A Practical Guide to Cashflow Driven Investing
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For professional investors - Marketing communication - August 2019 A PRACTICAL GUIDE TO CASHFLOW DRIVEN INVESTING The asset manager for a changing world A PRACTICAL GUIDE TO CASHFLOW DRIVEN INVESTING CONTENTS 1 INTRODUCTION 2 THE VALUE OF CASHFLOW DRIVEN INVESTING Page 3 Pages 4 - 5 3 OUR APPROACH TO 4 OUR APPROACH TO PRIVATE CREDIT AND REAL ASSETS CASHFLOW DRIVEN INVESTING Pages 6 - 14 Pages 15 - 19 5 OUR SPECIALIST 6 WHY BNP PARIBAS PENSIONS SOLUTIONS CAPABILITY ASSET MANAGEMENT FOR CDI Pages 20 - 25 Pages 26 - 27 2 A PRACTICAL GUIDE TO CASHFLOW DRIVEN INVESTING 1 INTRODUCTION With UK Defined Benefit pension schemes turning increasingly cashflow negative and traditional Liability Driven Investment (LDI) portfolios offering lower returns, schemes are turning to cashflow driven investing (CDI) to better match cashflow while generating higher risk-adjusted returns. Many of the underlying asset classes that At BNP Paribas Asset Management (BNPP AM) comprise CDI portfolios are contractual in we are able to offer investors a broad blend nature, have lower default rates than of underlying private market and real assets equivalently rated investment grade credit exposure, a unique dual proprietary origination (e.g. infrastructure debt1), are backed by model, co-investment with the BNP Paribas tangible collateral and are marked to model, Group, holistic cashflow management and lowering overall portfolio volatility. bespoke investment solutions to clients needs. About the authors: Julien is Head of Pension Solutions Philip is Head of UK Sales (UK & at BNP Paribas AM having joined Ireland) at BNP Paribas AM having in April 2018 from Mercer where joined in November 2017 from he spent 6 years as Principal. Allianz Global investors where Prior to that Julien worked for he spent 16 years working with Goldman Sachs, Aon, P-Solve and institutional clients. During his time Lazard. With investment banking with the Allianz Group, Philip was and consulting experience involved in the creation of a number Julien stretching over 26 years Julien Philip of new products across multi- Halfon has spent over 15 years advising Dawes asset, listed and private markets, institutional clients on structuring inc. the launch of the first UK fund Head of Head of and implementing pensions and to facilitate primary greenfield Pension Sales insurance solutions for national transactions in infrastructure debt Solutions (UK & Ireland) and cross-border clients. for institutional investors. [email protected] [email protected] 1 Moody’s ‘Default and recovery rates for project finance bank loans, 1983-2010’, 31 January 2012. 3 A PRACTICAL GUIDE TO CASHFLOW DRIVEN INVESTING 2 THE VALUE OF CASHFLOW DRIVEN INVESTING (CDI) WHAT IS CASHFLOW DRIVEN INVESTING? The rise of liability driven investment (LDI) has Cashflow driven investing involves using reflected the need of institutional investors additional sources of credit in order to better to lower the volatility associated with pension match the liabilities. At present, for example, funding levels. many pension schemes, being cashflow negative, are forced sellers of liquid assets in order to Recognising that funding levels represent meet their increasing income requirements. the interaction between assets and liabilities, trustees have sought investments, linked to Typically for most early proponents of CDI inflation, interest rates and duration that approaches this has meant investing in behave in the same way, leading to a rise buy-and-hold investment grade credit to in partially funded liability hedges (e.g. swaps), supplement cashflows. Increasingly however, backed by cash and gilts, with the balance more sophisticated solutions are available invested in growth assets. that involves supplementing liquid credit with illiquid private credit. Pension Liability Cashflow 2018 2021 2027 2030 2036 2039 2042 2045 2051 2054 2057 2060 2066 2072 2075 2078 2081 2087 2090 2094 2099 BNPP AM, November 2018 4 A PRACTICAL GUIDE TO CASHFLOW DRIVEN INVESTING THE BENEFITS OF A PRIVATE CREDIT APPROACH TO CDI WHAT ARE TYPICAL CDI ASSETS? At BNPP AM, we believe a portfolio of secure The universe of CDI assets available to pension private credit and real assets provides investors schemes has expanded rapidly over the past with a better match of liabilities as well as other decade. tangible benefits that liquid strategies do not. More stringent capital requirements on banks The incremental benefits of a private credit have seen the disintermediation of traditional approach to CDI can be summarised as follows: financing models by asset managers and institutional investors across a broad range of Additional returns above gilts and asset classes such as: investment grade credit Senior infrastructure debt Cashflows backed by high quality collateral Commercial real estate debt Cashflows that provide inflation linkage Mid-market loans Long-term cashflows Asset backed securities H ighly covenanted, secure income streams Mortgage backed securities Limited market exposure Social housing Lower default rates 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. 5 A PRACTICAL GUIDE TO CASHFLOW DRIVEN INVESTING 3 OUR APPROACH TO PRIVATE CREDIT AND REAL ASSETS EXPERIENCE IS EVERYTHING BNP Paribas Group has been financing the real economy for 150 years with market leading 50 positions in real estate and infrastructure financing. For both the Group and BNPP AM, our goal is PRIVATE DEBT AND to provide quality investment solutions for our clients, building strong, lasting relationships REAL ASSET based on confidence and trust. PROFESSIONALS Within private markets and real assets this confidence and trust helps support origination as our specialist investment teams have a reputation for rigour, scale and execution. Whilst private markets can be illiquid we believe active portfolio management significantly mitigates the associated risks. Across asset classes, a focus on diversification and strict credit risk assessment offers institutional investors access to high quality assets and co-investment opportunities that deliver long-term performance. BNPP AM’s CDI strategy leverages the specialist investment teams that comprise the Private Debt A RESPONSIBLE INVESTOR and Real Assets (PDRA) investment group of over BNPP AM has been involved in responsible 50 investment professionals. investment since 2002. ESG criteria are BNPP AM’s approach to CDI relies on specialist systematically incorporated into the investment investment teams to access the underlying processes of our private debt solutions. An initial asset classes, namely Global Loans, SME ESG filter is applied, followed by an in-depth Lending, US Mid-Market Lending, Structured analysis. The definition and implementation of Finance, Infrastructure Debt and Commercial a specific taxonomy for each asset class makes Real Estate Debt. Each team offers a long- it possible to refine the ESG analysis from a term track record in the technical under-writing qualitative perspective. of private credit with established networks of project sponsors offering sustainable origination, supplemented by proprietary BNP Paribas Group origination partners. 6 A PRACTICAL GUIDE TO CASHFLOW DRIVEN INVESTING THE PRIVATE DEBT AND REAL ASSETS INVESTMENT GROUP ORGANISATION CHART: David Bouchoucha Private Debt & Real Assets Investment Committee Vanessa Stéphane Laurent Ritter Blanchoz Gueunier Global SME Alternative Real Assets, Loans Finance SME Lending, Strategic Finance SME Lending Europe USA Philippe Karen Deloffre Azoulay Real Estate Infrastructure and Debt Debt Michel Fryszman Structured Finance Business Development Structuring Leveraging the wider BNP Paribas Group resources Investment Financial Fixed Income Global Trading ESG Research Research Engineering Platform Functions Source: BNPP AM, December 2018 7 A PRACTICAL GUIDE TO CASHFLOW DRIVEN INVESTING CASHFLOW ASSET EXAMPLE 1: INFRASTRUCTURE DEBT BNPP AM created its infrastructure debt team to offer investors direct access to private A infrastructure transactions which can be used to generate stable and predictable long-term DIVERSIFIED UNIVERSE cashflows. Offering attractive spreads, lower default OF PROJECTS rates and higher recovery rates relative to equivalently rated corporate bonds, AND COMPANIES infrastructure debt has an appealing risk / return profile that can be used to enhance fixed income and matching portfolios. Physical assets include: 1 2 3 Renewable energy Conventional energy Utilities Solar, on-shore/off-shore Storage facilities, gas power Gas, electricity & wind, biomass, hydro plants, pipelines, LNG heating networks, waste & water treatment 8 A PRACTICAL GUIDE TO CASHFLOW DRIVEN INVESTING BNPP AM focuses on essential physical assets across a diversified universe of projects and companies that have a stimulative effect on the real economy. Typically the activities financed benefit from regulated revenues with low technological risk offering resilience through the economic cycle. Further assurance of potential future revenues is reinforced by the strong contractual frameworks, exhaustive security