Executives at pension funds, money management firms and consultants are increasingly focused on cash flows, as defined benefit plans mature and face the prospect of having to sell assets to satisfy cash calls.
Sources said the issue is particularly acute in the U.K. and the U.S., with aging populations and the natural cycle of a pension fund reaching, and in some cases at, an inflection point.
“We are seeing more and more schemes beginning to adopt a cash flow focus,” said Calum Cooper, Glasgow, Scotland-based partner and head of trustee consulting at Hymans Robertson LLP. “It is a healthy complement to looking at what balance sheet growth and protection a pension fund needs.”
“This is also a trend in the U.S., where there are an increasing number of public defined benefit systems moving into a negative cash flow situation,” said Steven J. Foresti, chief investment officer at Wilshire Consulting in Santa Monica, Calif.
Research last year by Goldman Sachs Asset Management showed 82% of S&P 500 companies' defined benefit funds are cash flow negative, and a study of U.K. FTSE 350 funds showed 57% are cash flow negative.
Further, the Office for National Statistics' latest data show a £31.1 billion ($38.8 billion) net disinvestment by U.K. institutional investors in the 12 months ended Sept. 30.
Sorca Kelly-Scholte, Europe, Middle East and Africa head of pensions solutions at J.P. Morgan Asset Management in London, said it could mean investors are liquidating assets to service negative cash flows; they might also be parking assets in cash to lock in high equity returns, or in anticipation of other opportunities. However, she added: “We are now on the cusp of seeing many funds going into negative cash flow.” A bounce in inflation over the next year or two could “be the final thing that tips it over the edge,” she added.
The issue is exacerbated in the U.K. by increased flexibility in the retirement market, with participants no longer needing to purchase an annuity to provide income in retirement.
“That in itself introduces more cash flow volatility,” Mr. Cooper said. “You are never going to be able to anticipate perfectly what cash flows you need — that is why it is important to make realistic assumptions,” and, doing so using a live stream of data from administrators and looking quarterly at cash flows to ensure there is no forced selling of assets.
Consultant Mercer Investments is also seeing the trend. “It is unsurprising that cash-flow-driven investment is becoming more popular — especially for trustees that want more of a focus on the payment of benefits and less on mark-to-market risk,” said Tim Banks, London-based senior fiduciary consultant at the firm. “It is an intelligent way to invest if you are targeting self-sufficiency rather than a buyout.”
Mercer has a number of clients already using this focus, with a strategy designed against an individual fund's cash flow needs. “In 2016, which was a very turbulent environment for scheme funding, our clients' funding levels were impressively boring,” added Mr. Banks.