Cashflow driven investment (CDI)
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?
- We can partner with you to provide customised support and advice as a recognised and world-leading specialist in decumulation phase investing2
- Our investment platform has been customised to deliver sophisticated risk-managed solutions, 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 and were awarded Professional Pensions UK Pensions Awards, CDI Manager of the Year in 2018 and 2019
As at 31 March 2019. 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.
LDI Manager of the Year
Global Investor Awards 2019
Investment manager of the year, Fixed income manager of the year, CDI manager of the year, LDI manager of the year.
Professional Pensions UK Pensions Awards 2019
CDI investment manager, Fixed income manager & Investment manager of the year. Fixed income innovation of the year.
Professional Pensions UK Pensions Awards 2018
LDI Manager of the Year
Global Investor Awards 2018
LDI Manager of the year
European Pensions Awards 2018
Fixed Income Manager of the year
Pension Age Awards 2018
Fund and strategy profiles
1Assets for which investors have a contractual claim.
2Insight ranks first for Overall LDI Quality for the ninth consecutive year and first for Overall Fixed Income Quality for the sixth consecutive year.
Source Greenwich Associates 2019, GICF LDI-19 LDI overall and GICF FI-19 fixed income overall. LDI: results are based on interviews with 12 UK consultants evaluating LDI. The median (513) is the middle of those managers with five or more evaluators (this chart excludes two managers who have five or less evaluators). Fixed income: results are based on interviews with 13 UK consultants evaluating fixed income managers. The median (493) is the middle ranking manager of those managers with five or more evaluators (this chart excludes 12 managers who have five or less evaluators). Greenwich Quality Index scores for each evaluator range from 1,000=‘Excellent’ to 0=‘Poor’ with a population mean of 500. 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.
Fixed income and liability-driven investment
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.
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 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.