Cashflow Driven Investment Blog Series - Part 1
Putting cashflow driven investing into context
20 Dec 2017 - Estimated reading time: 3 mins
Welcome to the first blog in our series where our experts cover everything you need to know about cashflow driven investment.
Back in June 2013 our Chief Investment Officer Andy Green delivered a presentation to the fund management community explaining a major flaw with DB investing in the UK. Specifically that no one was focussing on ensuring schemes had the assets required to pay the cashflows out to pensioners. Back then he was a lone voice highlighting the need to look not just at the growth and protection required from assets, but also the income needed to pay pensions.
Fortunately today many in the industry have caught up. But more need to. If they don’t, as schemes mature, they could be staring down the barrel of deep capital losses. The warm glow of balance sheet measures of success (i.e. a focus on deficit figures which encourages a short-term approach when a longer-sighted cashflow focus is required – see previous blog on this) will provide scant comfort if we experience a market downturn and schemes need to sell assets at depressed prices to meet benefit payments. That’s like driving a bus and looking out of the driver’s door to see if you’re still on the road.
While it’s great that we’ve seen an explosion in cashflow strategies in the market over the past 4-5 years, it can also be bewildering for trustees. Filtering out the substance from the noise to improve outcomes for members is a challenge.
It’s also essential to see cashflow driven investment in context – whether it is a priority for you will depend on your circumstances. For example, CDI should not be at the expense of LDI. Schemes and their advisers need to think about outcomes.
The outcomes schemes need are growth to clear deficits, income to avoid being a forced seller of assets and protection to reduce balance sheet risk. The balance between these will be scheme specific, and that’s why we need to think about investment strategy in the context of growth, income and protection requirements, as per our investment framework (GrIP).
To help trustees get to grips with it, this is the first in a series of blogs that seek to answer the following questions:
- So what is cashflow driven investment (CDI)?
- How do we do it?
- Why is it such a big deal?
- What’s the most capital efficient way to approach CDI?
- How CDI is supporting the growth of innovative businesses in the UK?
- Why cashflow planning, alongside balance sheet management, is core to integrated risk management?
What is CDI?
In investment we love an acronym. And the latest buzz phrase we are hearing is CDI – cashflow driven investment.
What are the cashflows?
The cashflows are the reason for being for a DB scheme. It’s what it’s there to pay. It is the amount of money we expect to pay out each year from now until the last beneficiary dies. A CDI portfolio is one that is designed to generate the required level of cash each year to meet the benefit payments. Here is a picture of the cashflows for a typical scheme (this one has c£700m of assets).
The bars show the amount we are expecting to pay to pensioners each year for the next 70 years. Some of the pensions are inflation linked and some have fixed or no increases. This is reflected in this chart. The current payments are c£10m pa rising to c£20m pa in 10 years, c£40m in 15 years and peaking at c£60m pa in 30 years before dropping away over the next 40 years. In short, CDI is making sure you can match these cashflow bars with an income from your investments to pay the benefits from the scheme.
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