How to manage your cash flows effectively

As schemes become better funded and deficit reduction contributions reduce, efficient scheme cash flow management to meet benefits payments will become increasing critical. 

The increasing closure of DB schemes removes a source of future positive cash flow, in the form of employer and employee contributions that these schemes previously relied upon as part of the solution for their cash flow requirements. 

Few UK defined pension schemes have adequate arrangements in place to manage their cash flow needs efficiently, and this issue needs to be urgently addressed. 

A recent survey commissioned by Buck Global Investment Advisors has provided extensive data on the cash flow requirements of the respondents’ pension schemes, and how these requirements are managed.  

Fifty trustee and sponsor respondents participated in the research, representing schemes with assets ranging in value from less than £50m to more than £500m.  

The results corroborated our experiences as investment advisers to mid-sized UK schemes of the urgent need for more efficient cash flow management.

Pension funds facing negative cash flow are becoming the norm. Around one-third of DB scheme respondents face negative net cash flow, with this proportion expected to increase over time.

Scrutinise your investment income

Schemes undertake limited scrutiny and use of available investment income. Around one-third of those schemes that have negative net cash flows do not access investment income as a means of assisting with cash flow requirements.

There is a high level of activity in monitoring transaction costs associated with investing and disinvesting to manage net cash flow requirements. However, we are concerned that while costs are monitored, the income forgone as a result of transacting is not widely considered.

There are material benefits in approaching cash flow management in a structured way. While there are a wealth of complex, tailored solutions available to manage schemes' requirements, when considering easily implemented and low-cost opportunities to improve scheme cash flow, our survey found even these are not being widely utilised by scheme trustees and sponsors.  

In many cases, trustees will be able to draw down income from their asset holdings on a monthly or quarterly basis, with equities and property, for example, providing a valuable, and often overlooked, source of cash flow. 

Giving up returns

Similarly, we found schemes are forgoing material investment returns by holding significant portions of their asset portfolios in cash, with 25 per cent of DB scheme trustees and sponsors reporting that they are holding in excess of 10 per cent of total scheme assets in cash to pay benefits.

With total UK pension fund assets estimated at £1.7tn last year, responses indicate more than £85bn of DB scheme assets can currently be assumed to be out of the market.

This represents a total loss of £6bn a year in investment returns, on the basis of current assets under management and assuming, for illustrative purposes, an expected return on assets of 7 per cent a year.  

In many instances this cash requirement could be reduced by the receipt of investment income. However, even where trustees do wish to retain a portion of scheme assets in cash to meet benefit payments, expected investment returns can be maintained through the use of equity derivative instruments to maintain equity market exposure.

This process is known as equitisation of the cash holding. A vast range of approaches are available to deliver such a solution in a cost-effective and risk-controlled manner.

There are many readily available opportunities and benefits to manage cash flow efficiently that are being successfully used by the minority.

Too few are capitalising on these with the result that inefficient cash flow management sadly remains prevalent within the UK pension fund industry. It is surely time for trustees and investment professionals to ensure all actions are taken to stop this easily avoidable loss of investment returns.

Simon Hill is a senior investment consultant and Emma Lowry is an investment consultant at Buck Global Investment Advisors