Carolyn Schuster-Woldan Managing Director, Investment Consulting
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10-second summary
When setting out on a long journey, it’s important to refuel (or recharge!) – and it’s helpful to add a little extra too, to cover any unexpected detours. The same applies to managing a pension scheme.
There are plenty of reasons why you need to ensure you have access to cash in your pension scheme – the obvious one being the payment of member benefits. You might also need capital to top up your LDI portfolio, meet capital calls or fund a buy-in. Unfortunately, holding cash comes at the cost of lower expected returns. That’s why we help our clients formulate a robust plan to balance these two competing objectives.
How do we approach liquidity management at Redington?
The ultimate objective for your pension scheme is to pay all member benefits as they fall due, so it’s crucial you’ve got enough cash available to do so.
Much like everything we do, we approach liquidity management in a holistic way, considered alongside your scheme’s other objectives and constraints. Liquidity management forms part of our PRMF because, while it might seem like a ‘housekeeping’ exercise, it’s crucial to keeping your scheme on track.
We start by working out the scale of your liquidity requirements and then take a proportionate response. Cashflows over the next year may be fairly predictable, but the level of uncertainty will increase the further ahead you look. A sensible approach might be to think about the next five years and update on an annual basis. Of course, there’ll be less precision the further out you go, but you should still have an approximate idea of where you’re heading over the longer term.
Pitstop 5: Liquidity management Planning for unexpected detours
We consider there to be three sources of collateral to fund your liquidity requirements:
1. Contributions (if your scheme receives any): this is the most obvious place to fund collateral requirements from as you won’t need to buy or sell anything, which minimises potential transaction costs. If contributions are lumpy (e.g. paid once or twice a year), make sure you aren’t sitting on excessive cash, as that’ll have a drag on potential performance. Instead, consider investing this collateral in liquid assets – these will boost your expected returns whilst allowing you to divest at relatively short notice to fund cashflow requirements (just remember to check the transaction costs before you do!).
2. Income payments from liquid mandates: if cashflows out of the scheme are small in relation to overall scheme assets, you could use income-generating assets to help fund them. Very few clients have the option to perfectly match their cashflows, and we’re not sure that’s even possible given re-investment risk and the fact that liabilities are founded on actuarial assumptions, but a reasonable level of cashflow matching might be attainable.
3. Distributions from illiquid mandates: while these distributions aren’t always easy to accurately predict, your manager should be able to give you an indication of the anticipated timing and size. You can use these to plan for future cashflows. It’s also important to consider the run-off rate of these assets to ensure the proportion of illiquid holdings remains sustainable – and that you have enough flexibility to fund risk transactions (e.g. buy-ins) if such opportunities arise.
How does this benefit our clients?
Since liquidity requirements are considered alongside key investment objectives and constraints, and are monitored on a regular basis, our clients can be confident that they have sufficient collateral to fund benefit payments as they fall due – and that they have a robust plan in place to cover any unexpected payments – such as transfers out or LDI rebalancing.