We started off in Widener Memorial Library, and then went on to Memorial Hall and Annenberg Hall without finding what we wanted. We looked briefly in on University Hall, and we even crossed the Charles River to the Harvard Business School. Still no luck. Then, on a tip, we journeyed to downtown Boston, hard by South Station. There we found an odd structure of steel and glass that looked like some oversized version of an airport traffic-control tower. The principal occupant was the Federal Reserve Bank of Boston, but hidden away on three of the building's floors was just what we had been looking for: Harvard Management Co., stewards of the nation's largest university endowment.

Well, of course.

Having just surpassed the $9 billion mark, Harvard's huge endowment promises in coming years to be more important than ever in helping the university to hire top-notch professors, erect new buildings or offer aid to gifted students. In fact, in the past two years, Harvard's annual budget of about $1.5 billion, has been relying more on the endowment than on tuition.

But don't think for a minute that America's most prestigious university is eating its seed corn. While the budget for the academic year ended last June drained $322 million from the endowment, during the same period Harvard Management earned the university $1.8 billion in markets all around the world.

Indeed, it's a source of great pride at Harvard Management that its return of 26% for the 12 months ended last June was well ahead of the average endowment's 17%. Harvard's investment performance was good enough to put the school in the top 2% of the 352 university endowments tracked by the National Association of College and University Business Officers. Among returns on the nation's 50 largest endowments, Harvard's was edged out only by those of Emory, Stanford and Duke [...].

The man in charge at Harvard Management, Jack Meyer, 51, came to Harvard in 1990 from the Rockefeller Foundation and has assembled a staff of 150, including some remarkably talented portfolio managers. Among the most talented is Jonathon Jacobson, who hit the headlines last summer when it was learned that he earned $6.1 million in salary and bonus in 1995 because of the torrid performance of the stock portfolio he runs for Harvard. Some Harvard professors and students were outraged that the 35-year-old Jacobson made nearly 25 times as much as Harvard President Neil Rudenstine, who took home $251,000, and 50 times as much as what most tenured faculty members earn.

What's more, there was concern at Harvard that the compensation flap would undermine alumni support for the university's current $2.1 billion fund-raising campaign, the largest ever by an American university. Their reasoning: Why would alumni give to a university that is not only the country's richest but goes around paying millions to hot-shot money managers?

Meyer has refused to back down in the face of his Cambridge critics. He defends Harvard management's compensation system, pointing out that his portfolio managers earn big bonuses only if they significantly outperform appropriate benchmark indexes over extended periods. The base salaries for Harvard's money managers, Meyer maintains, are modest by industry standards. Rudenstine told the Harvard Crimson earlier this year that Jacobson's base pay is $200,000 a year.

"Jon literally has provided over $300 million in value added to the endowment" in the past five years, Meyer says. He explains the $300 million isn't a tally of the absolute profits on Jacobsen's portfolio, but those earned in excess of Jacoben's benchmark, the Standard & Poor's 500 Index. Says Meyer, "In a real sense, Jon is perhaps the biggest benefactor Harvard has ever had."

There can be no disputing that Jacobson's performance has been extraordinary. His portfolio generated a 29.7% annualized return in the five years ended June 30, nearly double that of the S&P 500. That performance would put him in the top 1% of all mutual-fund managers over that span.

The fireworks may not be over yet. That's because Jacobson's $6 million compensation last year was based on his showing for the 12 months ended in June 1995 and in prior years. In the most recent fiscal year, ended this past June 30, Jacobson's portfolio gained 40.3%, far ahead of the S&P 500's advance of about 26%. That means the young money manager may take home even more than $6 million this year.

Already people are talking about getting Harvard University to distance itself from Harvard Management Co., perhaps by selling the investment firm to Meyer and his fellow employees. But this would be little more than window dressing. What the academics in Harvard Yard have to realize is that top portfolio managers get paid big bucks, whether they work for Wall Street firms or nonprofit institutions. Meyer's critics should also know that Yale, Princeton and many other schools pay their best portfolio managers fat fees, but these lush compensation arrangements are never made public because the managers involved work for outside firms, that don't have to file detailed compensation data with the Internal Revenue Service. Indeed, Harvard is one of the few big schools that manages its money almost exclusively in-house.

Though Harvard Management has generally shunned publicity, in several recent visits, Meyer and some of his top portfolio managers discussed their investment strategies with Barron's in unprecedented detail. They included some talk about their current favorites, such as Eli Lilly, Corning, General Motors, GM Class H, Philips Electronics, Guidant and some smaller issues.

But what's more interesting than the individual picks is how stocks like these are incorporated into Harvard's overall investment strategy. Meyer's marching orders to his portfolio managers are pretty simple: If you identify an opportunity, seize it. But if you don't have any great ideas, index your portfolio to the appropriate benchmark, like the S&P 500 index for equity managers. This approach ensures that Harvard is fully invested at all times, with a lot of money geared to indexes and some funds riding on his managers' best individual stock picks. It's an approach that many savvy individual investors could use with good results.

"Meyer's strategy is a hybrid of optimism and cynicism. He's cynical because he feels it's hard to beat the market. But he's optimistic because he feels occasional anomalies can be identified and exploited," says Byron Wien, Morgan Stanley's chief domestic-equity strategist, who is also a Harvard benefactor and solicitor of sizable gifts from Harvard alumni in the financial community.

Viewed more broadly, Meyer's strategy hinges heavily on diversification. In the months after arriving from the Rockefeller Foundation back in 1990, one of his biggest decisions was to settle on diversification as a key theme. Relying on techniques of modern portfolio theory, Meyer decided that to get the best returns with lowest level of risk, Harvard needed to cut its exposure to publicly traded U.S. stocks and bonds, and increase its investments in foreign stocks commodities and private companies. Result: Right now the Harvard endowment has about only about half its portfolio in U.S. stocks and bonds, versus about 75% for the typical university endowment.

It can be argued that Harvard Management would have fared even better the past five years if it had put more money to work in the U.S. stock market. But Meyer argues that the benefits of diversification are indisputable. "Diversification rules," he says. "It's powerful, and our portfolio is a good deal less risky than the S&P 500."

Meyer is likely to be proven right or wrong in a bear market. In theory at least, his portfolios should hold up better than most in a downturn.

But for now, he can revel in the fact that he helped end a rocky period in investing at Harvard, which included hefty losses on real estate and oil properties in the late 1980s. In the past five years, by contrast, Harvard's annual returns have been 16.1%, beating the overall market as well as the average endowment. Says Meyer proudly, "If we had generated the median performance among endowments over the past five years, Harvard would have $1.4 billion less than it does now." Given that Harvard takes about 5% of its endowment each year for operating expenses, Meyer's extra contribution of $1.4 billion allows the university an additional $70 million or so to spend annually.

Harvard Management's largest single portfolio is invested in U.S. stocks and run by Robert Atchinson, an 11-year veteran of the firm. Atchinson's seven-member investment team keeps its $2.6 billion invested by industry weighting in strict accordance with the S&P 500. But they use their own research on individual companies in an effort to beat the S&P index by underweighting and overweighting various stocks within each industry group. This approach is conservative in that it prevents Atchinson from making huge industry bets like the one that got former Fidelity Magellan chief Jeff Vinik into trouble with technology stocks last year.

Atchinson's crew seems to be thriving despite the contraints of their technique. They have beaten the S&P 500 for three years running, including a 33.9% showing in the year ended June 30.

Right now, Phillip Gross, Atchinson's health-care specialist, likes Eli Lilly. So Lilly is over weighted in the portfolio, while Merck and Johnson & Johnson have been underweighted. "It isn't that we don't like Merck and Johnson & Johnson, it's just that we like Lilly even more," says Gross.

Gross favors Lilly largely because he's high on the company's new drug for schizophrenia, called Zyprexa. Gross believes Zyprexa, which hit the market in recent months, could be a big winner, producing as much as $2 billion in annual sales for Lilly by the year 2001 and taking significant market share from Johnson & Johnson, whose Risperdal is now the dominant drug for schizophrenia, which affects over two million Americans.

His favorite medical-devices company is Guidant, which should benefit in 1997 from a new defibrillator, an implantable device that helps people with rapid heartbeats. Guidant, Gross believes, also has a winner with a new stent, a device used to hold open coronary arteries after they're unclogged by balloon angioplasty. Gross hopes the Guidant stent will allow it to gain market share from J&J, which now controls the stent market. Guidant, at 53, trades at about 21 times projected 1997 profits.

In the auto sector, Harvard Management analyst Frank Dunau likes GM and Chrysler better than Ford. And its strategy of owning plenty of GM and Chrysler and very little Ford has worked well this year.

Atchinson, a conglomerate and defense expert, is bullish on GM Class H, the letter stock representing Hughes Electronics, which is 75%-owned by General Motors. GM H, at 54, is down from a 1996 high of 68. But Atchinson values Hughes's various business, including auto electronics, defense, DirecTV and satellites, at around $68 per share. Importantly, he believes GM is interested ``in doing something to unlock the values in Hughes,'' which accounts for about $20 of each GM share. Possibilities include GM repurchasing the 25% of Hughes it doesn't own, or selling the business. Indeed, there were rumors a few weeks ago that Raytheon might be interested in buying Hughes.

Companies with significant ownership in other firms often attract Harvard managers because they can profit by artfully isolating the most attractive part of the company. Such is the case with Philips Electronics, the Dutch conglomerate that controls about 80% of publicly traded Polygram, the large recorded music company. Harvard managers feel the parts of Philips excluding Polygram are undervalued. To play this theory, Harvard has bought Philips shares and sold short Polygram in proportion to Philips's ownership in the company. Philips trades for 40, but the Philips ``stub'' excluding Polygram effectively cost around 20. That's less than seven times Philips's projected 1997 profits. Atchinson believes Philips is serious about restructuring its operations to focus on its strengths, primarily lighting and semiconductors, while overhauling its large but underperforming consumer-electronics business.

Then there's Cable Design Technologies, a company that Atchison sees as a ``low-risk way to play the networking business.'' The firm makes sophisticated cable with wide bandwidth that can be used by companies to form computer networks. The company's shares, at 29, trade at about 15 times projected profits in the current fiscal year ending in July. ``Here you've got a company growing at 25%, yet it's trading with a below-market multiple,'' Atchinson says.

Over at Harvard's other U.S. stock portfolio, run by Jonathon Jacobson, the approach is more free-wheeling. A former trader at Shearson Lehman Brothers, Jacobson seeks out values that others have overlooked. "I don't feel I have an edge in coming up with a better estimate on Intel than the consensus," he says. "I tend to focus on special situations: companies that are undergoing complex financial restructuring, or where you have a situation where good businesses have been masked by problems in other areas. I like to see a catalyst for change."

Jacobson was a heavy buyer of Melville earlier this year when its stock traded in the high 20s because he believed the company's break-up into three separate corporations would prove to be a winner. He calculated that CVS, Melville's drugstore operation and best asset, as worth at least the price at which Melville's stock was then trading. Melville, now called CVS, has since risen into the low 40s.

Jacobson admits that in the current market, "It's getting very hard to find things to do." Corning, one of his current favorites, should benefit because it plans to spin off its underperforming health-care-services division, enabling the company to focus on its most attractive business: fiber-optic cable.

"Corning is the Intel of the fiber-optic business. They make high-end, value-added cable," says Jacobson, who believes Corning's fiber-optic business is worth at least the company's current share price of 41, and that Corning shares could hit 50 in the next year.

Another Jacobson favorite is Martin Marietta Materials, one of the country's largest producers of construction aggregates, the crushed rock used for highway construction. The company, formerly part of Lockheed Martin, was fully spun off last month. ``Here's a company that has been well run for some time, but it was part of a large defense contractor,'' says Jacobson. He thinks the company's shares, now at 23, could hit 30 in the next year.

Jeff Larson, who oversees Harvard's $328 million portfolio of foreign stocks, doesn't just go in for straight stock investing. He likes closed-end funds, which can often be bought at a discount to the trading price of the individual stocks they hold. He searches for bargains among closed-end funds that trade on markets as far away as Bangkok and Taipei. But he does own some closed-end funds that trade on the New York Stock Exchange as well. Among them are France Growth Fund, New Germany Fund and Spain Fund, as well as the Latin America Discovery Fund and Korean Investment Fund.

In addition to its traditional stock and bond investments, Harvard runs a huge arbitrage operation. In fixed-income arbitrage, Harvard uses borrowed money to increase its investments to about $15 billion of offsetting long and short positions.

Harvard will say little about its bond arbitrage operation other than that it avoids making interest-rate bets, instead focusing on exploiting market inefficiencies that don't depend on the direction of rates. "We're not like George Soros; we don't make leveraged bets on the direction of the yen," Meyer asserts. Speculation in the investment community is that one of Harvard's biggest trades has involved a multibillion-dollar arbitrage involving Italian bonds and interest-rate swaps, which are arranged by banks. The profit on this trade alone for the year ended last June is said to be about $50 million.

What Harvard saw in Italy was a highly unusual situation. Normally, investors get higher interest rates on swaps than on government bonds because government debt is viewed as more secure than anything issued by banks. Yet as recently as 1995, Italian government debt was paying a higher rate than swaps denominated in lire because of the country's high deficits, weak credit rating and perverse tax system. This created an opportunity. Harvard supposedly bought several billion dollars of Italian government bonds, yielding about 11%, and agreed to finance a comparable amount of interest-rate swaps, at a rate of around 10% a year. This arbitrage was so attractive because holders were virtually assured of making one percentage point a year over the 10-year term of the swaps with the only real risk being the highly unlikely one that Italy would default.

This Italian bond-swap arbitrage has been a big winner in the past 18 months because Italian rates have plunged as confidence in the Italian government has risen. This move, and the $50 million profit it is said to have created, more than likely helped Harvard's domestic and foreign bond portfolios do considerably better than their benchmarks for the year ended in June.

The second-largest chunk of Harvard's endowment, its $1.5 billion private equity portfolio, soared 43.9% last year, as some private companies like United Auto Group, a Harvard holding, took advantage of a bull market to make initial public offerings. Meyer says Harvard runs about half of its private-equity portfolio internally and farms out the rest. The focus in-house has been more mature companies, like United Auto, a group of car dealerships, rather than young startups. "Six or seven years ago, we did a lot of startup, high-tech companies, dozens of them. But we weren't particularly skillful at that. And we don't do it anymore," Meyer says. The exposure to startups, he says, comes through outside managers.

Harvard allocates 3% its assets to commodities, even though few endowments have any exposure at all to this sector. Commodities were a big winner for the university last year, returning 46.1%, making it the single-best-performing part of the portfolio. This largely represents some good luck because Harvard's commodity investment is indexed to the Goldman Sachs Commodity Index, which soared on the strength in oil prices.

The endowment's $539 million real-estate portfolio consists of a diversified mix of about a dozen properties around the country.

Meyer says Harvard is off to a good start in its current year, which began on July 1. The overall portfolio, which stood at $8.6 billion on June 30, recently passed the $9 billion mark, and is ahead of its benchmarks by about two percentage points. Ever the hedger, Meyer warns that Harvard management can't be expected to continue to do so well - having beaten its benchmarks by 2.5 points in the past five years.

Later this month, Harvard Management's board of directors will take up some of the hot issues surrounding the investment outfit, including its compensation packages. Additional discussion is likely at a regular March gathering.

Ronald Daniel, Harvard's treasurer and the chairman of Harvard Management's board of directors, won't tip his hand about the discussions, but his views are pretty clear. "We'll take a broad look at a variety of issues, but we do it from a starting point of real satisfaction and delight about Harvard Management's performance," he says, adding, "We don't want to fix something that's not broken."

As for the compensation controversy, he says: "People at Harvard Management only get paid large amounts of money if they make enormous amounts of money for Harvard."

Indeed, some think the compensation issue has been overblown. Morgan Stanley's Wien says that strong performance is more important to potential big donors than the particulars of Harvard Management's pay system. "Since Jack Meyer has come to Harvard, the investment performance has been excellent, and I think that makes big givers feel better about writing checks to Harvard now. In the past, when the investment performance wasn't as good, people would say: 'I can manage the money better than Harvard so I'll leave it to the university in my will.' These people know the way the world works. Talented money managers don't come cheaply."

Daniel maintains that even with the bonuses, Harvard Management represents a cost-effective way for the university to run its endowment. "We manage this for about half of what it would cost us for comparable performance by outsiders," Daniel maintains. In fact, bonuses and all, Harvard Management cost the university about $35 million to operate in 1995, or about one half-percent of total assets, which isn't high by institutional standards. Meyer points out that the Harvard Management's base fee is only about one-third of a percentage point.

"It's my sense that from an economic standpoint, Harvard should keep Harvard Management as it is," Meyer says. "It's a good deal for Harvard."