Brian Pellegrino is in a tiny minority of corporate plan sponsors. That is because the chief investment officer of United Parcel Service oversees defined benefit plans that are still open to new hires. And, unlike many of his peers who invest for closed private sector pensions — including General Motors Co., IBM Corp. and Xerox Corp. — UPS is not pursuing a liability-driven investment strategy for its $30 billion fund. But perhaps the most unusual feature of the UPS pension fund, given the challenging low interest rate environment, has been its ability to meet and exceed its annual expected return bogey of 8.75 percent for the past six years.
“Due to long duration liabilities and a low benefit payout ratio, we believe we have time on our side to earn returns,” explains Pellegrino, 54, who began his 35-year career at the package delivery company loading trailers in New Jersey while still in high school. Time — thanks to having a younger workforce with longer duration liabilities than at other large corporations — has allowed Pellegrino to pursue a host of innovative opportunities to boost fund performance and work toward the corporate goal of full funding for UPS’s three pension plans, including one Taft-Hartley pension.
In 2005 Pellegrino found his true home in the investment office following decades on a corporate career path of rotational assignments — and moves from New Jersey to Buffalo to UPS’s Atlanta headquarters — that included stints in accounting, mergers and acquisitions and corporate finance. In the investment office he was able to tap his interest in markets. Pellegrino first got a taste for finance while in the UPS treasury division, where he was involved in foreign exchange and energy hedging, a share repurchase program and working capital management, (the latter included issuing commercial paper and investing excess cash).
Since 2010, the UPS pension fund’s annualized return has exceeded its return expectation of 8.75 percent. “We deem ourselves absolute return investors so we don’t spend a lot of time talking about how we do on a relative basis,” says Pellegrino. Instead, he focuses on “how we add value and meet return objectives.” His approach started with hedge funds and grew to include opportunistic investments, a dedicated credit portfolio and customized beta.
Pellegrino in 2006 began by lowering the 65 percent allocation to public equity and creating a 10 percent allocation to hedge funds. Shunned at first by desirable hedge fund managers, the UPS CIO placed these assets in a global tactical asset allocation portfolio. The 2008–’09 financial crisis soon created opportunities for cash-rich institutions like his as desperate investors pulled their money out of hedge funds to plug holes in their diminished portfolios.
To build what is now a concentrated, $3 billion portfolio of hedge funds with ten managers and a dozen strategies, Pellegrino devised a disciplined set of manager selection criteria. He looks for equitylike returns with less volatility than equity; low correlations to the rest of the portfolio; liquidity and transparency; low chance of headline risk (“no risk of ruin” as he puts it); and diversifying to other portfolio alphas (such as real estate and private equity).
These criteria yielded investments in global macro, commodity trading advisers, multistrategy hedge funds and some very unique, noncorrelated credit strategies. Not on the list: long-short equity, merger arbitrage and most event-driven hedge funds. When asked to name his managers, Pellegrino politely refuses.
Working without a hedge fund or general consultant, Pellegrino built out the investment office from three professionals at his arrival to 21 today. (He plans to add another three to five positions.) With the hedge fund portfolio in place, in 2012 Pellegrino added a managed account platform on which to house opportunistic investments — those with a finite life cycle that are neither strategic nor core and do not fit anywhere else in the portfolio.
“It’s a plug-and-play structure for opportunities that come in,” explains Pellegrino. “The allocation is in flux; it expands and contracts.” For example, UPS might be offered a strategy that doesn’t fit a manager’s mandate but would work well in the UPS portfolio. The manager creates a “fund of one” or separate account where the strategy will live until it runs its course. Examples of such investments include opportunities in the currency and rates markets as well as opportunities resulting from 2010’s Dodd-Frank Wall Street Reform and Consumer Protection Act, which forced banks to shed undesirable assets.
In January 2016 UPS launched a credit portfolio by lifting out all the credit-related investments across major asset classes, including real estate, hedge funds, core fixed income and private equity. The credit portfolio can go as high as 10 percent of the total fund and is currently around 8 percent. The core fixed-income portfolio, which reached a high of 40 percent in 2011, is currently closer to 20 percent. UPS changed its pension governance structure in 2007, permitting the CIO to reconfigure the asset allocation as needed, as well as approve staff and manager hires and dismissals.
Pellegrino is currently pursuing strategies that allow him to get close to the assets, seeking custom mandates, especially in real estate, credit and private equity strategies. The investment office works with “strategic partners,” large asset management firms that help identify and execute these custom strategies, now 5 percent each in real estate and private equity. These allocations can double in size but in private equity, which has been experiencing a lot of distributions, current opportunities are limited. In real estate, “we don’t think there’s a bubble but we’re watching it closely,” says Pellegrino.
These days Pellegrino has reduced public equity to between 40 and 45 percent of UPS’s total portfolio. In 2010 he began to build a custom beta portfolio that now exceeds 40 percent of the equity portfolio and is slated to grow to 50 percent by year-end. Active management has been reduced as the custom beta component has grown. “We do research in-house on the exposures we want as we feel [the custom beta portfolio] provides better exposure than a typical cap-weighted portfolio,” he explains. The rest of the equity portfolio is actively managed with a small allocation to a passive, capital-weighted index portfolio.
While it may not be the sexiest part of the portfolio, the UPS CIO has been overweighting cash to allow for nimble investing as opportunities emerge. “We try to let the industry know we’re here as a liquidity provider,” says Pellegrino, who is prepared to give managers a quick yes or no answer. “We want to be the first call when managers have unique opportunities.”
Brian Pellegrino will be appearing at the Delivering Alpha conference, hosted by Institutional Investor and CNBC, on September 13 at The Pierre in New York.
Follow Frances Denmark on Twitter at @francesdenmark.
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