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The case for defensive equity income Adapting to the times, a ‘satellite’ allocation to higher yielding assets like defensive equity income can provide diversification benefits. They could be considered alongside more traditional CDI assets as part of a medium to long-term strategy. Over the long term, defensive equity income strategies can improve risk- adjusted returns through: – reliable income streams – reduced volatility – reduced drawdowns during crises; and – equal or better performance than cap-weighted equity benchmarks
Relative to the alternative option of meeting cash-flow needs by distributing income from existing equity mandates, some pension funds prefer this approach due to the higher dividend yields and the other mentioned benefits.
In recent weeks some companies have suspended their dividends to preserve the long-term viability of their businesses. While main- taining similar levels of dividends will be difficult in this environ- ment, the most significant advantage of holding a global portfolio of defensive equity income is diversification. More generally, they could also be considered by underfunded pension schemes as part of their journey plan towards an end- game strategy. These assets could be part of a ‘growth CDI’ sleeve, before transitioning to a low-risk CDI strategy when they reach their long-term self-sufficiency or buyout target.
ESG – not just for bull markets
CDI strategies that rigorously apply ESG principles should experi- ence better risk-adjusted returns during stressed markets and over the longer term. For example, more resilient CDI strategies have little exposure to carbon-intensive businesses such as travel, oil and energy, which have recently been severely affected by travel restrictions and the steep decline in economic activity around the world. Pension funds that invest in CDI strategies with an inte- grated ESG approach geared towards enhancing returns and reducing risks (i.e. not only focused on negative screening) are likely to be more successful over the long term.
Conclusion
Despite crises, DB pension funds that have adopted diversified CDI strategies for most of their portfolio can progress towards their endgame while paying members’ benefits out of income. These volatile market conditions could also offer opportunities to lock into higher yielding income generating assets. This could help meet cash-flow needs and ease current funding challenges. Although it takes time to set objectives and strategy for a CDI so- lution, pension funds should be engaging with asset managers now to mitigate risks and, where possible, take advantage of opportunities in the market.
Important Information
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April 2020 portfolio institutional roundtable: CDI
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