you put that into a fund structure it is still going to limit access for people who can’t put on the table a £50m ticket to get in. It is not only the fact that you need an in-house team, it’s that the asset class itself does not lend to meeting the requirements of small schemes. Exley: If a pension scheme arrives in 10 years’ time and doesn’t buyout it would be invested in gilts and matching investment-grade credit. So it is also a solution that could apply as a self-sufficiency strategy, but these schemes wouldn’t necessarily lock themselves into illiquid assets such that if they wanted to buyout in 10 years’ time they would have difficulty transferring those across. The relatively low governance costs of smaller schemes sitting in investment-grade credit and gilts in 10 years’ time would also make this a reasonable solution. Payne: Looking at an end portfolio of long-dated gilts and credit is aspirational for a lot of schemes. A good number of clients that I work with would not be looking to fund schemes to that degree of certainty. Their definition of self-sufficiency will be quite different to gilts-flat. We have to be realistic about the types of portfolios which a lot of the small schemes are going to be looking to run. They will need to carry running a degree of risk and relying on the sponsor to an extent as well. Exley: That’s why CDI is not about negative cash-flow. There are lots of schemes that are in negative cash-flow that aren’t running CDI strategies. You have lots of under-funded schemes in negative cash-flow that are going to have to adopt the sort of strategy that you are talking about. CDI, to me, is for relatively well-funded mature schemes that are looking to a strategy of attaining self- sufficiency funding on a relatively conservative basis or buyout in something like 10 years’ time. If we are not careful, we are just going to stray into a general discussion about investment strategy for pension schemes just because all pension schemes are cash-flow negative. Payne: That doesn’t mean that those schemes aren’t cash-flow aware in the way that they invest and they aren’t aware that they need to have cash in the right place at the right time. Our job is to pay benefits on time to the right people, so cash generation is absolutely important. We know that when there’s a market shock there is no liquidity, so you don’t want to be relying on sell- ing assets at those times. We need to have assets which are producing cash-flow to pay the benefits at those times. That is just as valid a way of looking to cash-flow driven investing as it is to say: “Right, we have to lock everything down, sit here and let it pay its way out. So as the cost of buyout comes down with the maturity of a scheme, we can then buyout.” Exley: I agree with you, except when I started in investment 30 years ago the objective of a pension scheme was to meet its cash-flows as they fall due. There is nothing new about the idea of investing to meet cash-flows. What we are talking about is something slightly different for schemes that are in a position now to lock things down by investing in fixed income assets with more certainty of outcome. Payne: Historically people sold assets to produce cash, but there has been a realisation since 2008/09 that we can’t rely on that going forward. There are all sorts of issues, such as sequencing risk, that need to be built into portfolio construction as well. That is cash-flow aware investing.


14 March 2019 portfolio institutional roundtable: CDI


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