JPMAM's Sorca Kelly-Scholte makes the case for cashflow-driven investing at a time when many schemes are underfunded and need to grow investment returns to meet future liabilities.
UK pension funds could be reaching a "tipping point" into cashflow-negative status, data from the Office for National Statistics suggests.
Indeed over the past decade, UK pension schemes have engaged in a consistent programme of de-risking - moving from growth-focused portfolios to liability-driven investment strategies in a bid to reduce short-term balance sheet volatility.
Yet, at a time when schemes are fast maturing, they are now facing a cashflow challenge.
Speaking to Professional Pensions, Sorca Kelly-Scholte, head of EMEA Pensions Solutions & Advisory at J.P. Morgan Asset Management, says many schemes are getting to the point where they are paying out more than they are receiving in contributions - becoming increasingly cashflow negative as they mature.
She says: "Cashflow-driven investing aims to secure liquidity for payments while preserving the ability to generate return. In today's environment where we are seeing low yields, pension plans need to start using principal payments on fixed income in order to generate the required cashflow as well."
Kelly-Scholte adds that if schemes are underfunded, it will create additional drag on the funding level rate. She explains: "In a scheme scenario of 3% negative net cashflow and a funding level rate of 90%, you will probably expect to see funding levels fall by around 0.33 percentage points each year. That might seem small but, at a time when funds are already struggling to repair deficits, it counts over the longer term.
"Cashflow-driven investing doesn't obviate the need for liability-driven investment (LDI), rather it works alongside it. It also uses credit as a venue for duration hedging, lifting some of the burden of that task from traditional LDI strategies and accordingly reducing reliance on leverage to hedge duration."
According to Kelly-Scholte, the types of assets that should be considered for a CDI strategy are high quality credit in order to capture cashflow. Alongside this, she says schemes should be looking at "income-generating assets" which include "private lending, commercial mortgage loans, and emerging market debt".
All of these, she concludes, have a role in helping deliver a base level of income that can go towards servicing cashflows. She says: "It's about finding the right balance and ensuring you're servicing the cash flow but also having capital to put into those long-term return opportunities."
Click here to learn more about how Kelly-Scholte makes the case for cashflow-driven investing at a time when most schemes are underfunded and need to grow their investment returns to meet future liabilities.