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Balancing act

Balancing act

Charlotte Moore
Friday 15th December 2017

Pension funds are struggling to deal with inadequate cash-flows and rising deficits. Charlotte Moore takes a look at how to stop schemes blowing up.

“If a scheme focuses just on an asset’s ability to generate cash-flow, it could end up investing in assets which do not meet its other goals.”

Vivek Paul, Blackrock

The risk burden on UK pension schemes keeps increasing. As well as narrowing the funding gap and managing interest-rate and inflation risk, schemes have to deal with negative cash-flows. Balancing these competing demands can be tricky.

Negative cash-flows reflect the maturity of most UK pension schemes. With many closed to new members and to future accrual, the ratio of retired members to the active or deferred population is increasing. That means schemes will soon have to pay more in benefits than they will receive in contributions.

Benefit payments outstripping contributions is a relatively recent phenomenon: over the past decade the majority of schemes have been cash-flow positive.

Gatemore managing director Mark Hodgson says: “Schemes have had significant contributions from sponsoring employers to help reduce deficits.”

In addition, decreasing bond yields have led to an absence of margin calls for cash from liability-driven investment (LDI) providers. But as contributions reduce and further calls on capital become possible, there is a greater likelihood that pension schemes will become cash-flow negative.

This is a particular problem for pension schemes as they can ill afford to hold significant sums of cash. Legal & General Investment Management head of UK bespoke solutions Anna Troup says: “This can create a liquidity problem as they might lack the funds to pay benefits and expenses.”

Lacking the available cash, schemes may need to liquidate assets in order to meet those liabilities. But there is a danger this could unbalance the scheme’s investment strategy or increase other risks.

If a scheme found, for example, that it lacked the cash needed to meet its obligations; it might decide to sell a portion of its equity portfolio. However, disposing of growth assets might make it harder for that scheme to close its funding gap.

“And the scheme might be a forced seller of assets at a low price, which no investor wants,” Hodgson says.

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