Aug. 13 (Bloomberg) -- The University of Pennsylvania, the Ivy League school founded by Benjamin Franklin, beat Harvard University’s endowment by choosing the right stock pickers, investing in credit strategies and boosting its Treasury bonds.

The Philadelphia university’s stocks outperformed market indexes, said Kristin Gilbertson, chief investment officer of the fund. Penn’s endowment fell 16 percent in the year ended June 30 to $5.2 billion, better than Harvard’s estimated 30 percent decline and the 26 percent loss for the Standard & Poor’s 500 Index, including dividends.

“Our portfolio is not typical of a large endowment,” Gilbertson said in an interview. “The endowment model is not having a lot of private equity, real estate, natural resources. I think the endowment model is about being creative.”

Penn, where endowment returns have funded 9 percent of the budget, has limited layoffs and spending cuts and will enter the school year with a balanced budget, President Amy Gutmann said this week. Investment losses at Harvard and Yale University, whose endowment declined an estimated 25 percent, have forced those universities to reduce budgets and fire workers. In the past year, endowment earnings covered more than a third of spending at Harvard and Yale, the wealthiest U.S. schools.

Yale’s David Swensen, the top-ranked college endowment manager in the 10 years ending June 30, 2008, boosted returns by trimming stock and bond holdings and buying more real estate, private equity, hedge funds and resources such as timber, a strategy copied by schools across the country. His rationale is that the best alternative-asset managers can produce better returns than the top traditional equity and fixed-income firms.

Access to Cash

Swensen said in May that his approach to diversification can’t prevent losses during market declines, and the crisis that slashed the Standard & Poor’s 500 Index by 54 percent from the start of 2008 to the nadir on March 9 underscored the importance of maintaining access to cash.

Penn, which has 13 percent of its fund invested with private-equity, real-estate and natural-resource managers, had the cash to meet their capital calls, Gilbertson said. Harvard in Cambridge, Massachusetts, and Yale in New Haven, Connecticut, began the past fiscal year with more than half of their funds in alternative assets.

Private equity has been one of the best-performing asset classes at both schools, helping Harvard and Yale deliver average annual returns of 14 percent and 16 percent, respectively, in the decade through June 2008. The fund overseen by Penn’s investment office, which makes up 92 percent of the endowment, returned 7.1 percent per year on average in that period, according to the school’s annual report.

Extra Credit

Penn’s fund measures its public equities against a performance benchmark that combines U.S. equities with developed-country and emerging-market indexes. Beating that gauge contributed as much as 6 percent to the endowment’s out- performance, Gilbertson said. The decision to shift 10 percent of the portfolio from stocks to credit funds early in the year added about 2 percent.

About 25 percent of the endowment is dedicated to absolute- return strategies, including credit funds investing in distressed debt, she said. Putting 15 percent of the endowment into Treasury bonds, exceeding the endowment’s long-term target of 10 percent, added 1 to 2 percent, Gilbertson said. She wouldn’t identify which outside managers the school uses.

‘Quality Tilt’

“If our public-equity portfolio had not outperformed by such a wide margin -- due to our quality tilt, underweight to financials and some fortunately timed currency hedges -- the endowment would have been down another 5 or 6 percent,” said Gilbertson, who spent a decade at the World Bank in Washington, where she helped manage $10 billion in pension assets, before joining the endowment at Stanford University in 2002.

About 44 percent of Penn’s endowment is allocated to stocks, while 2 percent is in high-yield bonds and bank loans.

U.S. endowments fell by an average of 24 percent in the last six months of 2008, according to Commonfund Institute in Wilton, Connecticut. The loss for the fiscal year ended June 30 probably will be the biggest since 1974, said the researcher, which is affiliated with Commonfund, a manager of about $24 billion for nonprofit institutions

When Gilbertson took the Penn job in 2004, she faced the task of expanding the portfolio’s holdings of private equity, real estate and natural resources from 7 percent of the fund to the school’s target 25 percent. Deterred by the sizes of funds being raised and their fees, Gilbertson didn’t plow the endowment into those raised at the peak of the 2006-2007 buyout market. She parked the money in Treasuries.

Losses Expected

“People will have losses in 2005-, 2006-, 2007-vintage funds,” said Gilbertson, who attended Harvard as an undergraduate and has a master’s in business administration from Stanford. “If we had raced to catch up, we could’ve blown this thing up.”

Buyout firms gorged on a record $1.4 trillion of takeovers in 2006 and 2007, relying on easy access to debt before the recession began. Firms struggled in the past two years after the credit crisis shut off the debt financing they depend on for takeovers. They marked down the value of the companies they own to match a global decline in prices for most types of assets.

Endowments and pension funds typically agree upfront to invest a set amount with asset managers over a period of years, though not all commitments are ultimately tapped. Penn has enough liquidity to make good on its unfunded commitments of less than $1 billion, or about 18 percent of the endowment’s asset value, Gilbertson said.

Dry Powder

College funds with more than $1 billion in assets face pledges totaling 20 percent to 40 percent of the endowments, according to estimates from John Nelson, an analyst at Moody’s Investors Service in New York.

Gilbertson said she expects more bankruptcies and losses in private equity and real estate, with “a lot of issues in the small, regional banks.” She’s interested in buying “quality” stocks, real estate and private equity funds focusing on turnarounds and distressed assets, which will diversify the portfolio over time, she said.

“We’re not blowing all our dry powder right now,” Gilbertson said. “It’s a lucky accident we didn’t have private equity and real estate. Over time, the next two years, we will have a more diversified portfolio.”

To contact the reporter on this story: Gillian Wee in New York at gwee3@bloomberg.net;

Last Updated: August 13, 2009 00:00 EDT