How schemes can manage cash flows

Findings from a Buck Global Investment Advisors survey show schemes are failing to manage cash flows effectively which can increase the cost of pension provisions.

With more DB schemes closing to new entrants and with some ceasing to future accruals, pension payments have begun to overtake contributions, forcing schemes into short-term liquid assets or to disinvest to make payments. 

And the trend is expected to continue. Schemes that are currently cash flow positive due to contributions from sponsors could see a change of fortune as investment markets improve, prompting sponsors to cease cash injections.

A rise in gilt yields could see a sudden movement in funding levels, resulting in some schemes being pushed into a cash negative position at the time of their next valuation, said Steve White, managing director at Buck Global Investment Advisors.

The survey also found a quarter of respondents were holding more than 10 per cent of their assets in cash to meet benefit payments, forgoing potential investment returns.

What can schemes do?

White has advised schemes to put in place a cash flow management policy. If a policy were in place, schemes “would know exactly what needs to be paid out in the next 6 or 9 months, you should be able to keep cash holdings at a low level and stay fully invested in either equities, bonds or alternatives". 

He also recommended schemes consider income generating investments such as equities, property and fixed income.

“Of those that are cash flow negative, a large proportion, a third or so, are not using the investment income they could be using. They are not taking the investment income from their portfolios to meet the benefits, which is the first and simplest and most obvious thing to do,” White said.  

Instead, schemes are disinvesting from assets at inopportune times, which can prove costly. “Each time you do that you normally incur a spread. [Schemes] are losing between 0.5 per cent and 2 per cent, depending on where it is taken from, each time they do a disinvestment.”

According to data from the Office for National Statistics, for the first quarter of 2013 the use of short-term assets was strong, which indicated schemes are favouring liquidity rather than longer-term investment strategies. Short-term assets include cash and investments that mature within one year of their originating date.

The data show pension schemes were holding £52bn worth of short-term assets in Q1 2013, compared with £51bn in Q4 and Q3 2012 and £48bn in Q2.

ONS data from earlier this year showed the amount of short-term assets held by pension schemes has also steadily been on the rise (see graph). In 2011, the last year of the data set, short-term assets were worth £298m on pension scheme balance sheets, compared with £60m in 2000.

“Schemes are concentrating on ensuring that part of the portfolio is extremely liquid to enable short-term obligations to be met,” said Bobby Riddaway, head of investment consulting at Capita Employee Benefits.

He added: “The main risk of short-termism is for those schemes that do not hold diverse cash-based funds, but take the risk of holding deposit accounts. The safer approach to holding short-term assets is to either hold institutional cash funds or short-dated bonds.”