Definition of Matching Strategy
Matching strategy is the acquisition of investments where the payouts will coincide with an individual or firm's liabilities. Under a matching strategy, each investment is chosen based on the investor's risk profile and cash flow requirements. The payout might consist of dividends, coupon payments or principal repayment.
Breaking Down Matching Strategy
A matching strategy for a fixed-income portfolio pairs the durations of assets and liabilities in what is known as immunization. In practice, exact matching is difficult, but the goal is to establish a portfolio in which the two components of total return—price return and reinvestment return—exactly offset each other when interest rates shift.
There is an inverse relationship between price risk and reinvestment risk, and if interest rates move, the portfolio will achieve the same fixed rate of return. In other words, it is "immunized" from interest rate movements. Cash flow matching is another strategy that will fund a stream of liabilities at specified time intervals with cash flows from principal and coupon payments on fixed income instruments.
Other Examples of Matching Strategy
Retirees living off the income from their portfolios generally rely on stable and continuous payments to supplement Social Security payments. A matching strategy would involve the strategic purchase of securities to pay out dividends and interest at regular intervals. Ideally, a matching strategy would be in place well before retirement years commence. A pension fund would employ a similar strategy to make sure its benefit obligations are met.
For a manufacturing enterprise, infrastructure developer or building contractor, a matching strategy would involve lining up the payment schedule of debt financing of a project or investment with the cash flows from the investment. For example, a toll road builder would obtain project financing and begin paying back the debt when the toll road opens to traffic and continue the regularly scheduled payments over time.