Stream sponsored by: Media partner: BUILDING A CASHFLOW-ORIENTATED INVESTMENT STRATEGY SPEAKERS SORCA KELLY-SCHOLTE ROGER BOULTON HEAD OF EMEA PENSIONS CHAIR OF SOLUTIONS AND ADVISORY INVESTMENT COMMITTEE J.P. MORGAN ASSET MANAGEMENT BABCOCK INTERNATIONAL GROUP CHAIR MARK DUNNE EDITOR PORTFOLIO INSTITUTIONAL @MarkDunne2 APP POLLING SESSION
Q1. IS YOUR SCHEME CASH FLOW NEGATIVE, OR DO YOU EXPECT IT TO BECOME CASHFLOW NEGATIVE IN THE NEXT 5 YEARS? APP POLL
Stream sponsored by: Media partner: INTRODUCING CASHFLOW DRIVEN INVESTMENT SORCA KELLY-SCHOLTE HEAD OF EMEA PENSIONS SOLUTIONS AND ADVISORY J.P. MORGAN ASSET MANAGEMENT For professional clients / qualified investors only – not for retail use or distribution
BEING CASHFLOW NEGATIVE CREATES IMPORTANT CHALLENGES Funding Drag Volatility Administrative Burden Underfunded schemes pay out a Being a forced seller of assets locks in Identify and process required larger portion of assets than of losses and amplifies volatility transactions, suffer transaction costs liabilities and risk liquidity squeezes Rule of thumb: Rule of thumb: Rule of thumb: Drag ~ @ 10% surplus volatility, Beyond ~2% negative cashflow, Cashflow x % Deficit 5% negative cashflow adds interest, regular investment income Funding Level ~ 5% to Deficit VaR exhausted for most schemes For example, drag for a 90% For example, a plan with a For example, a plan with a funded plan with 5% negative deficit VaR of 70% will see negative cashflow of 5% can cashflow is ~0.55% per that fall to ~ 65% with 5% expect to have sell ~ 3% of annum negative cashflow assets per annum Source: J.P. Morgan Asset Management. For illustrative purposes only. Cashflow defined as cash income (not including investment income) less benefit outgo and expenses, expressed as a percentage of the plan’s assets.
MANY UK SCHEMES ARE, OR WILL SOON BECOME, CASHFLOW NEGATIVE Positive Net Cashflow as % Assets 0 Negative Accumulation Transition Runoff Positive cashflow: Modest negative cashflow: Deeply negative cashflow: Beyond -2% Accrual and deficit To -2% contributions Asset sales and principal Benefits paid from repayments needed to pay Benefits paid from contributions and benefits contributions investment income 47% of FTSE 350 schemes 24% of FTSE 350 schemes 29% of FTSE 350 schemes Source: J.P. Morgan Asset Management. For illustrative purposes only. Cashflow defined as cash income (not including investment income) less benefit outgo and expenses, expressed as a percentage of the plan’s assets.
CASHFLOW DRIVEN INVESTING Building your strategy to explicitly take account of cashflow needs SERVICE CASHFLOWS CASHFLOW DRIVEN INVESTMENT HEDGE LIABILITIES DELIVER RETURN Source: J.P. Morgan Asset Management. For illustrative purposes only.
AN ILLUSTRATIVE CASHFLOW DRIVEN INVESTMENT STRATEGY Ensuring Cashflows are met through asset liquidity Liability Cashflow Projection Income & Principal Buy & Maintain Credit Growth Equity and real assets Income Generation High yield, private credit, core real assets Duration Completion LDI and collateral Source: J.P. Morgan Asset Management. For illustrative purposes only.
PORTFOLIO BUILDING BLOCKS Securing the cashflows at a reasonable price Non Contractual Cashflow and Total Return Income & Equity income Growth Infrastructure Equity Real estate Contractual Cashflow and Enhanced Yield Core Plus Mortgages Infrastructure Debt Direct Lending High Yield and leveraged loans Core Secure Cashflow and Duration Management Investment Grade Emerging Market Debt Investment Grade Credit Gilts Cash & swaps Source: J.P. Morgan Asset Management. For illustrative purposes only. Mortgages includes Mortgage Backed Securities, Residential Mortgaged Backed Securities, Covered Mortgage Bonds and Real Estate Debt. High Yield Debt includes Emerging Market High Yield Debt
RESTRICTING TO STERLING MARKETS LIMITS OPPORTUNITIES Global markets offer greater depth at all durations Global Credit Universe Size Statistics 2500 UK Euroland 2000 US 1500 Number of issues 1000 500 0 5-10 1-5 10-15 >15 -500 Duration buckets Source: J.P. Morgan Asset Management, Bloomberg Barclays Point, as of 31 December 2017.
A MULTI-ASSET SOLUTION CAN PROVIDE THE RETURNS REQUIRED TO REPAIR FUNDING DEFICITS Domestic solutions do not provide the returns needed to repair deficits or build capital buffers 4.5% 4.0% Multi Asset Portfolio Solution 3.5% Expected Return Core + Core Plus - Global 3.0% 2.5% Core + Core Plus - Domestic 2.0% 1.5% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% Balance Sheet Volatility Source: J.P. Morgan Asset Management. For illustrative purposes only. The three solutions provide 15 years of cashflow matching and immunize the Plan’s balance sheet from changes interest rates along the curve. Analysis as at March 31, 2017. Core assets include UK Government Index Linked, UK/EUR/US Government bonds, UK/EUR/USD Government Related bonds, GBP/USD/EUR IG Corporate and USD-Issued IG Emerging Market Debt. Core Plus assets include GBP High Yield excluding financials, EUR High Yield, USD High Yield, US Commercial Mortgage Backed Securities, US Asset Backed Securities, US Collateralized Loan Obligations, US Real Estate Mezzanine Debt, Bank Loans and Direct Lending. Multi Asset instruments include Global hedge Funds, Emerging Market Equity, AC World Equities (MSCI World), Private Equity, Infrastructure Equity and UK Real Estate. Fixed Income expected returns based on currency and default-adjustments made to yield-to- worst values obtained from Barclay’s Point. Expected returns for non - Fixed Income assets are based on the 2017 Long Term Capital Market Assumptions. Covariance estimates are based on historical monthly or quarterly returns from Q3 2006 to Q2 2016 depending on the reporting frequency for the underlying asset class.
REFINING THE DERISKING JOURNEY From an ‘LDI + Growth’ Journey… …to a Cashflow -driven Journey Funding Level Funding Level Cashflow-driven Investing LDI CDI Growth Time Time Implicitly assumes that LDI assets are optimal means Focuses on securing cashflows at a reasonable price of securing cashflows, regardless of price using a broad range of assets Requires substantial use of leverage in the Reduces reliance on leverage in the middle phase middle phase Allows more holistic, balanced strategies to evolve Tends to ‘barbell’ strategies Source: J.P. Morgan Asset Management. For illustrative purposes only.
TAKE-AWAYS Cashflow driven investment A strategic mindset Trades off return, funding volatility and the need to service cashflows Not a product From early in the journey Majority of funds have to service cashflow now, and need to evolve their strategies accordingly First step is to start looking at strategy through a cashflow driven lens Credit at their core Accessing global credit markets is key In particular US credit markets
APPENDIX
TAKING THE FIRST STEPS Different options to start on the journey Build Income Build Buy & Maintain Build multi-asset hub Add yield oriented assets Adapt and expand credit portfolio Create cashflow driven hub Objective Objective Objective Diversify across assets with an Improve risk management without Create risk and cashflow income generation focus sacrificing yield management foundation, maintain specialist mandates Source: J.P Morgan Asset Management. The portfolio risk management process includes an effort to monitor and manage risk, but does not imply low risk.
LIQUIDITY MANAGEMENT Illustrative CDI Strategy 1 a. Delivery of cashflows 1 Liability Cash-flow b. Currency hedging Projection 2 Cashflow Amount 3 Corporate Bonds + 2 a. Commitment management Swaps Cash Equivalents b. Redemption planning Covered Bonds c. Reinvestment 3 Gilts + Swaps Emerging Market Debt Leveraged Loans Infrastructure Debt Gilts & CMLs Swaps RMBs Infrastructure Equity Direct CMBs Lending Real Estate 3 a. Collateralisation / margining 0 5 10 15 20 25 50 Time Source: J.P. Morgan Asset Management. For illustrative purposes only. CMLs = Commercial Mortgage Loans, RMBs = Residential Mortgage Backed securities, CMBs = Commercial Mortgage Backed securities.
SUCCESS METRICS More than excess return Versus benchmark Preserve yield Versus liabilities Enhance yield Return Yield Cashflow Stability Deliver cashflows Maintain duration Manage liquidity Stabilise funding Source: J.P. Morgan Asset Management. For illustrative purposes only.
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