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Build your own annuity book with cash-flow matching solutions
Jeremy Richards, fund manager, M&G Investments
For many pension schemes and trustees, the ever-more pressing challenge is not only meeting cash-flow liabilities now, but also into the future. Planning to pay out the right amount of cash at the right time not only creates challenges in terms of generating the level of cash necessary, but also in how to weather changing market dynamics to deliver these required cash-flows over the long term. This is an issue that affects a vast number of schemes. According to Mercer’s European Asset Allocation 2018 survey, six out of 10 plans were already cash-flow negative and, of those that were not, 80% expect to be so within the next 10 years.
Some schemes could consider a fully insured buy-out, but this is often unaffordable. Therefore, aiming for self-sufficiency by matching cash-flows over time could be a solution. After all, a healthy, self-suffi- cient scheme could always consider insured options at a later stage.
Building a bespoke annuity book The approach of matching cash-flows to liabilities as they fall due is similar to how an annuity book is run, which is one of the reasons why many pension schemes are asking how our own annuity book, managed for our insurer parent, has delivered over decades. We believe it necessitates being flexible and asset-agnostic, as well as being patient and disciplined when building a portfolio.
Primarily using physical assets to match liabilities can help a scheme reach a different kind of certainty, rather than hedging risk via swaps alongside a growth portfolio. Exposure to physical assets, such as through secured debt, can offer another way to address some of the risks that are met with traditional LDI portfolios, such as interest rate risk. Infrastructure debt, for example, can offer long-dated cash- flows, with debt being repaid over 20 to 30 years, while they are usually inflation-linked and predictable, with contracted payments often derived from well-regulated entities.
Predictability of cash-flows is a feature that lends itself to a cash-flow matching portfolio and flexibility to access public and private financing can allow schemes to, in effect, build their own bespoke, commer- cially-efficient annuity book.
Asset in focus: Alder Hey Children’s Hospital, Liverpool, UK M&G Investments provided funding for the re-development of Alder Hey Children’s Hospital
Annuity-like repayment profile provides stable cash-flows from the NHS trust Conservative covenant package provides lender protection Structure provides credit support and additional security
20 March 2019 portfolio institutional roundtable: CDI
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