DB schemes' negative cash flow matters, but is not a crisis

While one in five CFOs of FTSE 350 sponsoring companies said that unplanned selling of assets to meet the resulting pension liabilities is the biggest threat to their DB schemes, only 4 per cent of trustees do, the survey found.

The evolution of scheme profiles is making cash flow more of an issue and it is not a fad or a trend that will disappear

Alan Collins, Spence & Partners

However, consultants and trustees both emphasised that cash flow negativity is a natural phase of maturing DB schemes, and that it has to be managed, not avoided or reversed, making long-term risk management the bigger issue.

Member-driven investment

Jon Hatchett, partner at consultancy Hymans Robertson, which conducted the survey, said DB schemes are becoming cash flow negative because they are reaching maturity. While this is normal, they “need to be derisked to… start shrinking safely,” he said.

Awareness of asset-selling has not been highlighted as an issue for DB schemes before now; however, the Pensions Regulator drew attention to cash-flow for the first time earlier this month, which, Hatchett said, means “trustee awareness will increase”.

“The one thing you can predict is that the markets will be volatile”, he pointed out. To mitigate this, cash-negative schemes must invest in assets that will generate cash flow, such as fixed income, bonds and other types of debt.

He advised schemes to invest in assets that meet cash flow promises made to members: “This sounds like common sense, but it isn’t the way most schemes think”.

Confusion causes concern

Paul McGlone, partner at consultancy Aon Hewitt, said that while the survey indicates awareness of unplanned disinvestment is higher among CFOs than trustees, “it is easy to get a concerned reaction from people not dealing with the issue day-to-day”.

“Trustees know they have the [cash flow] issue under control… and have a better understanding of it” than CFOs, he noted.

Asset selling is an issue trustees have in mind, but “it is not high on the list”, as they know that cash flow negativity “should be the natural state of most schemes” as they mature.

McGlone stressed that cash flow and risk management are not either-or choices, adding that “no trustee board in the UK will focus on one [issue] at the expense of the other”.

He conceded that while many schemes are using outdated data, “fixing the problem is very difficult”, as the data, collected since the 1950s, cannot be updated retroactively. “Data is undoubtedly an important point, but trustees are doing the best they can”.

Diversify to avoid forced selling

Alan Collins, partner at actuarial consultancy Spence & Partners, commented that “the survey is more indicative of schemes’ maturing nature, not of a cash flow problem”.

However, he added, cash flow should be integral in making long-term plans. “Schemes should constantly update their cash flow measures, and define their strategy accordingly”, he said.

“The evolution of scheme profiles is making cash flow more of an issue [and] it is not a fad or a trend that will disappear”, he stressed, adding that diversification is the best way of mitigating the risk of unplanned asset sales.

“Spread your buying and selling activity across many asset classes”.

He questioned whether the survey might also indicate that trustees over-delegate to fiduciary managers. “Trustees should remember that they are ultimately responsible… these issues should be put more on trustee meeting agendas”, he said.

Trustees should make detailed plans

Roger Mattingly, managing director at Pan Trustees, said: “All schemes will be cash flow negative at some point in the future… the challenge is to ensure that disinvestments are done in the most efficient manner”.

Trustees are doing everything they can to “have very detailed cash flow plans in place… and to plan for the likeliest shortfalls,” he said, adding that they are derisking by disinvesting from hedge funds and ensuring their schemes are drawing down less from markets as they become more volatile.

“I would be concerned if all trustee boards were not doing the same thing”.

Mattingly cautioned that “both [cash flow and risk management] need proper attention and governance; don’t neglect one for the other… this wouldn’t be proper governance”.

He added: “Trustees need expert advice… but there is a lot of superficial expertise in the market... It’s having the intelligence and know-how to make the advice work that matters”.