THE VALUE OF CDI

Many of the underlying asset classes that comprise CDI portfolios are contractual in nature, have lower default rates than equivalently rated investment grade credit (e.g. infrastructure debt1), are backed by tangible collateral and are marked to model, lowering overall portfolio volatility.

At BNP Paribas Asset Management (BNPP AM) we are able to offer investors a broad blend of underlying private market and real assets exposure, a unique dual proprietary origination model, co-investment with the BNP Paribas Group, holistic cashflow management and bespoke investment solutions to clients needs.

1 Moody’s ‘Default and recovery rates for project finance bank loans, 1983-2010’, 31 January 2012.

What is cashflow driven investing?

The rise of liability driven investment (LDI) has reflected the need of institutional investors to lower the volatility associated with pension funding levels.

Recognising that funding levels represent the interaction between assets and liabilities, trustees have sought investments, linked to inflation, interest rates and duration that behave in the same way, leading to a rise in partially funded liability hedges (e.g. swaps), backed by cash and gilts, with the balance invested in growth assets.

Cashflow driven investing involves using additional sources of credit in order to better match the liabilities. At present, for example, many pension schemes, being cashflow negative, are forced sellers of liquid assets in order to meet their increasing income requirements.

Typically for most early proponents of CDI approaches this has meant investing in buy-and-hold investment grade credit to supplement cashflows. Increasingly however, more sophisticated solutions are available that involves supplementing liquid credit with illiquid private credit.

The benefits of a private credit approach to CDI

At BNPP AM, we believe a portfolio of secure private credit and real assets provides investors with a better match of liabilities as well as other tangible benefits that liquid strategies do not.

The incremental benefits of a private credit approach to CDI can be summarised as follows:

  • Additional returns above gilts and investment grade credit
  • Cashflows backed by high quality collateral
  • Cashflows that provide inflation linkage
  • Long-term cashflows
  • Highly covenanted, secure income streams
  • Limited market exposure
  • Lower default rates

WHAT ARE TYPICAL CDI ASSESTS

The universe of CDI assets available to pension schemes has expanded rapidly over the past decade.

More stringent capital requirements on banks have seen the disintermediation of traditional financing models by asset managers and institutional investors across a broad range of asset classes such as:

  • Senior infrastructure debt
  • Commercial real estate debt
  • Mid-market loans
  • Asset backed securities
  • Mortgage backed securities
  • Social housing
  • Ground rents

In creating a diversified portfolio of secure income generating assets, diversification is of critical importance.

Often idiosyncratic in nature, the underlying asset classes diversify well against each other and traditional liquid components of institutional portfolios, minimising tail risks.

Equally, a holistic multi-asset approach with active asset allocation minimises timing risks and reduces the potential for opportunity costs that traditional static allocations can suffer from.