P-Solve: Cashflow negative, don’t worry about it!
Ajeet Manjrekar, co-Head of P-Solve, analyses the risk to pension schemes of being cashflow negative in the current environment.
Cashflow negativity is the topic du jour. But, we question how material is this risk to pension schemes today versus other challenges they face. Are schemes really in the position to be matching out specific tranches of their cashflows? It is important to understand the impact and strain this may place on the rest of the pension scheme assets.
A lot has been said about the risks that DB pension schemes increasingly face from becoming cashflow negative. This has been coupled with concerns of being forced sellers at inopportune times, for example during a period of market stress. This is an issue, but are we underestimating the inherent liquidity profile of most DB investment portfolios?
First of all, being cashflow negative is an eventual reality for all pension schemes if they are closed to new members and future accrual, but how material is this risk to the scheme today that requires explicit action to match future cashflow payments.
One could lock up a proportion of the assets to explicitly take this risk away and match the next 10-15 years of pension payments. However, that may leave the scheme with less money to generate return, particularly if you also look to incorporate liability hedging.
We therefore conducted some analysis to evaluate the impact of a sustained period of asset falls (5% p.a. over three years) on four typical pension schemes of different maturity (33 years, 25 years, 15 years and 10 years of duration) – how much extra return would they each need to get back on track.
Source: P-Solve Investments Limited
This analysis highlights that for many schemes, the impact of being cashflow negative has little bearing versus the larger risk of market shocks and needing to work the scheme assets harder. The exception is for very mature schemes, where they may have passed their peak total asset value. Yet this is less than 5% of UK pension schemes today.
So, focusing on investment return and the risks that may “blow you off course” is essential in order to truly address cashflow negativity further down the line when you may really need to.