Schemes in that situation can look to lock down the remaining flightpath with a CDI strategy to get more certainty of outcome. Julien Halfon: Illiquid credit is not what would be defined as purely cash-flow driven investing; it can be much shorter term, too. SME loans, for example, can be three or four years. They are not matching assets or cash-flow driven assets, but will generate an excess return of sometimes 6%, 7% or 8% above Libor. If you have a larger liability driven investment (LDI) portfolio that has a negative real yield, having some- thing that can balance the returns, diversifies risk and has a duration of three, four or five years is a risk worth taking. Exley: It is the increased certainty of return over that horizon. You are locking into an asset that through income and redemption will secure that return over the holding period. John Atkin: Being the asset management arm of an insurer, people come to us and say: “We can’t help but notice that a mature, closed pension scheme which is reasonably well funded looks an awful lot like an annuity book; we’ll have one of those, please.” You then have to explain that that took decades to build and when it comes to implementation, we haven’t found two schemes whose approach to cash-flow driven investing is the same. Everyone has different starting positions in terms of their sponsor, their liabilities and their funding. So most cash-flow strategies are bespoke.


PI: So what approaches are asset owners taking to build these portfolios? Ghosh: We have looked at what insurers do and thought about how we can capture those opportunities without having the capital requirement regulations that they face. So, for example, using shorter-dated cash-flows where there is a good risk-return profile and accepting that we take reinvestment risk as we deliver our cash-flow strategy. Atkin: It is also avoiding the areas that the insurers are playing in. When you have large life insurers dominating the bids for long-dated infrastructure, for instance, the value is not there. Locking into some of those cash-flows for 20 or 30 years at poor value is a mistake you will live with for a long time. Exley: Schemes using CDI fall into two distinct categories. Some are basically acting like an insurer in looking to build a self-sufficiency portfolio to hold long-term. Then there are schemes that are relatively mature and well funded but cannot afford to buyout yet. In 10 years’ time, pretty much all of their mem- bers will be pensioners so they are looking for a strategy to deliver certainty of return over that period to deliver a portfolio value sufficient to achieve buyout. That is where the shorter-dated higher yielding fixed income assets come in to deliver the required returns in the early years before rolling off as they mature to leave a portfolio of gilts and investment grade fixed income. These schemes are not trying to build a 30-plus year illiquid strategy. Giles Payne: There are schemes out there that require growth but need to protect those long assets to avoid becoming a forced seller. So you need to be able to predict what your front-end is going to produce so cash-flows are met as they arise. Then the long-end is protected because a lot of people are looking to get additional returns out of illiquids, but you don’t want to be selling them at the wrong point in time. Halfon: You have long-dated gilts, which may have negative real yields, and you have shorter-dated corporate bonds which give about 150bps on average above gilts. So technically you have either zero or slightly positive real yields.


What is missing is that between the maturities of 10 and 30 years there’s nothing in the corporate world. In some ways, long-dated leases and infrastructure debt meet that deficiency. The market has not yet found anything liquid that can provide excess return and maturity at the same time. So in the search for yield, the long dated excess return box was not filled until people started to realise that they could monetise the illiquidity premium by looking at longer-dated illiquid debt.


PI: What kind of assets are we talking about? Halfon: The two longest dated assets are technically infrastructure debt and commercial real estate debt, which could be pure debt or leases.


March 2019 portfolio institutional roundtable: CDI 7


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