NEW YORK (Fortune) -- When it comes to college investing, Harvard and Yale's endowments are powerhouses. Yale has posted a 12% annualized return over the last 10 years, and Harvard has returned 9% (versus 1.4% for an indexed stock-and-bond fund).
But with the numbers from last year recently released, there's been an upset -- the University of Pennsylvania came in at number one in the Ivy League for 2009.
It's all relative of course. Every Ivy endowment lost money. Penn just lost the least. Its $5.2 billion endowment was down just under 16% from June '08 to June '09.
Harvard, with the biggest endowment at $26 billion, was down the most, 27%. Yale, with a $16 billion endowment, was down 25%. (Columbia fared a little worse than Penn, losing around 16%, and Princeton, Dartmouth, Cornell, and Brown all lost about 25%, more or less.)
The Quakers actually have the oldest college endowment investing program in the country, founded in 1937. Legendary Vanguard investor John Neff was the chairman of the fund through the 1980s and imbued it with his deep-value investing philosophy that produced relatively low but steady returns.
Fortune spoke with Penn's chief investment officer Kristin Gilbertson about her investing methods. Gilbertson previously worked at Stanford's endowment and, before that, was a pension expert at the World Bank. She joined Penn in 2004 with a mandate to start investing more aggressively in alternative assets. Fortunately, she had other ideas.
Q. What's behind your relatively strong performance?
I'd say three factors led to our relative outperformance. The first is that in April 2008 we sold about 10% of our public equities and moved that money into funds that specialize in distressed debt. We were seeing some early signs of a credit crunch, and we wanted to be waiting on the sidelines ready to gear up. In retrospect it was fabulous decision.
The second thing is we had a historically high allocation to fixed-income, around 15%, and we stayed there even though our long-term goal was closer to 10%. Most of our cash was in T-bills. Fixed income was the only asset class last year to have positive returns.
The third and biggest contributor was moving our equity allocation to large-cap quality stocks. Our public equity managers outperformed the S&P on average by 12%. They were overweight tech, light on financials and energy and materials, and focused on companies with high return-on-equity.
Q. What made you want to cut back on equities and move into distressed debt?
It came out of the experience of our alumni and our board, [like] Howard Marks [chairman of Oaktree Capital Management], who has been chair of the investment board for many years and feels very comfortable with distressed debt.
We'd long had a lot of concerns about systemic risk, were worried about commercial paper, and had moved our cash to Treasuries. At the time, we thought we just were being prudent and cautious. We never thought things could fall apart like they did.
Q. Did you move out of a lot of hedge funds?
We're actually not underweight [in] hedge funds. We're about 25% allocated to hedge funds, similar to our peers. In our hedge fund portfolio, our top performers were the multi-strategy funds and credit-oriented funds. They were very disciplined in putting their money to work. They didn't get overexcited and start buying early in the cycle and blow their money. They were patient and have waited for the right moment to invest. And even those who did get overexcited protected our capital pretty well.
Q. What about private equity?
We are much lighter than our peers in private equity and real estate and other illiquid asset classes. They're only about 12% to 13% of our portfolio.
We were disciplined in avoiding 2005 and 2007 vintage private-equity funds that we thought were going to be poor performers and take years to return capital. There was tremendous pressure on us in 2004 as an institution to catch up with the peer group, as some funds back then were returning 20% or 30% a year.
But we wanted to invest over a full market cycle, not start at the top. We thought back in 2005 that valuations were stretched, there was too much money in the space, the terms on the partnerships were not limited-partner friendly. We focused on a smaller number of managers with a unique edge.
We have one real-estate manager who'd been in our portfolio for several years but had only invested 10% to 15% of our capital. One of our best private equity funds hasn't put a dollar to work in several years. They missed overpaying for assets. Those are great investments. The thing we did best was not race to catch up.
Q. What risks are you still worried about?
I think we have problems we haven't dealt with and still haven't priced in. Like commercial real estate. We don't know to what extent banks have priced in the decline in those assets' value.
Unemployment is near 10%. There are going to be more regional bank failures. The securitization market isn't functioning like it should, and so credit is really constrained.
We've just narrowly averted a crisis here in Philadelphia with the city's budget. That's more than just trash pickup to worry about; we're talking about jobs and employment and GDP growth that's at risk in many cities.
Q. Any reasons for optimism?
The situation is still serious, but we have averted Armageddon. The benefit of intervention has been that the government and FDIC have time to work through those issues and keep the financial system functioning while they work on things. But there's plenty of bad news yet to come. There's no cause for euphoria just yet. 
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