Seeking diverse sources of liquidity and return

2022's significant gilt market volatility threw a spotlight on the importance of deep liquidity. Here’s our latest thinking on what tools DB schemes may have available to help build a diverse and stable liquidity pool, while still keeping one eye on future returns.

As defined benefit (DB) schemes look to the future and aim to build resilience to market shocks, many will be considering enhancing the mix of assets they hold within the 'top-up' funds that sit beside their liability-driven investment (LDI) portfolio. As a broad rule of thumb, we believe approximately 50% of the assets held in LDI strategies should be held in liquid funds alongside, to help ensure an appropriate amount of assets can be accessed quickly if necessary.

However, these assets do not all have to be held as cash. This is important for most schemes, as while to do so might meet their objectives of having scheme stability and ready liquidity, it would be likely to compromise their other objectives of delivering growth and generating stable cashflows sufficient to pay pensions. Instead, including a dedicated allocation to assets focussed on providing a more liquid and stable return than broader market assets can materially improve the liquidity profile of a scheme. We believe that these assets can complement existing holdings and potentially offer predictable cashflows and maintain expected returns in excess of gilts to help close funding gaps and keep DB schemes on their journey towards endgame.

The value of an investment and any income taken from it is not guaranteed and can go down as well as up, you may not get back the amount you originally invested. It should be noted that diversification is no guarantee against a loss in a declining market.