managing liquidity for defined benefit pension schemes · managing liquidity for defined benefit...

Managing liquidity for

defined benefit pension schemes

Martijn de Vree

Insight Investment

13 September 2016

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Agenda

Liquidity management for defined benefit (DB) pension schemes

Is it an opportunity?

What does ‘liquidity’ mean?

2

1

3


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sell an asset without

causing a drastic change in

the asset’s price”

What is liquidity?


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What does a liquid market look like?

Counterparty

• More counterparties

• Frequent pricing

• Easy price discovery/execution

Pricing

• Not sensitive to size

• Small difference between the price to buy and sell

(the ‘bid-offer’ spread)

Depth • Can deal during good and bad times

• Counterparty able to ‘warehouse’ risk


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Intermediary

The role of intermediaries

Buyer A

Seller

Buyer B


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The negative impact of regulation

The Volcker Rule

• Limits proprietary trading by banks

• Diminishes banks’ ability to step in and intermediate in challenging

market environments

Capital requirements and leverage ratios

• Regulatory push for balance sheet strength to make banks safer and

prevent future crisis

…likely path is towards more regulation not less


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0

2

4

6

8

10

2010 2012 2014 2016

Num

ber

of

quote

s p

er

bond

Intermediaries less willing to provide liquidity

US dealer inventories

Average number of quotes per

corporate bond trade

Source: Markit iBoxx, Morgan Stanley Research. Data as at January 2016.

0

50

100

150

200

250

2010 2012 2014 2016

$b

n


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0

5

10

15

20

25

30

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

(%)

Government bond liquidity

Sovereign debt held by central banks

Source: IMF, Deutsche Bank. Data as at June 2016. Chart shows percentage of total sovereign debt held by each country domestic

central bank.

UK

Japan

US

Germany


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Agenda




2

1

3


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Gold

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Mid blue

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Light grey

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Pea green

R121 G163 B42

Forest green

R0 G132 B82

Bottle green

R17 G179 B162

Cyan

R0 G156 B200

Light blue

R124 G179 B225

Violet

R128 G118 B207

Purple

R143 G70 B147

Fuscia

R233 G69 B140

Red

R200 G30 B69

Orange

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Factors influencing pension scheme liquidity

Assets

• Income from assets

• Trading frequency

• Dealing spreads

• Market impact

• Timing of selling

Liabilities

• Status of scheme

• Contributions

• Timing of outflows

• Net cash flow position

• Member options and

transfers


presentations

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Light grey

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Forest green

R0 G132 B82

Bottle green

R17 G179 B162

Cyan

R0 G156 B200

Light blue

R124 G179 B225

Violet

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Non-contractual versus contractual assets

• Short-term volatility does not capture certainty of returns

• Focus on investment outcome through contractual growth assets

• Assets with contractual returns have a role to play

For illustrative purposes only.

Non-contractual assets Contractual assets

Return Return

Time Time


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Violet

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Fuscia

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Change in value (assuming £1 of

initial investment)

£500m portfolio factoring in £25m

‘forced selling’ each year

0

1

2

1 6 11 16 21 26 31

Accum

ula

ted v

alu

e (

£)

Year

0

100

200

300

400

500

600

1 6 11 16 21 26Pro

jecte

d a

sset valu

e (

mill

ions)

Year

The impact of forced selling


Strategy A

Strategy B

Strategy A

Strategy B


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R124 G179 B225

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R143 G70 B147

Fuscia

R233 G69 B140

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Orange

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What is required?

• A shift from focussing on risk,

returns and balance sheet …

• … to cash flow driven investment,

with liquidity being a central

consideration

• Develop a plan for cash flow

management considering assets

and liabilities sides

• Use scenarios to consider liquidity

buffers

• Timing of returns is important


Retu

rn

Risk

Traditional risk vs returns


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Cash flow management in practice

Redemption

and coupon

Planned de-risking

(unforced selling)

Meet

requirements

Re-invest

excess

liquidity

15

Liquidity

buffer Pay benefits

Other

risk assets Contractual

returns


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Ideal position

16

Income from assets +

liquidity buffer

Cash flow required

• Avoid forced selling as timing of returns is important

• Sufficient but not excessive buffer under most circumstances

• Ability to re-invest in current opportunities


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R17 G179 B162

Cyan

R0 G156 B200

Light blue

R124 G179 B225

Violet

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Purple

R143 G70 B147

Fuscia

R233 G69 B140

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Orange

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Use investment toolkit available

• Liquid assets

• Use repo to generate cash

• Cash plus assets

• Maturing assets

• Physical equities replaced with

‘synthetic’ equities

• Physical credit can be replaced with

‘synthetic’ instruments

• Use single collateral pool


Index-linked gilts, gilts and cash

Equities

Corporate bonds

Maturing assets

Cash plus


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Cyan

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Violet

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Purple

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Fuscia

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Orange

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Dealing with lower liquidity?

• Focus on cash flow management

• Investing in maturing assets

• Use investment toolkit available


presentations

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Light grey

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Pea green

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Forest green

R0 G132 B82

Bottle green

R17 G179 B162

Cyan

R0 G156 B200

Light blue

R124 G179 B225

Violet

R128 G118 B207

Purple

R143 G70 B147

Fuscia

R233 G69 B140

Red

R200 G30 B69

Orange

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Dark grey

R63 G69 B72

Agenda




2

1

3


presentations

Dark blue

R17 G52 B88

Gold

R217 G171 B22

Mid blue

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Light grey

R63 G69 B72

Pea green

R121 G163 B42

Forest green

R0 G132 B82

Bottle green

R17 G179 B162

Cyan

R0 G156 B200

Light blue

R124 G179 B225

Violet

R128 G118 B207

Purple

R143 G70 B147

Fuscia

R233 G69 B140

Red

R200 G30 B69

Orange

R238 G116 29

Dark grey

R63 G69 B72

Use illiquid assets to meet liquidity needs Structure a ‘maturity ladder’ of illiquid assets

For illustrative purposes.

Cash

0

50

100

150

1 2 3 4 5 6 7

Cash flo

w n

eed (

£m

)

Years to maturity 0

50

100

150

1 2 3 4 5 6 7

Cash flo

w n

eed (

£m

)

Years to maturity

Asset matures in 2 to 4 years

Asset matures

in 5 to 6 years

Asset

matures

in 7 years


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R17 G179 B162

Cyan

R0 G156 B200

Light blue

R124 G179 B225

Violet

R128 G118 B207

Purple

R143 G70 B147

Fuscia

R233 G69 B140

Red

R200 G30 B69

Orange

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Investment grade High yield

0

150

300

450

600

750

AAA A BBB BB

Spre

ad o

ver

3 m

onth

Lib

or

(bp)

Attractive risk-adjusted returns Giving up liquidity can improve returns

Source: Insight. Data as at 30 June 2016. The spreads shown are for illustrative purposes and actual results may differ.

+340bp

Less liquid credit

Corporate bonds


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Bottle green

R17 G179 B162

Cyan

R0 G156 B200

Light blue

R124 G179 B225

Violet

R128 G118 B207

Purple

R143 G70 B147

Fuscia

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Red

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Orange

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Examples of less liquid credit Public and private asset backed securities

• Residential mortgage

backed securities

(RMBS)

• Buy-to-let RMBS

• Non-conforming

RMBS

Residential and

consumer

• Mortgage warehouse

• Bridge lending

• Auto/credit card

warehouse

Commercial real estate Secured corporate

Pu

blic

• Office

• Retail

• Hotel

• Corporate loan

warehouse

• SME warehouse

• Collateralised loan

obligations (CLO)

• Whole business

securitisations (WBS)

• Collateralised

mortgage backed

securities (CMBS)

Pri

vate


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R0 G132 B82

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R17 G179 B162

Cyan

R0 G156 B200

Light blue

R124 G179 B225

Violet

R128 G118 B207

Purple

R143 G70 B147

Fuscia

R233 G69 B140

Red

R200 G30 B69

Orange

R238 G116 29

Dark grey

R63 G69 B72

Summary

• Liquidity in financial markets has decreased

• Pension schemes can deal with lower liquidity through:

• Attractive opportunities are available to those managing liquidity

well

• Focus on cash flow management

• Investing in maturing assets

• Use investment toolkit available


presentations

Dark blue

R17 G52 B88

Gold

R217 G171 B22

Mid blue

R64 G150 B184



Light grey

R63 G69 B72

Pea green

R121 G163 B42

Forest green

R0 G132 B82

Bottle green

R17 G179 B162

Cyan

R0 G156 B200

Light blue

R124 G179 B225

Violet

R128 G118 B207

Purple

R143 G70 B147

Fuscia

R233 G69 B140

Red

R200 G30 B69

Orange

R238 G116 29

Dark grey

R63 G69 B72

13 September 2016 24

The views expressed in this [publication/presentation] are those of invited contributors and not necessarily those of the IFoA.

The IFoA do not endorse any of the views stated, nor any claims or representations made in this [publication/presentation]

and accept no responsibility or liability to any person for loss or damage suffered as a consequence of their placing reliance

upon any view, claim or representation made in this [publication/presentation].

The information and expressions of opinion contained in this publication are not intended to be a comprehensive study, nor

to provide actuarial advice or advice of any nature and should not be treated as a substitute for specific advice concerning

individual situations. On no account may any part of this [publication/presentation] be reproduced without the written

permission of the IFoA [or authors, in the case of non-IFoA research].

Questions Comments


presentations

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R17 G52 B88

Gold

R217 G171 B22

Mid blue

R64 G150 B184



Light grey

R63 G69 B72

Pea green

R121 G163 B42

Forest green

R0 G132 B82

Bottle green

R17 G179 B162

Cyan

R0 G156 B200

Light blue

R124 G179 B225

Violet

R128 G118 B207

Purple

R143 G70 B147

Fuscia

R233 G69 B140

Red

R200 G30 B69

Orange

R238 G116 29

Dark grey

R63 G69 B72

Notes

This is a marketing document intended for professional clients only and should not be made available to or relied upon by retail clients. Unless otherwise stated, the source of information is Insight Investment. Any forecasts or opinions are Insight Investment’s own at the date of this document (or as otherwise specified) and may change. Material in this publication is for general information only and is not advice, proper advice (in accordance with the UK Pensions Act 1995), investment advice or recommendation of any purchase or sale of any security. It should not be regarded as a guarantee of future performance. The value of investments and any income from them will fluctuate and is not guaranteed (this may partly be due to exchange rate changes) and investors may not get back the amount invested. Past performance is not a guide to future performance. This document must not be used for the purpose of an offer or solicitation in any jurisdiction or in any circumstances in which such offer or solicitation is unlawful or otherwise not permitted. This document should not be amended or forwarded to a third party without consent from Insight Investment.

Telephone calls may be recorded.

For clients and prospects of Insight Investment Management (Global) Limited:

Issued by Insight Investment Management (Global) Limited. Registered in England and Wales. Registered office 160 Queen Victoria Street, London EC4V 4LA; registered number 00827982.

For clients and prospects of Insight Investment Funds Management Limited:

Issued by Insight Investment Funds Management Limited. Registered in England and Wales. Registered office 160 Queen Victoria Street, London EC4V 4LA; registered number 01835691.

For clients and prospects of Pareto Investment Management Limited:

Issued by Pareto Investment Management Limited. Registered in England and Wales. Registered office 160 Queen Victoria Street, London EC4V 4LA; registered number 03169281.

Insight Investment Management (Global) Limited, Insight Investment Funds Management Limited and Pareto Investment Management Limited are authorised and regulated by the Financial Conduct Authority in the UK. Insight Investment Management (Global) Limited and Pareto Investment Management Limited are authorised to operate across Europe in accordance with the provisions of the European passport under Directive 2004/39 on markets in financial instruments.

For clients and prospects based in Singapore:

This material is for Institutional Investors only.

This documentation has not been registered as a prospectus with the Monetary Authority of Singapore. Accordingly, it and any other document or material in connection with the offer or sale, or invitation for subscription or purchase, of Shares may not be circulated or distributed, nor may Shares be offered or sold, or be made the subject of an invitation for subscription or purchase, whether directly or indirectly, to persons in Singapore other than (i) to an institutional investor pursuant to Section 304 of the Securities and Futures Act, Chapter 289 of Singapore (the “SFA”) or (ii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA.

For clients and prospects based in Australia:

This material is for wholesale clients only and is not intended for distribution to, nor should it be relied upon by, retail clients.

Insight Investment Management (Global) Limited is exempt from the requirement to hold an Australian financial services license under the Australian Securities and Investments Commission Corporations Act 2001 in respect of the financial services it provides. Insight Investment Management (Global) Limited is authorised and regulated by the Financial Conduct Authority under UK laws, which differ from Australian laws.

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managing liquidity for defined benefit pension schemes · managing liquidity for defined benefit...

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