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Investment Return and Market Commentary
The University of Texas Health Science Center at Houston

The PUF posted a net investment loss of 3.3% for the year ended August 31, 2008. The natural resources (+23.9%), investment grade fixed income (+5.0%), private investments (+2.3%), and hedge funds (+1.5%) asset classes posted positive returns, while real estate (-17.9%), developed country equity (-15.0%), and emerging markets equity (-9.7%) asset classes were negative performers for the period.

As of August 31, 2008, the PUF's assets were approximately 28% invested in global public equities, with about two-thirds of this exposure in U.S. domiciled and non-U.S. developed country domiciled companies and one-third in emerging market country domiciled companies. During the fiscal year, the developed country equity markets were down approximately 13.3%, and emerging country markets declined 10.1%. The PUF benefited from an underweight position in developed country equities relative to its policy portfolio benchmark. However, the value-add from active managers in the developed country equity and emerging markets equity asset classes was disappointing. These are areas UTIMCO staff will continue to focus on in the coming year.

Approximately 32% of the PUF's assets are invested in hedge funds which produced investment returns of 1.5%, with relatively low volatility and low correlation with the underlying asset classes in which they are investing. The hedge fund portfolio performance was especially strong given that the average hedge fund across the industry lost approximately 5.9% during this period.

Fixed income investments - including investment grade and credit-related nominal and real bonds across the maturity spectrum - are targeted at 10% of the PUF's assets. Excluding cash allocations, the PUF was overweight in these assets, which proved to be beneficial for the period ending August 31, 2008, as these assets fared better than most others during the period. Altogether, excluding cash allocations, fixed income returns were slightly higher than their policy portfolio benchmark.

Private investments including venture capital, buyouts, distressed or credit-related, opportunistic, natural resources and real estate strategies totaled approximately 19% of the PUF's investments. This was higher than the 13.5% policy portfolio target mainly due to increases in investments in the distressed or credit-related category, which primarily took the form of senior loans to large companies which were underwritten to extraordinarily high returns due to 'forced selling' on the part of large investment banks. Private investments returned 2.3% for the year, which trailed the average returns for private investment funds by 6.9% due to the PUF's private investment portfolio being newer, or less "seasoned", than the average private market portfolio.

The University of Texas of the Permian Basin

Finally, the PUF had approximately 6% of its assets invested in real estate, primarily REITS, and approximately 5% invested in natural resource focused investments. Declining real estate markets produced losses of 22.1%, while natural resources produced positive returns of 20.1% for the period.

Despite the unsettling events caused by the early subprime signals and increased market volatility during the summer of 2007, the final four months of 2007 ended relatively strong as our Policy Portfolio showed a 3.3% return for this period.

The first half of 2008 could best be characterized as filled with continued increased volatility as the markets reacted to new signs of excessive leverage and inadequate underwriting. In June 2008, however, as the full significance of the challenges of deleveraging, poor credit decisions and a slowing economy became clearer, the capital markets went into a steep fall. Liquidity vanished, credit markets seized and equity investors scrambled in attempts to preserve capital by placing it in 'risk free' investments. Losses of 10% and more were posted in markets across the globe during the summer of 2008.

The year will certainly be remembered as a watershed in capital markets. From two Bear Stearns sponsored subprime mortgage hedge fund meltdowns to the $700 billion U.S. rescue plan - and the multiple financial institution failures and trillions of dollars of government support in between - the world's financial system experienced periods of failure. There is no choice but to fundamentally reconstruct it over the years to come.

The outlook for fiscal year 2009 is sobering. Confidence in financial institutions and capital markets has yet to be fully restored. The world's developed economies are in recession and the emerging market growth is slowing. While shorter term inflationary concerns have eased with the slowdown in economic growth, longer term inflationary concerns have increased due to the injection of funds into the capital markets by governments across the globe. Because of the time it will take to work through existing credit problems and the structural issues surrounding reconstituting financial institutions and capital markets, it is difficult to envision a strong and vibrant economic environment for the upcoming year.

However, in periods like these it is good to have capital to invest. Because of the illiquidity in the system, those that can provide capital are in a position to receive very attractive risk-adjusted rewards. The PUF is strongly positioned to be just such a capital provider due to its size, diversification and liquidity.

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Figure E reports the PUF's investment results by asset class compared to each individual benchmark for the year ended August 31, 2008.