Cashflow Driven Investing

Alpha Real Capital is an investment services group focused on income security from real assets. We invest in asset‑backed income from real estate, infrastructure, and lending, with an emphasis on long income and inflation protection.

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What is Cashflow Driven Investing (“CDI”)?

CDIs are assets which provide an index-linked or nominal, contractual, secure cashflow with a yield pickup over government bonds. CDI strategies are becoming increasingly attractive to defined benefit pension schemes as they approach maturity, together with other real money investors with implicit or explicit liabilities. Pension schemes are looking to CDI as they seek to generate an appropriate level of investment returns to meet their liabilities as they fall due.

Chart 1: UK defined benefit pension schemes assets and liabilities over time (£bn)

Source: Payment protection fund PPF 7800

Advantages of CDI for defined benefit pension schemes

1) Improving portfolio diversification and portfolio efficiency

Assets that generate secure cashflows, have different return drivers to liquid return-seeking assets such as equities. Adding these to a portfolio can improve its risk-adjusted return. For example, increasing a portfolio’s allocation to CDI from a combination of LDI and return‑seeking assets has the potential to achieve the same expected return at a lower level of risk (or vice versa).

2) Enhancing the cashflow yield of the portfolio

If Trustees shift some of their portfolio from low-yielding LDI they can significantly improve the cashflow yield of their portfolio, which is particularly valuable for cashflow negative pension schemes. This can help to mitigate the need to sell down more volatile risky assets at inopportune moments; crystallising losses in a falling market, which can have a significant adverse impact overtime.

Further, having a higher cashflow yield also helps reduce a Trustee’s governance burden from making disinvestment decisions as well as potentially reducing transaction costs, including commissions and spreads.

3) Increasing security and predictability of cashflows

CDIs generate secure, predictable cashflows (relative to cashflows generated by traditional return-seeking assets) which is important in planning future member benefit payments.

4) Yield pickup above liabilities

CDIs generate a yield above liabilities, unlike government bonds, CDIs can help to close the funding gap in underfunded schemes, whilst still providing a high degree of income security.