The $50 billion pension fund for employees of United Parcel Service is poised to increase its allocation to risk assets. The fund doesn’t time the markets and Ernie Caballero, CIO for the last two years and with the postal group for 28 years, says any shift into risk assets in the wake of recent extreme market volatility will be prudent. But judging the bottom of the market is now his keen focus.
“We should prudently increase risk seeking asset exposure given the recent sell-off in the markets. You can’t time the market, but the environment is ripe for considering this approach.”
The pension fund’s assets are divided across three portfolios comprising a closed management plan which accounts for around $25 billion, with the remainder equally split between two union plans, still in growth mode. Assets in the larger management plan are split between a 48 per cent allocation to risk assets and a 52 per cent allocation to fixed income in a strategy carefully balanced to try and earn a return but protect the 90 per cent funded status.
As for where the fund will invest, Caballero says everything is on the table because all markets are down. He also says UPS has dry powder at the ready, thanks in part to high valuations throughout 2019 which left the fund more focused on reducing leverage in the portfolio than “jumping on assets.” The fund’s managers have discretion on the leverage they can use within set boundaries, and the investment team spent much of last year working with managers to keep leverage at the low end because of high valuations, he says.
Rebalancing within bands
The move into risk assets will also reflect UPS re-adjusting its strategic asset allocation back within its bands for each asset class in the wake of the market sell off. Market falls have left the fund’s equity and fixed income allocations at the lower end of their bands, which Caballero wants back to mid-range.
“We are not panicking, the portfolio is built around a strategic asset allocation that achieves expected long-term returns. With that said, I do believe it’s time to optimise and increase our allocations to risk-seeking assets. One could argue that recent market conditions have made the equity risk premium more in your favour to generate a long-term excess return over the risk-free rate. Over the next few weeks, we are planning to implement this approach.”
Equity hedges
The pension fund’s general preparedness for a downturn has helped it withstand the worst of the virus impact. Strategies that have helped protect the fund include equity hedges, he explains.
“We also benefitted from equity hedges we put on when markets were much higher. Although the premium paid for these hedges were a drag on returns, they were relatively inexpensive insurance policies that were monetised as the markets sold-off in Q1 2020.”
Elsewhere UPS bought US Treasury STRIPS in 2018 when rates were higher. As rates fell the investment helped with the hedge ratio and returns.
In a nod to the need to track liabilities, the management plan won’t invest anymore in private markets, taking all private market deals off the table as it matures and prioritises liquidity. We don’t want to lock up funds, he says. In contrast, the union plans will still invest in private assets.
The challenging times have revealed the strength of UPS’s 50 to 60 manager relationships.
“We’ve had a tremendous dialogue with our managers in Q1,” he says. These strong relationships have been fostered by UPS’s increasing focus and bias towards separate accounts. They require “a lot more work” but give the pension fund “a say on what happens” and ultimately produce better returns, he says.
“A good part of our portfolios are customised; this is the direction we are going in. We are very particular about our investment exposures and the managers we choose to work with. We have a symbiotic relationship and we have aligned goals and objectives – this is the core foundation that facilitates a very close and active dialogue with our investment managers,” he says.
UPS selects managers according to the usual filters around due diligence and compliance and Caballero stresses managers are not necessarily dropped for a loss of performance. A first priority is to understand what went wrong; his overwhelming concern is that the fund’s managers stay true to their strategic rationale, and don’t stray from the mandate.
While the investment team continues to work remotely, Caballero schedules a minimum of two daily market and portfolio impact sessions with various members of the 26-strong team.
“We talk about what is going on in markets, how our portfolio is positioned both tactically and strategically, and the impacts we can expect to materialise under certain scenarios. The team is so connected that we have even made time for virtual happy hours a few times at the end of the week after the markets close,” he says.
