The ‘Last’ Return-Seeking Corporate Pension In America | 5 Qs With Brian Pellegrino, CIO Of UPS Group Trust
Brian Pellegrino has served as the the chief investment officer of UPS Group Trust, an asset management arm of UPS, since 2005. He actively manages a portfolio of more than $30 billion. During his 37 years at UPS, Pellegrino has held financial management roles at various levels. As CIO, he grew the investment department from a three-person office to a 24-member team today.
UPS Group Trust is one of the few defined benefit corporate plans in the U.S. that’s open for new participants. Unlike many liability-driven investors among corporate pensions, UPS has a return-seeking strategy with sizable allocation in illiquid, alternative assets. In this interview, Pellegrino shares insights on the prevailing liability-driven investing, whether UPS’ unconventional approach is transferrable to peer institutions and how UPS structures its alternative assets book to control investment cost.
Pellegrino was named on Trusted Insight’s 2017 Top 30 Corporate Chief Investment Officers. He graciously spoke with us on Aug. 9, 2017.
Trusted Insight: In the corporate pension realm, many of your peers run their portfolios by a liability-driven strategy. You are doing the opposite thing for UPS Group Trust. What are the downsides of liability-driven investing as you see it?
Brian Pellegrino: The only downside would be if the strategy is not implemented correctly or if the plan sponsor is not committed to LDI (meaning they run the risk of abandoning it at the wrong time). Underfunded plans also have to be aware of the trade-off between potential lower returns associated with LDI and the impact on company contributions.
We're not liability-driven, because we have open plans and a very long-duration liability. Our liabilities continue to grow, so we have to manage the balance between company contributions and earning returns in excess of the growth of our liabilities in order to achieve our objectives.
One thing that pushes us more toward a return-seeking strategy is that we have a very low payout ratio. We only pay out 3 percent to 4 percent of our assets a year in benefits. A typical corporate payout rate can range from 8 percent to 10 percent. That means we have less liquidity constraints, allowing us to take a long-term view on a higher percentage of our assets, absorb market volatility and continue to earn sufficient returns to meet our benefit obligations.
However, the reality is that we are probably migrating more toward a traditional pension plan as our plans mature than our peers migrating toward our model.
Most plans are some type of closed, soft-closed or frozen, not taking new participants. It doesn't make sense for someone with a frozen or closed plan to actually run the model we run. As your future liability becomes more certain, liability-driven investing becomes more feasible and a better solution as your funded status improves. I think there are very few large corporates in the United States that have open traditional defined benefit plans.
Trusted Insight: Do you think the UPS model is applicable to other corporate pensions?
Brian Pellegrino: There are three things a pension plan needs in order to replicate what we do: 1) a significant pool of assets so the investor can make meaningful investments. I'm referring to the custom mandate type of work we do, which is currently approaching 50 percent of our alternatives book; 2) a governance structure that allows the investment team to function autonomously, eliminating the need to go to the board to get approvals every time we want to do something. Streamlining the process allows us to move quickly; and 3) deep asset-specific expertise in order to be able to execute. For example, if you're going to do a bespoke real estate deal, there's a huge benefit to have someone on staff who has had a career in underwriting real estate deals. In addition, that expertise also brings relationships. It is important that people in the industry know who you are and are willing to source deals for you to evaluate. You don't have to take every deal, but if you're going to do a deal, you should be able to close it quickly.
Trusted Insight: UPS has a sizable commitment to hedge funds. To what extent are you concerned with the hedge funds’ lackluster performance lately given their high management fees?
Brian Pellegrino: We have a core group of hedge fund managers. Our hedge fund strategies are diversifying in nature and non-correlated to our return-seeking pool of assets. That pushes us mostly to global, macro, CTAs and trend-following type of investments. We don't invest across a full suite of hedge fund products. For example, we shy away from equity beta, event-driven, merger arbitrage and long/short equity.
Our hedge funds are set up to help dampen the impact of a poor performance on our core return-seeking assets. From that perspective, they're doing exactly what we would expect them to do in strong equity markets.
In 2012, we created an in-house-managed account platform. So, we have a portion of our strategies run in separate accounts on that platform. That gives us better transparency and control over the allocations, and it allows us to manage costs and keep them well below a traditional 2-and-20 relationship. In some cases, we may have exposure in a manager’s core or flagship products, but then they come across idiosyncratic or bespoke investments that may not fit their core investment thesis, they're usually willing to run on a one-off basis for us.In addition to that, we are in the process of building out a risk-premia allocation to complement our hedge fund strategies. This is another way to manage fees because it allows us to get certain exposures in a more cost-effective manner compared to having to pay 2-and-20 to get the same exposure through a hedge fund.
However, if a manager can provide a return stream that we cannot replicate and it adds value to the trust, we really don't have an issue with fees.
Trusted Insight: You have built an investment team from three people to 24 since you joined UPS. How is your investment team structured?
Brian Pellegrino: We're divided into three main groups, soon to be four. We have a director of private markets, who manages the real estate, private equity and credit allocations. We also have a director of public markets who oversees global equities, core fixed income, which consists of long-dated Treasury bonds and high-quality corporate bonds. The public markets director oversees the liquid alternatives portfolio as well.
We recently added a risk team with responsibility for hedging strategies, allocation and overall portfolio risk management. Currently they report to the director of public markets, but in the very near future it will become a separate group.
Each asset class has a dedicated portfolio manager. So we currently have six PM’s: private equity, real estate, credit, equities, fixed income and hedge funds. Each one of those portfolio managers has a senior analyst that works with them.
The balance of the team is the compliance and operations group. The group is divided into three teams. There is an operations team that handles all our transaction-based activity and the relationship with our custodian bank; an accounting team that does all of the reporting, as well as manages year-end process and audit requirements; and a compliance team that ensures that we stay ahead of regulatory changes and remain ERISA-compliant. That team also handles operational (back office) due diligence for our managers.
Trusted Insight: How do you think artificial intelligence is going to change institutional investing?
Brian Pellegrino: I think that remains to be seen. You can look at it two ways. You can argue that artificial intelligence can help institutional investors do their jobs better, that it will provide a wealth of information that can make you a better investor. Or you can argue that the evolution of AI will totally eliminate the need for human involvement in the investment process. I personally think the total elimination of intellectual capital humans bring to the process is a long way off.
Today, it seems more institutional money moving toward passive, index-like investments. There's probably an index and/or an ETF available for just about any kind of investment strategy. These investment products now offer a better opportunity set for passive investors and are making it more difficult to add value through active management. The question is: does artificial intelligence help an institutional investor gain an edge, especially when there are market dislocations? Or does artificial intelligence totally eliminate market dislocations, leaving no value to be created through active management? And does that make everyone a passive investor by default?
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