Case Study – seizing an opportunity in credit markets to reduce cashflow risk
Cashflow Matching Credit (CFMC)
2020 was a volatile period for assets, but volatility also brings opportunities for those able to act quickly. One example of this was seen in investment grade bonds, with credit spreads temporarily widening to levels not seen since the 2008 financial crisis. We took advantage of this brief opportunity on behalf of many of our clients by implementing or increasing their allocation to CFMC, a basket of cash generative, investment grade, bonds that can be used to match benefit outgo.
One such example was the DB pension scheme of a UK-based engineering company, where we have been the advisor since 2003 and fiduciary manager since 2012. The Scheme had already made an initial 20% allocation to CFMC (as a % of total Scheme assets) to ensure it had the mandate in place to move quickly on further CFMC allocations when attractive opportunities arose. This forward planning meant that both we and the Trustees were able to adapt quickly to opportunities as they arose during the year.
As the world went into lockdown in March, we worked quickly to understand the implications of COVID on credit markets for our clients. Our analysis showed that, despite heightened uncertainty, Investment Grade Corporate Bonds were attractively priced even after taking into account the future impact of expected defaults in a post-COVID world.
With the infrastructure already in place to access this opportunity, we advised the Trustees to increase their allocation at the earliest available opportunity. The Trustees’ agreed and asked us to increase their allocation to CFMC to improve the level of cashflow matching, hence further reducing the cashflow risk the Scheme faced.
As a result, we were able to introduce an additional 10% allocation to CFMC, at a significantly better yield than previously possible. The weighted average yield achieved was gilts + 2.3% p.a., 0.7% p.a. higher than the margin on the existing CFMC assets. Due to the attractive credit spreads for the new CFMC allocation, the Scheme was able to reduce risk in the portfolio by c.5% whilst retaining its original return target, and now generates sufficient cash to cover almost all benefit outgoings whilst having a more stable path towards its long-term objective. This increases security for members and places less reliance on the Covenant.
This article constitutes a financial promotion and has been issued and approved by River and Mercantile Solutions, a division of River and Mercantile Investments Limited which is authorised and regulated in the United Kingdom by the Financial Conduct Authority and is a subsidiary of River and Mercantile Group Plc (registered in England and Wales No. 04035248).
Please note that this communication is directed at, and intended for, the consideration of Professional clients only. Retail clients must not place any reliance upon the contents.
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