Cashflow driven investment (CDI)
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As pension schemes shift their focus from accumulation and funding to decumulation and dealing with net cash outflows, there is less time and less latitude to make up any funding shortfalls.
Schemes can help to maximise the certainty of meeting their liability cashflows by focusing on investments with a low chance of default and holding them to maturity.
The changing focus of pension schemes
Source: Insight Investment.
Cashflow driven investment (CDI) is an approach which has a focus on building portfolios of assets that generate predictable cashflows to help increase the certainty of meeting a scheme’s cashflow requirements and funding objectives.
Broadly speaking, the three motivations behind a CDI approach are:
- Generate cashflows required to pay benefits
- Secure returns with greater certainty
- Reduce funding level volatility
Issues to consider
While such an approach sounds relatively straightforward, whatever route you take, there are new investment issues that you need to consider when investing in this new phase of your scheme’s lifecycle. These include:
- What are the options to ensure sufficient diversification in your portfolio?
- How can you retain flexibility, to enable you to capture new investment opportunities or respond to unplanned outflows, while still ensuring this does not give rise to the risk of forced sales to meet cashflow requirements?
- How can you minimise the impact of credit defaults, reinvestment at poor returns and prematurity forced selling at poor prices?
- How do you measure success?
Key success factors for CDI?
Based on our experience of creating bespoke liability-matching solutions and hold-to-maturity credit strategies to meet our client needs, we can work with you and your advisers to structure a CDI strategy to meet your specific needs.
Here are some areas that we would focus on to help you build and manage a successful CDI strategy:
- Access to a wide fixed income investment opportunity set1. We believe investors should start with the widest investment universe, including high-quality globally diversified fixed and floating rate income-bearing assets in both public and private markets. Such an approach would allow your scheme to secure the investment opportunities likely to provide the most attractive returns for a given level of risk
- Balancing flexibility and cashflow-matching precision. This approach will provide you with the flexibility to target the maturity profiles of issues with the most attractive potential returns whilst still retaining your ability to meet your cashflow obligations
- Integrating and dynamically managing your CDI strategy alongside any liability-hedging portfolio. Utilising an existing readily accessible liquidity pool provides you with more flexibility to pursue a greater cashflow mismatch and can offer economies of scale. Therefore, creating a holistic cash and collateral management framework helps you more efficiently ensure that the right assets are available to provide the right level of liquidity, at the right time. This should reduce the risk that you become a forced seller in adverse market conditions and increase your potential returns
- Providing access to rigorous portfolio construction and credit risk-management techniques. Strong credit risk analysis, with the aim of minimising the probability of defaults, is a fundamental requirement for any pension scheme considering a CDI strategy
- Ability to provide input and reporting on CDI-based funding strategies. We can provide the information necessary for those clients that are looking to integrate their funding and their investments more closely
Why would you choose to partner with Insight?
- Our market-leading investment platform has been customised to deliver sophisticated risk-managed solutions, such as liability-driven investment (LDI), and has been refined over more than 15 years2
- Our fixed income capabilities and process is highly rated, with a strong track record of avoiding defaults2
- We have expertise in dynamic cash and collateral management, and running CDI strategies which are integrated alongside a portfolio of liability hedging assets
- We are a long-running, recognised investment leader in quality for LDI and Fixed Income2
Financial solutions in numbers
- 2004 Insight launched its financial solutions capability
- €707.4bn in assets managed by our fixed income and financial solutions groups
- €124.60bn assets managed for cashflow-aware clients
As at 31 March 2023. Assets under management (AUM) are represented by the value of cash securities and other economic exposure managed for clients. Assets managed by our fixed income and financial solutions groups include clients who have liability driven investment, fixed income and cashflow-aware strategies.
Other related strategies
1Assets for which investors have a contractual claim.
2Over the last decade, Insight has been ranked in first place for Overall Quality in LDI for 11 years in a row and has ranked top decile every year since 2013 for Fixed Income Overall Quality with UK Investment Consultants, based on Greenwich Associates 2021 UK Investment Consultant Research.
Source: Greenwich Associates 2021 UK Investment Consultant Research. LDI results are based on interviews with 11 UK consultants evaluating LDI. Fixed income results are based on interviews with 11 UK consultants evaluating fixed income managers. Greenwich Quality Index Overall is a composite of Investment and Service scores.
Insight's assets under management reflects the AUM of Insight, the corporate brand for certain companies operated by Insight Investment Management Limited (IIML). Insight includes, amongst others, Insight Investment Management (Global) Limited (IIMG), Insight Investment International Limited (IIIL) and Insight North America LLC (INA), each of which provides asset management services. Insight's assets under management are represented by the value of cash securities and other economic exposure managed for clients.
The value of investments and any income from them will fluctuate and is not guaranteed (this may be partly due to exchange rate fluctuations). Investors may not get back the full amount invested. Past performance is not a guide to future performance.
Where the portfolio holds over 35% of its net asset value in securities of one governmental issuer, the value of the portfolio may be profoundly affected if one or more of these issuers fails to meet its obligations or suffers a ratings downgrade.
A credit default swap (CDS) provides a measure of protection against defaults of debt issuers but there is no assurance their use will be effective or will have the desired result.
The issuer of a debt security may not pay income or repay capital to the bondholder when due.
Derivatives may be used to generate returns as well as to reduce costs and/or the overall risk of the portfolio. Using derivatives can involve a higher level of risk. A small movement in the price of an underlying investment may result in a disproportionately large movement in the price of the derivative investment.
Investments in emerging markets can be less liquid and riskier than more developed markets and difficulties in accounting, dealing, settlement and custody may arise. Investments in bonds are affected by interest rates and inflation trends which may affect the value of the portfolio.
Where high yield instruments are held, their low credit rating indicates a greater risk of default, which would affect the value of the portfolio.
The investment manager may invest in instruments which can be difficult to sell when markets are stressed.
Where leverage is used as part of the management of the portfolio through the use of swaps and other derivative instruments, this can increase the overall volatility. While leverage presents opportunities for increasing total returns, it has the effect of potentially increasing losses as well. Any event that adversely affects the value of an investment would be magnified to the extent that leverage is employed by the portfolio. Any losses would therefore be greater than if leverage were not employed.