Harvard Management Company Update May 2011

Dear Alumni and Friends, Over the past year I have had the occasion to speak with and hear from hundreds of Harvard alumni in a variety of venues and locations. These conversations typically touch on several themes such as portfolio strategy, organizational structure and investment trends. One theme that has come into greater focus, particularly as markets have improved, is the importance of attracting and retaining the best investment talent and the compensation system that allows us to accomplish this. Our ability to hire top talent is critical to HMCs success. In light of the inquiries I receive on this topic, we developed this communication, structured in a question/answer format, to share with you. Appended you will also find a summary of the compensation information filed with the IRS in May 2011. It should also be noted that our connection to Harvard University provides unique access to a network of top talent, including immensely motivated young professionals and experienced investors with Harvard affiliations. Currently, there are 17 full-time employees at HMC who graduated from Harvard, two of whom have Harvard PhDs and three others who have multiple Harvard degrees.

Q. How are HMC investment professionals compensated?

The compensation of our internally-staffed investment teams is driven by a pay-for-performance system, which includes two primary elements: Performance Relative to Benchmarks: Over 90% of the compensation paid to our individual portfolio managers is variable, based on investment performance. Every investment management professional at HMC operates within the context of a market, and each managers return must exceed the return on that market to earn any variable compensation. This means, for example, that when emerging markets equities are up 35% in a given year and the manager in charge of emerging markets returns 35% on his/her portfolio, no variable compensation is earned. Only value-added growth over and above what the market delivers is included in our variable compensation calculations. This system ensures that incentives are earned only when the endowment receives added-value from our active management. Clawbacks: At HMC, only a portion of the performance-based incentive is paid at the end of the year in which it is earned. The remainder is kept in the endowment for potential payout, subject to clawback in subsequent years should the manager not continue to out-perform the applicable market benchmark. This system encourages a longer-term view and discourages undue risk-taking.

Q: What attracts high managers to HMC?

quality

investment

Without question, competition for the best investment talent is fierce, even post financial crisis. Despite this, we have succeeded in gathering a group of exceptional colleagues and Board members. We are fortunate that we consistently attract highly experienced and ethical investment professionals who share our passion for improving and growing the financial resources of one of the worlds greatest educational and research institutions. We compensate our investment professionals in line with market standards and individual achievement. Our performance-based compensation system is widely respected for its fairness and transparency. Our investment professionals make their money by making money for Harvard that is, by beating their market benchmarks over a sustained period of time, and by being better investors than the others in their field. To ensure effectiveness, our compensation system is reviewed annually by outside independent experts as well as by our Boards compensation committee.

Q: How has the compensation system at HMC changed in recent years?

The basic principals driving our compensation system paying for market-beating performance, paying out incentive compensation over time, and making a portion of the incentive compensation subject to clawback have not changed. We have made targeted enhancements under my leadership over the last two years. Specifically: We have lengthened the number of years before total payout of incentive compensation is achieved. HMCs entire senior management team now has a meaningful stake in the performance of the overall endowment portfolio. (In prior years, only the CEOs compensation was directly tied to the relative performance of the entire fund.) We have also taken steps to reduce amounts paid to our senior management in any year when the endowment has a negative nominal return.

Q: Have managers left compensation pressures?

HMC

due

to

HMC has had several spin-offs over the last decade or so. These now independent firms are largely very successful and we are proud that our hybrid model has allowed them to contribute to the growth of our portfolio both as internal and external managers. Their rationales for leaving HMC and starting their own businesses are known only to them but probably vary widely. The opportunity to make more money may have been a factor in some cases. However, we are aware that all investment organizations are continuously changing, and know that we will have some natural turnover in the course of doing our business.

Q: How successful have you been in retaining talented managers in the company?
We have been fortunate in the last few years to retain and grow exceptional talent at HMC, while opportunistically adding new talent across our investment platform. At the same time, we have continued to improve the systems, operations and culture supporting our investment professionals. HMC is a unique organization, where excellence, collaboration, and professional growth are not only encouraged but required to meet the demands of a constantly evolving investment landscape. This provides an exceptional work environment where we can remain focused on one common purpose generating strong results to support the educational and research goals of Harvard University. Over the last couple of years it has been a priority of mine to communicate more fully the workings and philosophy behind HMCs approach to endowment management with Harvards alumni and friends. Please feel free to let us know if you have suggestions along these lines. As always, thank you for your continuing interest in and support of Harvard University and HMC. Sincerely,

Q: Why hire an internal team, rather than outside managers?

HMC employs a hybrid model utilizing both internal portfolio managers and external investment management. Our internal team has the advantage of allowing us total transparency as to strategy and positions, a greater degree of nimbleness in entering and exiting the market, and lower overall costs of management. That having been said, we will not add internal managers unless we find people with excellent qualifications, track record and experience, who are committed to helping us achieve our long-term mission. In addition, we will continue to evaluate our choice and mix of managers, both internal and external, to ensure we have the right competencies to deliver outstanding performance. Because we use internal management for a substantial portion of our overall portfolio, the hybrid model is extremely cost effective for Harvard University. The cost of managing Harvards money through HMC, including all staff compensation, incentive payments, and overhead is about 0.3% of the total assets under management. This compares with an estimated cost of 4.0% (base and performance fees) for a typical hedge fund and 1.0% for more traditional long-only management. By either comparison, HMCs cost is a fraction of the expense of equivalent external management. These differences are significant and have saved Harvard over one billion dollars in management fees over the past decade.

Jane L. Mendillo President & Chief Executive Officer

Calendar 2009 Total Compensation

Position President & Chief Executive Officer Portfolio Manager Internal Platform Portfolio Manager Emerging Markets Equities Portfolio Manager Fixed Income Portfolio Manager Fixed Income Portfolio Manager Fixed Income Compensation * $3,498,269

$8,443,253

$6,848,872

$4,467,157

$2,904,927

$2,725,215

* As dictated by our compensation strategy, each of the individual portfolio managers listed above received a quantitatively-derived incentive based upon their performance relative to a benchmark during the prior fiscal year or years. Only growth over and above what the market delivers is included in our incentive compensation calculations. In several cases, the payments reflect an accumulation of several years positive relative performance (reflecting the portfolio managers consistent and long-term out-performance versus their market benchmark).