A fully invested CDI strategy can be a perfectly sensible strategy for pension schemes that are well funded on a low-risk basis (such as a risk free plus about 0.5% to 1% annual discount rate), have a higher degree of certainty on their benefit outlays and/or a strong employer standing behind the schemes through harder times.
Arguably, the precise yield achieved on CDI assets matters less for schemes that can afford to meet benefit payments based on the yield on offer. Moreover, investing in non-CDI strategies introduces risks that better-funded schemes do not necessarily need to take if they can meet their objectives with CDI strategies.
That said, there are several schemes for which CDI strategies would be unsuitable. Schemes that still require significant returns should continue to look at the overall portfolio and manage risk holistically — and not let the desire to implement a CDI strategy distract them from achieving their overall objectives.
Trustees should not lie awake at night worrying if they don't have a CDI strategy in place to meet benefit payments as they fall due. Assuming the scheme holds sufficient liquid growth assets, it can always sell return-seeking and liability-driven investing assets or sell return-seeking and LDI assets (noting that LDI assets typically consist of liquid instruments such as cash, gilts, interest rate and inflation swaps) to fund pension payments.
Pension plan trustees should be aware of the potential pitfalls of deploying a CDI strategy, which might result in schemes not meeting benefit payments as intended. Fixed-income assets with credit risk may experience higher defaults than expected; benefit payments could rise above expectations due to shifting mortality rates or as a result of incomplete member data; inflation-linked assets might not precisely hedge pension schemes benefit structures (e.g., capped and floored benefits), while credit risks can be more complex to model, resulting in unexpected asset cash flow profiles.
While CDI can deliver more predictable outcomes relative to other investment strategies, it can also reduce schemes' flexibility to manage unexpected outcomes (some of which have been listed above) without further support from sponsors. Trustees should not forget that reliance on sponsors may still be required even in a fully invested CDI strategy. This reliance presents particular challenges for schemes where the sponsors' strength may deteriorate over time.
On a related but separate note, for those schemes that are within striking distance of a buyout, holding illiquid assets as part of a CDI strategy could complicate the process. So trustees need to be clear on their time horizons for a buyout of the entire scheme.