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Some solace in improved funding positions, but is it enough?
In contrast, the Cashflow-driven Investing (CDI) Flash 2020 Report produced for abrdn highlights the main risks in CDI are cashflow matching and longevity, as CDI is designed to generate predictable cashflows to pay benefits as they fall due. As a result, CDI hedging is done through the selection of long-dated assets like credit.These two charts are telling of two things:
Liquidity is key to efficient operational execution
The Work and Pensions Committee (WPC) found the complexities of recapitalising fund structures were the ’key cause of LDI market turmoil’ in late 2022. In the unprecedented volatile environment, collateral calls were made which can put an extraordinary amount of stress on operational processes.
In this context, the LDI Report finds efficient execution and fees to be the most valued characteristic in LDI managers, with good reason.
Our report also shows that small schemes prefer to access LDI through pooled funds whereas larger schemes favour segregated mandates.Pooled LDI funds were most impacted in 2022, although only making up 15% of the market. They are less equipped to handle collateral calls as their leveraged and unleveraged investments may not be under the same manager. This creates a cashflow negative environment that forces them to sell assets to transfer money back into the fund. A forced sale in a declining market furthers a downward spiral, causing many to enter emergency arrangements to secure capital.
mallowstreet’s research supports this sentiment. At only 11%, low capital requirements was not a valued characteristic of LDI managers based on data from 2020.
Of these 11%, all schemes hired their LDI manager based on their ability to fulfil the low capital requirement. This suggests that few have this characteristic on their radar, but those that do consider it key to selecting LDI managers.
Now, to meet the stresses of the gilt market, LDI funds must have a minimum of 250bp level of resilience.
But what else can trustees and fund managers do?
Utilising CDI solutions to counteract the liquidity problem
Long-dated assets like credit appeal to CDI as generating cashflow does not depend on fluctuations in valuations, as revealed by mallowstreet’s CDI 2019 Report with AXA Investment Managers. Any potential losses from credit or duration risks can be recouped if they do not affect coupon payments.