PIMCO upheaval opens doors for real assets firms

Updated with correction

Years of low bond yields got real asset managers talking to asset owners looking for an alternative income source, but William H. Gross' departure from Pacific Management Investment Co. LLC has supercharged the conversations.

That's because the managers expect Mr. Gross' departure will prompt investors to focus on their fixed-income portfolios.

Managers say they had already seen money move their way from fixed income, but the volume and frequency of inquiries intensified after Mr. Gross jumped ship to Janus Capital Group. His departure handed real asset managers talking points for conversations with typically risk-averse fixed-income investors, encouraging them to consider the current income and inflation-hedging aspects of real assets over underperforming fixed income.

Officials at J.P. Morgan Asset Management, Capital Innovations, Clarion Partners, Inland Institutional Capital Partners, L&B Realty Advisors and LaSalle Investment Management are among those talking to investors about turning to real assets for income.

“It's a bigger decision than who will be your next fixed-income manager,” said Joseph K. Azelby, managing director and head of global real assets in the New York office of J.P. Morgan Asset Management.

Choosing between fixed-income managers is like “choosing between Diet Coke and Diet Pepsi,” Mr. Azelby said. “How much fixed income do you want to hold with the geopolitical risk? The more important conversation is about asset allocation.”

JPMAM manages about $79 billion in real assets.

“One of the benefits of investing in real estate is income stream and cash flow,” said Peter Rogers, investment consultant in the New York office of Towers Watson Investment Services. Mr. Rogers said he can see some investors potentially trimming fixed income to invest in real estate.

Client demand for real assets, particularly for real estate and infrastructure, is growing because of low bond yields, the prospect for rising interest rates and potential for inflation, John Hackett, a principal at real asset consultant The Townsend Group LLC, Cleveland, said in an e-mailed response to questions. By comparison, real assets as an asset class has greater potential income, growth and inflation hedge, he said.

At money manager Capital Innovations LLC, Pewaukee, Wis., Chief Investment Officer Michael Underhill said “phones have been ringing off the hook” from both defined benefit and defined contribution plan executives since Mr. Gross announced his departure Sept. 26. Capital Innovations has about $1 billion in real assets under management.

“People are looking” at real assets, Mr. Underhill said. DB plan boards are discussing moving more money into real assets from fixed income and DC plan executives are starting to consider stand-alone real asset investment options, he said. Since Mr. Gross left PIMCO, the pace of conversations and meetings with investors about real assets has accelerated, as investors inquire about real assets as an alternative to fixed income, Mr. Underhill said.

Lewis Feldman, managing partner in the Los Angeles office of Goodwin Procter LLP, said: “A yield-driven market is bringing (investors) to look at real estate and other alternatives as a way of generating income.”

At the same time, Federal Reserve officials in public statements indicated last week that interest rates could rise as early as the middle of next year, leading investors to consider using real estate and other real assets to hedge inflation, he said.

“Bill Gross has been calling for the collapse of stock and bond markets for some time,” Mr. Feldman said. “People listen to him. Investors moving assets to real assets from fixed income is part of their search for yield.”

Mr. Gross left PIMCO as the bull market for bonds is expected to come to a close, Mr. Underhill said. Investors are interested in real assets because real asset income strategies “like infrastructure and real estate can withstand a rising interest-rate environment,” Mr. Underhill said.

(Earlier in his career, Mr. Underhill had worked as a corporate fixed-income specialist at Janus.)

According to a Capital Innovations analysis, moving money to real assets from bonds in the last 20 years would have resulted in 30 basis points of excess return. A portfolio with a 10% allocation to a diversified real asset portfolio with 50% bonds and 40% stocks would have returned 7.2% annualized for the 20-year period ended May 31. A 20% allocation to real assets with the remainder equally divided between equities and fixed income would have produced a 7.5% return annualized over the same time period.

Investors are moving fixed-income assets into real assets, searching for current income to substitute for the income they used to get from fixed income, JPMAM's Mr. Azelby said.

The trend of investors starting to increase allocations to real assets at fixed-income's expense was already underway when Mr. Gross left PIMCO, but Mr. Gross' departure was “a bell going off,” and conversations with investors have increased, said George Pandaleon, president of real estate money manager Inland Institutional Capital Partners, Oak Brook, Ill.

“There is now an increasing focus on real estate for higher return and, more importantly, for more cash flow,” he said. Inland Institutional Capital Partners is the deal-making subsidiary of Inland Group and has arranged $5 billion worth of deals. Inland Group has $16.4 billion in real estate assets under management.

Dave Gilbert, CIO and head of acquisitions at Clarion Partners LLC, New York, said the shift to real assets from fixed income is the latest investment trend to be dubbed the “Great Rotation.”

“One of the stories is the exit of Bill Gross ... We believe some of the money out of fixed income will be coming to real estate,” said Tim Wang, Clarion's director and head of investment research.

Clarion manages $32.5 billion in real assets.

Real asset managers expect investors will take a hard look at whether they want to keep their money with PIMCO, and part of that thinking could lead them to switch some money to real assets.

While core real estate managers would be the direct beneficiaries, Kayne Anderson Capital Advisors LP would be an “indirect beneficiary” because its opportunistic real estate investment strategies produce current cash flow for investors, said Al Rabil, managing partner and CEO based in the Boca Raton, Fla., office of Kayne Anderson, a real asset money manager. The firm has a history of making distributions of cash to investors on a consistent basis, he said.

“Generally ... we've been speaking with investors who have nowhere to turn for fixed income and so there is a flight to real assets in that regard,” Mr. Rabil said.

However, institutional investors do not move capital overnight and so, according to Mr. Rabil, real asset firms would not immediately see PIMCO assets flow into their strategies.

“I think we will continue to see flows into real assets as a fixed-income and yield alternative for a while,” Mr. Rabil said.