Time for multiemployer plans to remove cashflow risks | Insight Investment

In an uncertain market environment, we believe multiemployer plans should prioritize protecting their financial position – ensuring they can continue paying members without jeopardizing the progress they have made.

Multiemployer pension plans face a unique set of challenges. Market volatility, shifting demographics and a growing need for predictable benefit payments make it increasingly difficult to deliver on long-term promises.

As the industry navigates elevated valuations, macroeconomic uncertainty, and changing market dynamics, it may be an opportune moment to rethink traditional investment approaches. Cashflow-driven investment (CDI) could offer a compelling solution, aligning assets with liabilities to enhance certainty, reduce risk, and improve outcomes for plan members.

Are cashflows now the largest threat to multiemployer plans?

Multiemployer plans’ cashflow demands are rising year by year, as more of their members enter retirement (Figure 1). We believe this is now their largest long-term threat.

Figure 1: Annual cashflow demands are rising¹

For many plans, these rising obligations mean they regularly need to sell investments to meet benefit payments (“forced selling”).

While selling at all-time highs may not be a burden, selling during market selloffs can mean crystallizing painful losses, missing out on recovery rallies, and undermining their portfolio’s longer-term growth potential. It can also result in higher transaction costs and trading frictions.

In the current environment, the risk of intermittent selloffs may be particularly high. Geopolitical uncertainty remains a concern, while high equity valuations (Figure 2 – left) and slowing economic growth (Figure 2 – right) have historically made for tricky environments for equity returns relative to fixed income.

Figure 2: Equities could be primed for near-term and medium-term volatility, a problem for those needing to sell assets²

Further, given persistent inflation risks, the traditional diversification benefits of equities and bonds has been eroding (Figure 3). Traditional diversification alone may no longer provide the protection it once did through risk market drawdowns. Additional solutions may therefore be necessary for meeting cashflows.

Figure 3: Plans may need more than traditional diversification to meet their growing cashflow needs³

CDI may help protect funded status gains while paying benefits

We believe strategies must adapt to shorter time horizons and net outflows, prioritizing the delivery of promised benefits over chasing returns. CDI portfolios seek to align income from bonds with projected cash outflows and mitigate the need to sell growth assets at potentially inopportune times. We believe CDI offers key advantages in the current environment:

• CDI portfolios are tailored to a plan’s specific needs, aligning asset cashflows with its liability schedule to help ensure predictable liquidity for benefit payments. This alignment mitigates the risk of forced asset sales during downturns, preserving asset values and enhancing funding stability.
• Holding bonds to maturity helps stabilize the plan’s funded status by reducing sensitivity to market volatility and minimizing reliance on capital market assumptions, and in our view increases the likelihood of achieving expected long-term returns.
• By meeting near-term cashflow needs through predictable income streams, cashflow-matched portfolios may offer greater flexibility in managing overall plan liquidity. We believe this will give trustees the confidence to allocate to less liquid, potentially higher return assets elsewhere in the portfolio.

Conclusion: The next frontier is making good on the pension promise

We believe cashflow-driven solutions can help remove the risk of near-term volatility that threatens comprising multiemployer plans’ ultimate goal: to put checks in their members’ mailboxes with the highest degree of certainty. Customized, cashflow-driven solutions may help plans pay benefits without selling risk assets, potentially allowing their equities and other risk assets to deliver uninterrupted growth over the long term.