Prospects of a continuing weak economy, unstable equity markets and low interest rates are upending traditional asset policy and will drive investors to raise allocations to real assets, said Bernard McNamara, executive director, global real assets, J.P. Morgan Investment Management Inc., New York.
“Look at the investment landscape these days. There is what I would characterize a unique constellation of challenges facing investors and their portfolios,” Mr. McNamara said.
“One is low-yielding bonds, with the 10-year Treasury sub-2% for now and the foreseeable future. Another (challenge) is in the equity portions of their portfolio, (with the) highly volatile and highly correlated equity markets across the globe,” he said.
“A third is generally low-growth prospects in developed markets. If you are looking at the U.S. and other developed economies, we're looking at real GDP growth rates for now and the foreseeable future in the range of 2% to 3%, well off the high growth of the '50s, '60s and '70s,” he said.
“A fourth challenge is what we call the looming specter of inflation. Inflation has been relatively contained over the last 30 years. … But if you look at all the liquidity that has been injected in the financial system (in recent years) we argue that inflation is at least a medium-term threat. It's hard to predict when it's going to spike. But what we say is one thing is for certain: That is, when it does hit it will be painful for portfolios that aren't prepared for it.”
“Each of those challenges ... can be addressed in varying degrees by real assets,' Mr. McNamara said.
Mr. McNamara said economic and market obstacles present challenges for investors in trying to reach their objectives without moving forward the needle on real assets.
“Our expectation is that real assets need to go from being an alternative allocation to really being a foundational mainstream part of a portfolio,” Mr. McNamara said. “Twenty-five percent is not going to be the exact right number for every portfolio. There is no one-size-fits-all allocation. But we use it as a way to spark a conversation about taking real assets to a new level of awareness and consideration.”
“Our expectation is that the realization will be a somewhat gradual process, perhaps over the next decade or longer,” Mr. McNamara added.
“So if you look at low-yielding bonds as one of the main challenges, core infrastructure, core real estate — meaning high-quality, well-located investments — are delivering income in the range of 5% to 7%” in nominal return, Mr. McNamara said.
That alternative return source is important for pension funds in need of liquidity to pay benefits, Mr. McNamara said. “Because the income tends to be steady and stable over time, that lowers typically the overall volatility of your return.”
”One of the defining characteristics of real assets is that they typically are underpinned by longer-term contractual arrangements,” which could be 30 or 50 years.
“So the lower volatility return characteristics particularly of core real assets,” such as an office building in New York or natural gas distribution network, “also address the challenge of volatility in the public markets,” Mr. McNamara said.
“I think it's interesting the majority (of respondents to the Pensions & Investments survey) are saying (real assets) are performing in line with expectations,” Mr. McNamara said. That points to a “steady lower volatility nature of real assets investments, particularly core real estate and core infrastructure as delivering stable returns with a high income component with ... a lower volatility than the public markets.”