CDI – Certainly Delivering Inflows

Although the focus of CDI is often on meeting assumed liability outflows, in reality it is all about securing the asset inflows.

04/03/2019
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Authors

Jon Exley
Head of Solution Innovation

One of the reasons why Cashflow Driven Investment (CDI) gains attention is that it benefits from a simple and intuitive explanation around arranging assets to meet liability outgo. However, this simple explanation alone doesn’t really distinguish CDI from many other pension fund investment strategies. After all, the investment objective of nearly every pension fund is to “meet the liabilities as they fall due”.

As a result, the simple explanation is easily critiqued. Unfortunately, this can deflect focus away from the real benefits of CDI as an investment strategy, which is the greater certainty of asset inflows. Liability driven investment (LDI) then complements CDI by matching liability outgo.

Traditional example of meeting liability cashflows

Let’s start with a traditional investment strategy consisting of equities and gilts. Importantly we will ignore risk initially and just work in terms of an expected outcome. To generate a strategy which is expected to “meet the liabilities as they fall due”, we apply an equity allocation strategy which disinvests uniformly over 20 years. Based on assumed equity and gilt returns, all of the liabilities are paid as they fall due out of the projected fund without running out of money for a typical scheme shown below in Figure 1:

Figure1

 

Our assumed equity disinvestment plan in this solution actually generates more cash than required to meet benefit outgo in the early years, while in the later years the equity disinvestment alone isn’t sufficient. This isn’t a problem though; in the early years the excess cash is invested in gilts to meet later cashflows and in the later years the pension outgo is met from both equities and gilts or just gilts.

Moving on to CDI strategies

To get from a traditional equity and gilt strategy to a CDI strategy, we would replace the equity allocation with a different (typically higher) allocation to fixed income assets held on a “buy and maintain” basis. This is illustrated below in Figure 2 with the asset cashflows separated between gilts and non-gilts.

Figure2

As with our previous example, the non-gilt portfolio does not need to match the liability cashflows. The gilt portfolio fills gaps and mops up excess asset inflows through reinvestment. Instead, as above, the non-gilt portfolio is designed to meet the client preferences in terms of risk
profile and deliver the overall quantity of cash required without worrying about precise timing.

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Authors

Jon Exley
Head of Solution Innovation
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