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17 May 2023 - Cashflow matching

By: abrdn

Cashflow matching


May 2023

In UK, the bulk purchase annuity (BPA) market has seen around £150bn of value transferred from pension schemes to insurers over the last five years. 1 Projections for the next decade suggest further transfers of over £500bn, fuelled in part by higher interest rates improving schemes' funding ratios.

Although the backdrop may seem irrelevant in APAC, the capability to efficiently construct cashflow-matching portfolios is of increasing importance to both insurers and pension schemes in the region.

In this article, we take a look at how novel portfolio construction techniques offered by asset managers can allow insurers and pension schemes to accurately match their liability cashflows whilst also ensuring their risk appetite and specific fund tolerances are fully considered.


With a holistic cashflow match framework, it is possible to optimally construct portfolios which offer desirable levels of yield, whilst reflecting all possible specific client specifications and restrictions. This includes clients who want their matching portfolio to meet the requirements for Matching Adjustment (MA) compliance under Singapore RBC 2 currently and the upcoming Hong Kong RBC.

An investment manager can also offer pre-trade modelling and optimisation capability

As well as portfolio construction, efficient ongoing portfolio management ensures assets also continue to be rebalanced and optimised throughout mandate life cycle.

Later in this article we will examine the range of assets and different client specifications that can be embedded into a flexible portfolio construction and management framework. But first, what about risk appetites and tolerances?


A cashflow matching framework is centred around maximising the correspondence between the asset cashflows and the client's liability cash flow. The latter can be on best estimate basis, or based on guaranteed cash flow, depending on the nature of the mandate requirements. The asset cashflows may also include haircuts reflecting the imperfect FX hedge, necessary for example in matching adjustment mandates.

It is through the additional constraints, however, that the portfolio can be tailored to meet client and regulatory requirements. For example, asset managers' tools can include:

  • A minimum yield constraint to increase the return of the cashflow matching portfolio.
  • Maximum issuer/sector constraints, e.g., no more than 3% of the market value of the portfolio within a specific issuer or no more than 20% of the market value of the portfolio in financials.
  • Maximum rating constraints, e.g., no more than 25% of the market value of the portfolio can be held in BBB bonds, or constraints on the 'average rating' of the portfolio.
  • Constraints around the accuracy of the cashflow match, even ensuring matching adjustment portfolios are able to meet Cash Flow Shortfall Test as specified by some RBC regimes. Such criteria are required to be met for on-going compliance with the matching adjustment requirement.


Such a framework is flexible enough to meet any requirements or risk appetites. It's also important that asset managers work collaboratively to ensure clients' views and demands are fully reflected in the portfolio construction and on-going fund management tools.

The full client life-cycle and all asset classes

Cashflow-matching managers are able to incorporate the full client life-cycle and a wide range of asset classes ensuring they are particularly well-placed to work with insurers and pension schemes. But what should these clients look out for in terms of manager skills, tools, capabilities and scale?

The best teams benefit from a suite of proprietary, on-desk cashflow matching tools and use these to manage sizable matching portfolios in accordance with regulations in different jurisdictions . These tools aid portfolio managers and clients throughout the full lifecycle of such funds:

*Initiation of mandates and fund restructuring e.g., a fund uprisking from government bond to credit or switching from credit to higher-rated supranational bonds whilst maintaining the match

*Pre-trade modelling to ensure proposed new purchases and switches are suitable from a cashflow matching or on-going matching adjustment compliance point of view.

*Portfolio rebalancing/liquidity management to meet cash requirements in and out of the fund.

With a fast growing MA market and a limited supply of eligible public securities in local currency, it's a key requirement for MA portfolios to widen the scope of asset classes in order to continue to offer attractive solutions within a competitive market place.

As such, in addition to local currency investment grade fixed income securities, best-in-class cashflow matching solutions can include overseas debt, e.g., USD corporate bonds, paired together with cross-currency swaps or repackaged up as a special purpose vehicle.

It's a key requirement for Muli-Asset portfolios to widen the scope of asset classes

The capability to model private placements, commercial real estate loans, and infrastructure bonds is also crucial. Naturally embedding such securities allows for efficient management of public credit alongside non-public debt within cashflow matched & matching adjustment mandates.

Quantitative portfolio design

In short, proprietary quantitative portfolio design can be applied on a wide and diverse investment universe. This design may be tailored to meet clients' needs and constraints. Such a flexible and transparent process also allows for informed discussion between key stakeholders, enabling comparison of the relative merits of a spectrum of matching portfolios with different 'risk-return' profiles.

To illustrate this point, we showcase such an 'efficient frontier' of matching adjustment compliant portfolios for a stylised liability profile and a public credit universe in Chart 1 and Chart 2 below.

Chart 1 Matching Adjustment 'efficient frontier' constructed from the public credit universe. Typical portfolio issuer/sector /rating constraints. Liabilities c. 12y duration. Close of Business (CoB) 30-Dec-2022.

A "Best cashflow match" portfolio with no yield constraint (meets various portfolio limits & MA CF-Match Tests).

B Better yielding MA Compliant Portfolio (still meeting all limits & CF-M tests)

C Pushing yield at the expense of cashflow match (portfolio only just matching adjustment compliant).

Source: abrdn. For illustrative purposes only.

Chart 2 Cashflow match plots for the three highlighted portfolios along the MA 'efficient frontier'. Stylised liabilities of c. £1bn PV (present value) and 12-year duration. All portfolios meet the required'Tests'. CoB 30-Dec-2022.

Source: abrdn. For illustrative purposes only.

The above portfolios also embed insurers' typical issuer, rating and sector limits and demonstrate the benefits of an optimisation exercise, potentially resulting in a 30bps gain in spread whilst retaining an acceptable quality of cashflow matching.

A huge opportunity for insurers and pension schemes

With Hong Kong insurers embracing the upcoming Hong Kong RBC and Singapore insurers moving from RBC adoption to RBC optimisation, we are witnessing a trend in APAC similar to what has been ongoing among their European peers. Asset managers with proprietary techniques and insurance asset management capabilities could be well placed to support this journeys that lie ahead.

Author: Mark Cathcart, Investment Director, Liability Aware

Funds operated by this manager:

Aberdeen Standard Actively Hedged International Equities FundAberdeen Standard Asian Opportunities FundAberdeen Standard Australian Small Companies FundAberdeen Standard Emerging Opportunities FundAberdeen Standard Ex-20 Australian Equities Fund (Class A)Aberdeen Standard Focused Sustainable Australian Equity FundAberdeen Standard Fully Hedged International Equities FundAberdeen Standard Global Absolute Return Strategies FundAberdeen Standard Global Corporate Bond FundAberdeen Standard International Equity FundAberdeen Standard Multi Asset Real Return FundAberdeen Standard Multi-Asset Income Fund

Source: Professional Pensions, October 2022

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