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CDI: Certainly Delivering Inflows
Jon Exley, Solutions manager, Schroders
Although the focus of CDI is often on meeting assumed liability out- flows, in reality it is all about securing the asset inflows.
One of the reasons why cash flow driven investment (CDI) gains attention is that it benefits from a simple and intuitive explanation around arranging assets to meet liability outgo. However, this simple explanation alone doesn’t really distinguish CDI from many other pension fund investment strategies. After all, the investment objective of nearly every pension fund is to “meet the liabilities as they fall due”.
As a result the simple explanation is easily critiqued. Unfortunately, this can deflect focus away from
the real benefit of CDI as an investment strategy, which is the greater certainty of asset inflows. Liability driven investment (LDI) then complements CDI by matching liability outgo.
Traditional example of meeting liability cashflows Let’s start with a traditional investment strategy consisting of equities and gilts. Importantly, we will ignore risk initially and just work in terms of an expected outcome. To generate a strategy which is expected to “meet the liabilities as they fall due”, we apply an equity allocation strategy which disinvests uniformly over 20 years. Based on assumed equity and gilt returns, all of the liabilities are paid as they fall due out of the projected fund without running out of money for a typical scheme shown below:
-2 -1 0 1 2 3 4 5 6 7
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 52 54 56 58 60 62 64 66 68 70 Year
Payment from gilt portfolio Equity dividends Amortisation of equity portfolio Data and calculations for illustration only Investment in gilt portfolio Liability cashflows Source: Schroders
Our assumed equity disinvestment plan in this solution actually generates more cash than required to meet benefit outgo in the early years, while in later years the equity disinvestment alone isn’t sufficient. This isn’t a problem though; in the early years the excess cash is invested in gilts to meet later cashflows and in the later years the pension outgo is met from both equities and gilts or just gilts.
22 March 2019 portfolio institutional roundtable: CDI
Cashflow (£m)
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