Cash-flow driven investing

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For defined benefit (DB) pension schemes the cash-flow forecast does not make good reading.Research published last year by consultancy Mercer discovered that more than half (55%) of UK DB schemes were not generating enough cash to pay all their members’ pensions. This was up from 42% 12 months earlier and the authors of the report believe that this is set to deteriorate further.Of the schemes that generated a cash surplus last year, 85% will be cashflow negative by 2027, Mercer believes. Those not earning enough cash from contributions or their investments may have to sell assets to meet their obligations. But is this a concern for trustees? After all, being cash-flow negative comes with the territory for a mature final salary scheme and the ideal endpoint is to have no members and no assets, so selling assets is part of that journey. The trick is having enough cash to make sure that the last member receives their benefits in full before the last share or bond is sold.The sell-off in developed market equities at the start of the year highlights why scheme managers could be having a tough time. Those forced to sell are likely to have done so after prices had fallen and will have to turn to the more liquid qualitystocks in their portfolio to raise the cash needed. This could mean losing dividend-paying blue chips. Not an ideal situation for investment portfolios to be in.Strategies to protect portfolios from not having enough liquidity to pay benefits and avoid having to sell at the wrong time in the cycle include keeping cash in the portfolio. This may not be popular with some so an alternative protection strategy could be to hedge with swaps.Transfer values are another issue that trustees have to navigate, which just adds to the uncertainty that makes it difficult to know how much cash a scheme needs and when.Insurance is another element that has increased in importance for pension schemes. This year more than one commentator has predicted a record year for risk transactions with insurers, a result of favourable pricing.With cash-flow investing rising in prominence we crammed trustees, pension funds, asset managers, consultants and other advisers around a table to discuss some of the biggest issues with the strategy.

Adam Lane, Mercer – Graham Moles, Legal & General Investment Management

Roundtable

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Raising cash-flow awareness: Effective cash-flow management for DB pension schemes