This is why there is an issue. While LDI meets your liquidity requirements by ensuring there’s always something that you can pay your cash-flow from, if you are cash-flow negative and you have a massive amount of CDI on your balance sheet and there is a default…it could be painful. That’s why everybody is saying that you need interaction with the LDI and CDI portfolio to optimise the illiquidity budget. Payne: It depends how important within the organisation matching valuations is. I have a number of private company schemes which are not so worried about that, so they have a different set of objectives. They are much more worried about saying: “Right, we have done our calculations with the actuary and we have to produce a 4% return from our assets.” You have a ladder of risk which you can run through your assets, some of which are illiquid, but you do not want to be selling illiquid ones at the wrong time. So there is a different way of looking at this. Mijakowska: CDI is popular at the moment. The not so well-funded schemes have a challenge in that if they want to invest in low-yielding assets and implement a CDI portfolio it will lock them into an outcome, which means they will not satisfy the ultimate objective of a pension scheme. It is striking a balance between having cash-flow at the front-end, so you are not worried about cash-flow problems, and having enough cash to invest in things that will generate the return to close your funding gap.
Payne: One of my schemes was an early adopter of PFI assets, property, things like that, all of which produce a sensible yield. If you produce layers of those types of assets where you can broadly predict the yield, you need to overlay cash generation on top of that to meet your liabilities. It is not that absolutely everything has to be corporate bonds at the front-end. There are other assets out there generating good cash-flows which are suitable for portfolios. It is just a matter of trying to build a portfolio with a range of these assets which meet your return and cash requirements. Greaves: There is a spectrum. Good investment strategies are exposed to the widest opportunity set that your expertise and governance budget can handle. So we look at assets like ground rents, life- time mortgages and long-lease commercial prop- erty as sensible assets that we want to build critical mass in because one day they might be suitable for CDI. For now, they are an important part of a diversi- fied portfolio. They provide more certainty of return over a 10 to 20-year horizon and that is attractive. Atkin: If you want to build as diversified and as good quality a portfolio as you possibly can, then take as long a time to build it; you will be able to carefully pick your entry point. If you tell your in-house team or external manager to only buy what’s good value, then over time you end up with a diversified portfolio of high quality cash- flows. If you try to solve it all in one go by building a CDI portfolio in 12 months, you are probably going to be forced towards poor value, in at least some asset classes. Mijakowska: You can only do that if you are going for self-sufficiency. If you have a five-year plan to buyout, for example, you don’t have that time. Critically, if you are going for buyout you probably wouldn’t be that creative with your asset allocation because insurers are quite fussy over what they want to take. They would love cash and maybe gilts. Halfon: Time is the crucial variable here. If you can be patient, if you can invest for 10, 15 years, you
Kate Mijakowska
10 March 2019 portfolio institutional roundtable: CDI
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