and private equity markets, our private capital team was able to add value by carefully selecting new partnerships and by helping existing investments get back on track. All in all, value-added efforts added more than $500 million to the value of the endowment funds beyond what would have been earned by simply matching benchmark returns.

The $500 million value-added is satisfying not only because it will help boost future distributions from the endowments, but also because it is the first dividend from the new organizational structure put in place over the past year at UTIMCO. As I indicated in my letter to you last year, we have changed the management structure at UTIMCO to intensify our focus on high potential value-added asset categories. High potential value-added investments offer the opportunity for superior returns and include actively managed domestic and international public equities, private capital, hedge funds, real estate and other inflation hedge assets. We now have skilled and experienced investment professionals managing more narrowly focused asset categories, overseeing both internal and external investment managers. We were fortunate to make two significant additions to our professional staff during the year. Larry Goldsmith, Managing Director, Public Markets Investments, joined UTIMCO from a senior position at The Common Fund, and Andrea Reed, Risk Manager, joined us from the Rice University endowment management team. Larry and Andrea are certainly welcome additions to our senior management team and played an important role in our value-added success last year despite their short tenure at UTIMCO. With our senior team now almost complete, I feel confident that our value-added focus will continue to provide benefits to the UT System endowment funds.

It is important to remember that although last year was a very good year for the endowment funds, and we are guardedly optimistic that this year will be favorable as well, economic and capital market environments are likely to remain extremely challenging over the intermediate term. The longer run expected return for the endowment portfolios is now between 8.0% and 8.5% per year, barely above the return necessary to maintain payout rates at current levels and allow the endowment funds to grow at the rate of inflation in order to maintain purchasing power for future generations. In fact, we expect value-added to be the difference in the future between meeting purchasing power return targets and falling short. With a skilled and experienced staff in place organized to focus on value-added investments, and with the support and guidance of the dedicated UTIMCO Board of Directors, I am confident that UTIMCO is well positioned to face the challenges of the future and meet the needs of its many constituents.

Bob L. Boldt, CFA
President, Chief Executive Officer,
and Chief Investment Officer