When the (cashflow) facts change
Covid-19 has highlighted more than ever the need for a flexible investment strategy
The impact of COVID-19 is lower pension scheme funding levels, weaker covenants and increasing liquidity requirements. So, schemes need return, risk management and cash more than ever. This calls for a flexible investment strategy set to adapt to the swift change in pension scheme needs.
It was around this time last year I wrote: an article - "Getting caught up with cashflow risk?”. In the piece, I highlighted a key challenge for trustees is knowing how much cashflow they will need. Even the best forecasts are unlikely to be realised as expected. Indeed, recent events show how the best-laid plans can be blown off course. Cashflow management strategies make assumptions about the amount of cash coming in and going out. Many schemes will now find their cashflow management strategy is out of kilter.
UK Plc is under significant financial stress because of lockdown restrictions. It's estimated 1 in 5 Sponsors could suspend deficit reduction payments1. Future contribution affordability is a lot shakier with the biggest recession since the Great Depression looming. Pension schemes are also exposed to the covenants of companies in which they invest. A wave of dividend cuts, higher bond defaults and weaker tenants mean asset income is also at risk.
A weaker Sponsor can also affect the liability side of the balance sheet. Companies in many sectors are cutting costs through lay-offs, redundancies and early retirements. These shifts in member status bring cashflow requirements forward as more members transfer out or pensions are paid earlier. Transfers out can put a particular strain on scheme liquidity as they are often large, lumpy and unpredictable.
So, with cashflows-in looking lower and cashflows-out looking higher, how can trustees balance the equation? Putting contributions and benefit augmentations aside, the only remaining levers are selling assets or skewing the investment strategy towards more reliable sources of income.
Schemes with liquid and flexible investment strategies are well set to adapt. But those with large allocations to illiquid assets, pooled LDI or full CDI strategies, may find themselves in a cash-22 (!) situation, with less viable options. At R&M we build strategies which offer much more liquidity, greater flexibility to generate income, and scope to capture niche opportunities.
British economist John Maynard Keynes is frequently misquoted for saying “When the facts change, I change my mind. What do you do, Sir?” Whilst the quotation might be wrong; the sentiment is not. The facts have changed for pension scheme trustees, and their minds will need to change too.
“At R&M we build strategies which offer much more liquidity, greater flexibility to generate income, and scope to capture niche opportunities.”
To our mind, this represents a more efficient, robust solution reducing the governance burden on trustees and allowing them to focus on the task in hand, i.e. to ensure they have sufficient funds readily available to meet pension payroll. If you would like to understand how a segregated approach to LDI can better support trustees through this challenging period then please contact us.
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