David Lebovitz: Welcome to the Center for Investment Excellence, a production of JPMorgan Asset Management. The Center for Investment Excellence is an audio podcast that provides educational insights across asset classes and investment themes. Today's episode is on alternative investments and has been recorded for institutional and professional investors. I'm David Lebovitz, Global Market Strategist and host of the Center for Investment Excellence. With me today is Anton Pil, Global Head of Alternatives. Hi Anton. Welcome to the Center for Investment Excellence.

Anton Pil: Great to be back David.

David Lebovitz: Well, thank you for joining us again. So today we're excited to bring you another episode on alternatives and the implications of the current macro environment for institutional investors.

We kind of plan on going around the world today and covering quite a bit from ESG and carbon offsets to what's going on in real estate with respect to the office and finally, private equity and private credit as well.

And so let's not waste any more time with formalities and jump right in with our first question. I figure let's kick off with ESG. It's timely. COP26 just wrapped up here and, you know, the importance of ESG has really been at the forefront of institutional investors' minds for the better part of the past year, and we very much think that that's going to continue into 2022.

And so can you talk a little bit about ESG in the context of alternatives, maybe touch a little bit on the topic of carbon credits? We'd love to hear what you're seeing as you look across the alternative landscape broadly.

Anton Pil: Yes. Look, I think it plays a critical role in investing in alternatives and generally for a very basic reason. Most of the investments we make have a time element that is fairly lengthy.

So the investments we're making today - we might only be profiting from them in five or ten years from now, so I think you have to be thinking ahead of how ESG has an impact to whatever asset you're buying or how you're thinking about your investment style.

So from my seat, I embedded sort of functionally every piece of our alternatives business. It's not sort of an overlay. It's not an afterthought. It's got to be critical to what you do and we've seen this over time, right. Like people who own real estate, people who want to live someplace or people who have an office someplace - they want to be in what's probably considered the highest LEED Platinum building.

This notion of ESG being an integral part of our investment cycle has been core to what we've done for a long time and I still think it's going to continue to grow. The carbon market one is fascinating. It's very rare that we wake up and there's a new market that we've decided to start trading, and it has a value and it's something we've been spending a lot of time on.

Obviously, as one of the world's largest owners of forests now and as a forest manager we've been thinking through this very, very carefully because generally people are thinking about how do we reduce emissions?

But you can also think about how do you capture those emissions and how do you pair those two thoughts together? I think it's going to be one of the most exciting spaces in alternatives coming up.

And whether you're transitioning from an old ship to a new ship and, therefore, reducing emissions, or whether you're going to plant a brand new forest that's going to capture carbon, the role of financial markets in the environmental question of carbon dioxide is going to just continue to grow and it's going to be a fascinating opportunity set for many clients.

David Lebovitz: Yes, and it's certainly something that comes up quite a bit in my client conversations. One of the other things that I wanted to get your perspective on - when it comes to ESG and actually, you know, the conversation today is a perfect example, we spend a lot of time on the E, a lot of time on the G and the S kind of gets lost in translation.

And so how do you think about moving the needle on the S across your various investment platforms?

Anton Pil: Yes. I think at least in some of our asset classes this has become maybe as important as E or in some cases more important, right. So if I think of - we own a lot of water companies and so, therefore, what role are we playing in society with those investments I think is a very important question and I think COVID tested a lot of those.

When you go back and you think of what happened during COVID, I think it's kind of fascinating to think through what were your managers or what were the companies you owned - what were they doing in the context of COVID?

Were they helping their local communities? You know, we set up vaccination locations at a number of our buildings across the US and were providing sort of free data services for some of our sailors on our ships.

Like what did you do in particular to sort of broadly help society? And I think COVID's going to be an interesting litmus test and people will be able to go back and check that on the S.

And frankly, a lot of investors are expecting us to play a much more active role on the social aspects not just of the investments we make, but also of the composition of our own investors, right.

So if I think of my team, I want my team to look like the broad communities we're serving and I think that it's not something you do passively. I think it has to be an active decision you're making and clients are beginning to demand more and more of it.

David Lebovitz: Absolutely - couldn't agree more. And, you know, you mentioned repurposing some of the real estate assets on the platform at testing sites - would love to get your perspective on real estate a little bit more broadly.

Particularly what are you seeing in terms of the shift towards remote work or hybrid work? What do you think that means for offices in particular? And maybe by extension of that, you know, the retail sector, which I think a lot of people went into the pandemic and kind of left it for dead, seems to be having a little bit of a renaissance here so would love your perspective on those two areas.

Anton Pil: So look, I think on the remote work people can look around at their neighbors, et cetera. It slowly seems to be converging that you would work three or four days from an office and one or two days from home, and that seems to be slowly growing as a consensus.

Fascinatingly enough, in a context of - as an office owner I'm not sure that's necessarily a bad thing. We haven't seen a significant reduction in office space by most of our tenants. If anything, it's quite the opposite.

A lot of tech companies are still increasing their space frankly to offer that degree of flexibility. So giving your employees more flexibility especially in a tight labor market does imply that they do have an office to go to, not that you have to exclusively or can only work from home.

And we continue to see at least even in our own investment teams having people get together a couple of days a week and in person have sort of the more impromptu conversations about their investments, et cetera is still very, very important and I think that's going to continue.

And on a valuation context by the way I think a lot of real estate hasn't come back the same way we've seen more publicly-traded markets come back as we're in the later innings of COVID.

The retail space is probably the most fascinating. Most of our retail spaces today have sales higher than they were pre-COVID, and across the board the foot traffic is often very similar or slightly lower but the spends are much, much higher.

And the piece that I find intriguing is that it hasn't sort of reflected yet in broader valuations of these assets. So you've got revenue that has picked up, that is now in some cases higher than it was pre-COVID but the valuations of the assets themselves oftentimes are still down 20% to 30% from pre-COVID levels.

So I do think there's sort of an interesting normalization that's taking place, and I think as we sort of hopefully get towards the end of some more normalcy post-COVID I think you're going to see some valuation normalization in that space.

David Lebovitz: Very interesting. And maybe just taking this one step further - so a lot of people going back to the stores maybe because they've had some challenges getting things shipped directly to their front doorstep.

I think the supply chain disruptions we've seen - they're well-known, they're well-understood. But from a transportation perspective what do you see as the impact of these broader supply chain issues on that asset class in particular?

Anton Pil: Yes. By the way - maybe just touch on the supply chain issues. Maybe (unintelligible) it'll be a month. In two months it'll be fine. I find that these things usually have a lot more little side effects that will take a lot longer to clean up than people think.

It'll also probably drive people to owning more inventories longer-term and you're right. It actually may be supporting some of the retail activity we're seeing because if you go to the store at least you can see it.

I mean, I don't know about you but like I've ordered plenty of things that have said 24-hour delivery or 48-hour delivery and four weeks later they're like, "Well, just kidding. It was a good try. We tried." So we - it - it's - so...

David Lebovitz: Exactly.

Anton Pil: ...I think most of us are experiencing that and I think that's here to stay. I mean, as an investor who owns a lot of ships and transportation-type assets it's kind of embarrassing to say, but it's not really a problem for us because just because a ship isn't moving doesn't mean I'm not getting paid my rents for the ship.

It's like when you rent a car from a car rental agency and you drive to the wedding day that you're trying to make it to and then you park the car and you go to the wedding, the 12 hours the car is parked there you're still paying for the car.

The same is true for us so that hasn't necessarily been a negative. I'm more concerned longer-term about how systemic inflation is going to be. And I'm sorry we're going off-topic here a little bit, but it's too easy as an excuse to try to excuse everything away.

And maybe it's because I grew up in Brazil but I think inflation once it's in people's psyche is quite difficult to get rid of. So I think some of these issues are here to stay for a lot longer than people probably expect.

David Lebovitz: I would certainly agree with that. And for a while we've been talking to the clients about how the forces of inflation - we're seeing the specific areas. We're seeing inflation come from - right, it's broadening out.

It's becoming less transitory and more difficult to simply write it off. I had a perfect example the other night. I had my whole family over for dinner and we ordered from an Italian place up the street.

I ordered somebody the chicken parm dinner, which used to come with a side of pasta - now decided pasta costs an additional couple of dollars. And so when you start to see things broaden out into restaurants, then there are impacts on wages.

And rightly so inflation is one of these economic forces that is very, very psychological, and once you begin to see that get ingrained particularly amongst lower-income individuals it can be very challenging to break.

And so I actually think that's a perfect segue way into something else I wanted to talk to you about and get a little bit of a sense of what you're seeing across some of the portfolio companies on the private equity side and in some of the borrowers on the private credit side.

What are you seeing in private markets broadly? One of the things we touch on in Guide to Alternatives is that applications for new business formation skyrocketed during the pandemic, and a lot of these businesses currently have no sponsored backing.

And so what are you seeing? What does the opportunity set look like and has the composition of the investments you're considering changed in the aftermath of this pandemic here?

Anton Pil: Yes. Look, I think private company creation continues to be very healthy in the United States. And I think if you go back 30 years ago and you wanted to start a company, generally what that would have meant - or even let's say 50 years ago you would have had to buy a special hat-making machine, and it would have been a very special heavy machine that you had to then specially design and it was probably fairly expensive.

Today you and I could use our laptop and design an app and try to sell it to 100 million people. The cost of entry is just extraordinarily low, and I think that's part of the reason why you're going to see continued growth in my mind in areas like tech in particular, which I think are very sort of entry-level light in terms of expense, right.

If you and I were going to start a new company to make chips because there's a chip shortage and we're going to create the Dave Lebovitz chip, it would cost us hundreds of millions of dollars to start that company.

If we want to start a company that calculates the distance of, I don't know, whatever it is on an app, we could do it for like probably $4000. So I think you're going to continue to see dramatic growth in the tech area because the barrier to entries are so low.

It does mean though that I think some of the other value creation that'll be fascinating especially on the climate side will be I think in some of the more actual technologies that are going to improve climate, where you're going to be investing in companies that are going to require hundreds of millions of dollars and not $10,000.

So I think there's some very interesting opportunities longer-term coming in sort of physical technologies that we haven't seen yet. And then I think we're also seeing continued growth in general in private credit markets as just the availability of credit - you just have many places that you can get credit as a company and people are going to continue to try to find whatever source fits their particular needs best.

And lastly, I think as we talked about inflation, the uncertainty about where markets are headed I think are going to continue to drive people to owning more privates in general, because whether for better or for worse private valuations tend to move slower than public markets.

They tend not to overreact. They are priced less regularly, which you might think from a - sort of a degree of transparency may be worse than something that prices every second.

But from a psychological standpoint when you're going through a particularly volatile period of capital markets, which I think we're going to get in the next 6 to 12 months, being forced to kind of wait out and look for the long-term for your valuation creation I think could be very helpful to keep people invested through what I think is going to be a very rocky period.

I know - and again this is going a little off-script but take, for example, the market movements on a number of cryptocurrencies. It's almost as if it's normal that that asset class moved 50% percent yesterday up or down.

And the reality is for a lot of investors a long-term investment plan requires you to stay invested, so to the ability that you can help people stay invested I think that's actually going to be a positive in longer-term.

David Lebovitz: Yes, I completely agree. The volatility of private assets is a big focus of our long-term capital market assumptions exercise this year and very sympathetic to the view you just expressed, which is, you know, if it's not getting marked every single day it can be easier to stay the course.

I would actually take that one step further and say on the private side you're able to much more nimbly pull levers to address the challenges that your company may be facing in a way that isn't necessarily the case with the large- and mega-cap corporations.

And so we've covered a lot here today and just wanted to give you the final word. We're a week out from Thanksgiving as we record this. The end of the year is in sight. As we think about rolling into 2022, what haven't we talked about today that is on your mind, and what do you want to leave our listeners with as you think about the coming year?

Anton Pil: The number one thing that most people should slowly be concerned about is that the free lunch from central banks around the world is over. It was a great time. It almost didn't matter which asset class you're in.

You've got to benefit from it and that's coming to an end. And now we all know it's coming to an end everyone's like, "Well, therefore, it's priced in." I'm not sure I buy that thesis.

I think unless somebody else steps up and buys these same assets that central banks were buying, we're going to see a pretty large supply-demand imbalance in some public markets.

And I think the implications on that to people's portfolios - people just need to have sort of an eyes wide open that the last several decades and particularly in fixed income of performance and returns are simply not going to happen.

And so I am a little bit more sanguine on the outlook and really would strongly encourage people to think about where are places that they can own? What are stable assets that have some degree of - maybe were a little out of favor for a while, that they have a stable degree of return and maybe some degree of inflation protection and ride out that transitory period that perhaps may not be that transitory.

That shift is something everyone's really got to be paying attention to, and if you don't do it before yearend you definitely should be thinking about it in the first quarter.

David Lebovitz: And I think that that makes a lot of sense. You know, for a long time on the institutional side we've had conversations around the role of fixed income and fixed income substitutes.

And to your point about inflation I think we're kind of reading the tea leaves in the same way. There's now another risk that needs to be taken into account beyond just rates moving higher in an absolute sense.

And so Anton as always an absolute pleasure having you join us today and looking forward to having you again on the show soon.

Anton Pil: Always fun David. Thank you for doing it.

David Lebovitz: Thank you for joining us today on JPMorgan Center for Investment Excellence. If you found our insights useful, you can find more episodes anywhere you listen to podcasts and on our Web site. Thank you. Recorded on November 15, 2021.

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