Our views

Cashflow aware investing Q&A


Nick Woodward, Head of Investment Solutions

31 May 2017

How appropriate is cashflow aware investing if you eventually want to engage in a buy-out?

The bond assets in which our cashflow aware strategy invests are very much the same that an insurer would hold in the event of a scheme going into a buy-out (or a buy-in). We have experience of moving or managing the transition from a cashflow aware strategy into a buy-out, where they just took those bonds on board. It is very much in line with how an insurer invests, and very much focused on risk management.

We already have LDI. Do we need a cashflow aware solution as well?

LDI has seen a large amount of demand over the last 5-10 years. One fundamental challenge that LDI doesn’t meet is that it doesn’t provide income. LDI provides pension schemes with an immunisation against changes in interest rates and changes in inflation, but it doesn’t provide cashflow. LDI and a cashflow aware strategy, hand-in-hand, work together not only to immunise, but also to provide those cashflows as they fall due.

If interest rates do normalise, would you want to invest in such a strategy?

That’s a good question! Lots of people have been discussing ‘normality’ over the last 10 years and whether rates will return to normal. If you are talking about interest rates returning to 4%, there’ll be a long timeframe for that to occur. I don’t think we are going to see interest rates change to go a lot higher. If we compare and contrast to other European countries, lower for longer, or indeed falling interest rates, is still on the cards. If they were to normalise, of course hold off by all means, but what we have seen over the last years is that we’re very poor at predicting where the market is going to go. So, from a risk management perspective, I wouldn’t hold off too long.

How is the strategy going to work given that inflation is increasing?

When we build these portfolios, we have to allow for the assumptions that actuaries use for predicting cashflows, and these incorporate inflation assumptions.

If you are selling down equities to pay benefits, why do you need a cashflow aware strategy?

It really does depend on where a scheme is on its flightpath, and selling down equities may serve you well in certain environments. However, if you are having to sell down growth assets in e.g. the credit crunch, where everything fell, you could find yourself a long way down. As cashflows become negative, there is a more efficient way to deal with this, and this is partially through adoption of a cashflow aware approach, which helps to avoid becoming a forced seller of growth assets at times when prices are falling.

What return can I expect from strategy?

The return is very much defined by admissible assets in portfolio. For example, if we were to include high yield or loans, this would increase the expected return. We always focus on the security aspects underlying all the instruments in the portfolio, and we have been expanding to include other assets to provide a regular stream of cashflows. We can do this just with investment grade credit too, but the expected return would be lower.

For more on cashflow ware investing, please click here to access our recent webinar.

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.

Cashflow aware webinar