Last month, Penn’s Chief Investment Officer Kristin Gilbertson was named Institutional Investor magazine’s Large Endowment Manager of the Year for what the magazine called her “innovative strategies and fiduciary savvy.” It’s an honor that shines the spotlight on Penn and Gilbertson during what many financial experts consider one of the worst eras for university investments since the Great Depression.
Bad news came out of almost every Ivy League institution late last year, with headlines announcing that endowments had plummeted by 17 percent, 24 percent and even 27 percent. Except at Penn, where under Gilbertson’s leadership, the $6 billion endowment declined only 15.7 percent, making Penn the top performer among the Ivies.
For many years, Penn’s endowment was considered a low achiever, particularly when compared to the frothy returns seen by the endowments of its Ivy peers during the go-go days of the market. Gilbertson, who in 2004 become the second chief investment officer in Penn’s history, knew she had to diversify the University’s portfolio. But she, along with the Trustee-comprised Investment Board, made the key decision that Penn was not going to race into alternatives to catch up with the sky-high returns being experienced by other institutions. And it was that critical move, plus a bold directive to “batten down the hatches” at the first signs of the economic downturn, that helped Penn traverse the choppy financial waters of the past few years.
Gilbertson, who earned her undergraduate degree from Harvard and holds an MBA from Stanford, worked as an urban economist for the Europe and Central Asia region of the World Bank for six years before joining the Bank’s Investment Management Department in 1998. In 2002, she became managing director of public equities at Stanford Management Company, which handles the endowment for Stanford University.
The Penn Current sat down with Gilbertson to talk about the history of the University’s endowment investment strategy and her vision of its future.
Q. Can you tell me a bit about the history of Penn’s endowment?
A. In the early ’70s, the endowment was invested by the Franklin Investment Company, a wholly-owned subsidiary of the Trustees, which worked closely with the Investment Board as well as a local broker. Pretty much every institution, with a handful of exceptions, managed their money in this way. Industry consultants joke that in the old days, most university endowments were a list of securities in the treasurer’s desk. Also, in those days, the endowment was managed for yield [income and dividends] to meet the payout requirements of the endowment. And, I am told Penn had a very high payout requirement during the challenging period of the 1970s.
Q. What prompted the Trustees to change their way of doing things?
A. As you may recall, the ’70s were a volatile time for the markets because of the oil crisis, and stocks dropped dramatically. Penn was running a very concentrated portfolio with no portfolio manager, with no one really responsible, and the returns were very poor.
Paul Miller, a young Trustee and founder of bond manager Miller Anderson & Sherrerd, thought this is no way to manage the endowment. He offered to run the fixed income portion of the portfolio pari passu with his own portfolio at Miller Anderson & Sherrerd and convinced his friend John Neff to run the equity portion of the portfolio pari passu with the now famous Wellington Windsor Fund. So, the Trustees shifted from the Franklin Investment Company organization to having an outstanding fixed income shop and an outstanding equity shop running our money for free—from a committee-oriented structure to world-class management.
Q. So, by the 1990s, was Penn investing more like other institutions?
A. Well, what was going on at other institutions was very different. Starting in the ’80s and early ’90s, other institutions were hiring their first chief investment officers and were building out their investment teams. They were getting into alternatives [hedge funds, private equity, venture capital and real estate] at the inception of those asset classes. Those were really fruitful areas for investment, particularly in the ’90s when many of our peers [Harvard, Yale, Princeton, Stanford, MIT] were exploring this very diversified, somewhat more esoteric asset allocation strategy and doing very well.
Meanwhile, Penn was still very equity oriented and still very deep-value oriented. Penn’s performance had been stellar during the ’80s—the decade of the value stock. But during the ’90s—the decade of the growth stock—our relative performance was less strong because of our concentration in value stocks.
This all began to change when John Neff announced his intention to retire from Wellington. Penn needed to replace him in his role as U.S. equity portfolio manager. By this time, the money management world had evolved and nobody was going to take on that assignment, much less do it for free.
So, it was in 1998, under President Rodin, that Penn hired its first chief investment officer, Landis Zimmerman. His charge was to build up an office and to start to diversify the portfolio.
Q. You came to Penn as only the second investment officer in the University’s history?
A. Yes. The endowment was still very much in its early stages of its development. Relative to the strong brand of the institution, Penn didn’t have the endowment it deserved. We were one of the last large institutions to set up a separate investment office, and there was more to do in terms of building the organization, and building the portfolio.
Q. When you arrived in 2004 what did the portfolio look like?
A. When I arrived, we already had six years of history of the Investment Board working with the investment office, and we had established the role of the Office of Investments vis-a-vis the Investment Board. Landis did a fantastic job of diversifying the portfolio. I inherited a solid hedge fund portfolio, which was about 18 percent of our assets, comparable to other large endowments. What I didn’t inherit was a large portfolio of private equity, real estate and natural resources, and that is where we were very different from some of our peer institutions.
At the time, private equity, real estate and natural resources were really on fire. We were just emerging from the 2000 to 2002 recession. Returns for private equity and real estate were spectacular and beat public equities hands down because of the implicit leverage. Penn was at a little bit of a disadvantage not having a mature real estate and private equity portfolio. So, when I came in, the important decision that we made was not to race to catch up.
Q. Why not?
A. We made a commitment to being more diversified. But, we decided we would do it on our own time frame and get invested in those asset classes over a full market cycle.
Q. But wasn’t there a sense of pressure to catch up?
A. Penn’s Investment Board is very pragmatic. They understood where we were and that we had a different history. They are all fantastic investors, and they are all very experienced investors, and I think that they understood that it would accomplish nothing to race to catch up at a time when it was already starting to look as if valuations were stretched.
Q. I find that interesting because from what I’ve read, there seems to have been quite a fervor at that time because of Yale’s strategy [developed by David F. Swensen, promoting an aggressive use of alternative investments].
A. Yes, everyone wanted to look like Yale. But, the one sure thing was that while you might know what Yale was doing in the past, you didn’t know what Yale was doing at the moment. So, Yale did what was right for Yale at the time. But, if we were going to try and second-guess what they’d done five years ago, we weren’t going to lead. And, to lead, we had to do what was right for us. Our Investment Board works very well as a group, and that is very much their philosophy.
Q. So, your charge was to take this philosophy and move it forward?
A. The work program when I came in was, first and foremost, to rebuild the office because there had been some departures. I’ve hired four managing directors who have great asset class experience and have really added depth to the portfolio. It has been a wonderful opportunity, and it’s a huge investment by Penn to bring us all here and to dedicate the resources that is has to managing the portfolio.
The second priority was to come up with a plan to diversify the portfolio. We had a measured plan. We were putting money to work every year, but we didn’t get ahead of ourselves. We were concerned about valuations; we were concerned that private equity and real estate funds were getting too big. But, we didn’t know when things were going to break and when we’d get our opportunity. So, we knew we needed to be investing, but with people we knew were disciplined and who would wait and use our funds judiciously, rather than throwing money out and committing to deals that made no sense.
It’s interesting, if you look at our real estate portfolio, of all that we committed in the five years leading up to the crisis, only 40 percent was called, which means the majority of the money was still waiting in our pocket, available to commit to new deals at reduced prices.
People have focused a lot on how our asset allocation is different and how our history is different, but the largest single determinant of our relative success last year was our quality tilt in the public equity portfolio. That added 5 percent to returns, protecting 5 percent of value. Our international public equity portfolio outperformed by 20 percent in fiscal year ’09. That is astounding, really a once-in-a-lifetime achievement, and it did that because we had picked good managers and we focused on large-cap quality stocks. Our U.S. equity portfolio outperformed by 7 percent, which is also astounding.
Q. Did anything else help prevent disaster?
A. There were three things that definitely helped us last year. There was the quality tilt. We reduced our equity exposure by 10 points to fund new investments in credit and distressed debt going into the crisis. And then there was the fact that we were relatively overweight Treasuries versus our peers. We had so much in public equities at the outset that we had to use Treasuries for diversification. We knew we would gradually be diversifying into private equity and real estate and that we would spend our Treasuries down over time, but not now.
Q. So, that was just a happy coincidence?
A. No, it was a conscious decision. We literally revaluated it six months before the crisis and decided to stay put. We set forth a strategic asset allocation five years ago and, although we have stuck to that, we reviewed it periodically. So, it wasn’t an accident. These were all conscious decisions.
Q. Do you feel vindicated by Penn’s investment philosophy?
A. I feel grateful that I’ve had the confidence of [Penn President] Amy Gutmann, [Executive Vice President] Craig Carnaroli and the Investment Board in me, and in my team, over the past couple of years. They really trusted us, and I’m grateful that we have earned that trust.
Q. How does it feel for Penn to suddenly be at the head-of-the-class? Right now you are the golden girl in endowment investment.
A. Hardly. One year’s performance—and, certainly, it was not a positive year—does not a legacy make. What I am most gratified by is that, in 2004, when we came in, we could have made a disastrous series of investment decisions, we could have overcommitted the University to illiquid alternatives at the worst possible moment and, thank God, we didn’t.
Q. What strategy do you see Penn pursuing in the future?
A. What I am most excited about is that we don’t have any liquidity issues. That gives us a great deal of flexibility to invest going forward, to pursue opportunities where we see them—85 percent of my portfolio marks to market every night. That means we can pretty much change the entire asset allocation overnight, if that’s what we choose to do. We have tremendous flexibility.
Q. Is the Swensen model dead?
A. Oh no, I don’t think so. You look at the endowment model, at Yale, in particular, and at Stanford, Harvard and Princeton, and all have done incredibly well over the long term. To me, the endowment model is being absolutely return-oriented, being creative, being a pioneer and going into new asset classes, being contrarian and going into asset classes that no one else is interested in at that particular moment; and it’s all about due diligence and doing good work. If anything, what we have just lived through simply heightens the need for intelligent investing.
Q. I assume that your discussions with the Investment Board about strategy are pretty lively. There must be people who have a different philosophy of investment than you.
A. It’s a very lively discussion and there certainly is healthy debate. Some people like hedge funds above all other asset classes, some people hate liquid alternatives and some people love them. So yes, there is a diversity of views on the board. But at the end of the day, we all have a common vision. The members of the board are all big thinkers, and they have a wonderful top-down view of the industry. ... They are at the vanguard of the investment profession and they give us wonderful advice. They see where new opportunities are emerging. They are advising us when problems are coming up. It gives us a great deal of freedom that you don’t necessarily have if you are running a corporate pension fund or a big mutual fund. Our board is incredibly sophisticated.
Q. We’ve been talking about how things look good, but the reality is that the last two years have been pretty awful, haven’t they?
A. It was actually the year before the last two years that was the most stressful for us here in the office. Fiscal year 2008, the year before Lehman failed, was the most challenging. That was when we realized there was tremendous risk with some of the things that were going on in the fixed income market, and it was an enormous race over the summer to move almost $2 billion in various cash and fixed income accounts into Treasuries and Treasury bills.
We had to bulletproof the endowment because we thought there could be problems and we worked ‘round the clock from June through December of 2007 to batten down the hatches. We did a lot of things that protected the endowment and other University portfolios.
Q. I suspect this is not a professional arena in which you can be collegial with your counterparts at other universities.
A. At the time, I told Craig Carnaroli that as far as I was concerned, if you thought there might be a fire in the theater—as long as you didn’t see flames and you didn’t smell smoke—it was perfectly acceptable to get up and move near the emergency exit without telling anybody else. It would be different if there were actually flames, but there were no flames at that point and there wasn’t even smoke.
Q. Where does the University’s endowment stand now?
A. If the markets don’t crater between now and June 30, we should have recovered our losses from last year. But that’s a big ‘if’ because who knows what’s going to happen in the next few months?
Certainly, markets are more stable. The economy is more stable. The risk of Armageddon has passed, but clearly there is a lot to be done in terms of structural reform. There is going to be some sort of structural adjustment necessary, but I think we have averted catastrophe.
Q. After graduating from Harvard undergrad and getting your MBA at Stanford, you got your first job at the World Bank. What did you do there?
A. I joined the World Bank as part of the Young Professionals program; it’s their management-training program. I was very fortunate as an American to get in. When I applied, I had the then-desired combination of speaking Russian and having had private sector work experience. And so, it was as if I had won the lottery. I’d been dreaming of working at the World Bank since I was 16 years old. I spent my first six years there working on Eastern Europe during the transition [from Soviet rule]—in Latvia, Estonia, Lithuania, Moldova, Slovenia and a number of other countries.
Q. What was your assignment in that emerging region?
A. I worked on municipal finance, infrastructure finance, pension reform and housing finance. All these countries were getting their independence, and they were restructuring their governments. They were facing issues they’d never faced before. For example, deciding who was going to provide urban transport; and how do you pay for it? People at that time were waiting an hour just to get a bus to and from work, in the freezing cold. And, in Moldova, people were waiting in the freezing cold in the dark because they didn’t have street lighting. Those were really tough years for these countries.
Q. Did you live in those countries?
A. I would go for three or four weeks at a time, several times a year, and we would work with the governments to decide what the priorities were. We worked with the central government, regional governments, the mayors of local governments and local utilities, really government at all levels, as they were working through this restructuring process. It was fascinating. It is similar to what is going on now here in the United States with some of the stimulus programs, trying to pump money into the economy to finance hard infrastructure projects.
Q. How did you make the transition into the investing side of finance during your time at the World Bank?
A. After six years of working with Eastern Europe, I moved to the Investment Management Department of the World Bank. The World Bank is like a central bank in that it has large reserves. Those reserves have to be invested, and a good part of that is invested in fixed income, but the pension plan was managed very much like an endowment or a foundation. It had a long-term time horizon, it was very absolute-return oriented, and it was very well diversified. The World Bank had already moved into alternative investment strategies, like the endowments and the foundations. I moved into that group and it ended up becoming a new career for me.
Q. Do you miss the public sector?
A. In my mind I am still very much in the public sector by being here at Penn. Every dollar that I make is a dollar that is going to do good, it’s a dollar that goes back into quality education.
This is a job that is intellectually stimulating. You have a bottom line, you have accountability, but you are participating in the world of ideas and you make money by understanding what is going on in the world, what is going on with a company, what is going on in a sector and analyzing things. And, it’s much more stimulating to be able to do that ultimately for a good cause.
Q. Did you know Philadelphia at all when you moved?
A. No. I grew up in Tulsa, Oklahoma. I moved East to go to college, my first job before business school was in Boston, then there was the World Bank and then Stanford. It was the Penn brand and the opportunity that really drew me here, to a city where I essentially knew no one. But, it has surprised on the upside.
Q. What do you do outside of the University? Any hobbies?
A. I do a bike trip pretty much every summer. In the past couple years I’ve been to Denmark, the Basque country, Banff in Canada. Last year, it was the Italian Lakes. It is really two vacations in one, because it forces you to get out and train beforehand.