Higher inflation and rising interest rates have created a situation where, for the first time in a generation, bonds and fixed-term deposits are returning 5-6% - attractive returns at a time when equity markets have been uncomfortably volatile and often unrewarding.
Unsurprisingly, the relatively high returns available in fixed income markets have encouraged significant fund inflows there, at the expense of equities in general, and investment companies in particular. Investment company share prices have declined accordingly and share price discounts to net asset value (NAV) have widened across the entire sector, regardless of companies’ investment strategies or geographical focus.
Balanced portfolios should look to include uncorrelated investments
However, investors may be well-advised to think twice before following the pack. As ever, portfolio diversification can be key to minimising risk, and balanced portfolios should include a selection of ideally uncorrelated investments. It is equally important to consider how investments will evolve over time, and this is especially the case for cash and bond investors at present. We feel interest rates are at or near their peak, and while rates may remain high over the coming year or more, at some point in the not-too-distant future, they will begin to decline, dragging investment returns lower and leaving investors to cast around for ways of replicating the returns they enjoyed during the brief, high-rate interlude.
Real assets: an attractive alternative
Investment in real assets provide an attractive alternative to this rollercoaster approach. Real assets such as commercial and residential property, infrastructure and transport facilities can generate stable and predictable income over long timeframes. Indeed, income from real assets is often coupled with contractual uplifts to rents and prices, safeguarding real incomes when inflation is rising.
Real assets offer the additional potential for capital gains as the values of underlying assets increase. And returns on real assets are often uncorrelated with the performance of financial markets, giving investors a smoother, more remunerative ride at times when conventional markets are in decline. That being said, investors will have to balance the benefits of investing in real assets with the risks such as illiquidity, low economic growth and poor corporate earnings, which could impact on the returns of the Company.
JPMorgan Global Core Real Assets (JARA) offers investors exposure to this interesting and rewarding asset class. Approximately half of JARA’s portfolio is invested in global commercial and residential real estate. Many of these investments have automatic inflation-linked rental uplifts. The remainder of the portfolio is invested in a diversified selection of other real assets including infrastructure projects such as wind and solar energy generation plants, and transport assets such as liquefied natural gas (LNG) tankers, container ships and railcar leases.
JARA focuses on ‘core’ real assets that aim to offer strong, long-term cash flows which aim to pass through to shareholders in the form of regular, competitive dividends. Albeit yield is not guaranteed, JARA targets an annual income of between 4-6% and has increased its dividend steadily since its initial public offering (IPO) in September 2019.
In the financial year ended February 2023 JARA paid a total dividend of 4.05 pence per share and the Board has indicated that total dividends for this financial year, ending February 2024 is expected to exceed 4.20 pence per share. Based on the last four dividend payments and the current share price, JARA offered a dividend yield that is broadly comparable with the returns available in cash and bond markets. Although past performance is not a reliable indicator of future results, JARA’s Board expects the level of income to continue growing over time, in line with the success of the Company’s underlying businesses and strategies.
This already competitive return is further enhanced by capital gains, which make a significant contribution to JARA’s total investment return. JARA’s portfolio is positioned to benefit from major structural trends such as the transition to net zero carbon emissions, which will increase demand for energy efficient buildings, renewable energy infrastructure and LNG tankers, driving up the value of these assets over time.
Increasing demand for office space and affordable housing underpins real assets
The Company’s managers are optimistic about the outlook. They see clear signs that real estate prices are stabilising after the past year’s sharp falls, while demand for office space is improving as workers return to the office, albeit reluctantly in many instances. The shortage of affordable housing, especially in the US and the UK, will underpin this market over the medium-term. Elsewhere, renewable energy and related transport assets are likely to experience heightened demand in the near term, as the global transition to net zero emissions gains momentum. This trend is likely to be amplified in the US by the recently implemented Inflation Reduction Act, which includes extremely generous energy-related tax incentives aimed at combating climate change.
In sum, JARA can offer investors potentially more attractive, more diversified, and more consistent returns than the transitory rewards offered by investments in bonds and cash deposits. And with JARA’s share price now trading at a significant discount to NAV, now may be a particularly good time for investors to step off the investment return rollercoaster, and opt instead for a vehicle offering stable and rising income, combined with capital gains supercharged by some of the most powerful structural trends set to drive investment returns over the long term.