Endgame portfolios: making the most of CDI
The benefits of cashflow driven investment (CDI) are slightly controversial. Some believe it is a powerful risk management strategy for DB schemes nearing their endgames, whereas others are more sceptical given that it may compromise multi-asset diversification
One of the issues is that CDI is a buzzword, but is poorly defined. The broadest definition of CDI is any strategy with a heavy tilt towards corporate bonds and other debt instruments, rather than using a diversified growth approach that only recognises the benefits of such assets as diversifiers.
In its narrowest sense, CDI involves ‘full matching’, i.e. closely lining up contractual cashflows from corporate bonds and other debt with expected liability payments in a similar manner to an insurance company. What is the right balance for a DB scheme nearing its endgame? Any movement away from full cashflow matching is a step towards rejecting CDI, but we should be careful to avoid ‘slippery slope’ arguments.
The aim of this paper is not to debate whether a credit-heavy strategy in the endgame makes sense – overall, we believe it does; our case for DB schemes tilting towards credit in the endgame was made a few years ago in our paper ‘Endgame portfolios and the role of credit’.1 Rather, we ask if full cashflow matching is the right answer and, if not, how credit portfolios ought to be structured to maximise efficiency. However, in the appendix we have briefly outlined the basic arguments for and against a CDI approach.