The macroeconomic environment has changed significantly since the launch of JPMorgan Global Core Real Assets Limited (JARA) in September 2019. Over the past year, inflation has spiked to four-decade highs in the UK and many other developed economies after over a decade of running below the long-run average. Interest rates are following a similar path, rising faster than expected after sitting at near-zero levels since the 2008-2009 financial crisis.
Investors are understandably asking about real assets – which include real estate, infrastructure and transportation assets – and how these might perform in this changing environment. We discuss our expectations for real assets and how we are managing JARA’s exposure.
Real assets: Sources of stabilityReal asset investors have reasons to be optimistic about the potential for returns. A large portion of the revenue from real assets comes from contracted sources, such as long-term leases for commercial real estate or container ships, or regulated income, in the case of utilities. These business models tend to provide more stable, predictable cash flows that are also more insulated from changes in the macroeconomic environment.
Some of these same features can also support real assets when interest rates and inflation are rising. In addition to implicit linkages to inflation through market pricing, many real assets have contracted or regulated sources of income that explicitly provide for increases in inflation. Although these adjustments may come with a lag, they will ultimately flow through and help protect real revenues – and returns.
Our analysis shows that market environments where interest rates and inflation are rising tend to be broadly supportive for investing in real assets, including real estate. While conventional wisdom suggests that rising interest rates eventually cool the real estate market and dampen values, evidence does not support a strong correlation; in fact, the combination of rising interest rates and falling real estate values has only happened twice since the 1970s. In these two instances, deteriorating fundamentals in real estate markets coincided with the recessions in the early 1990s and following the 2008-2009 financial crisis, leading to price declines.
Diversification within real assetsDiversifying real asset exposure can help provide investors with more stable yields and returns through different market environments. Just over half of JARA’s portfolio is invested in real estate, while the remainder is broadly split between infrastructure (23%) and transportation (21%) assets.
JARA is further diversified in several additional ways. Geographically, JARA’s real estate assets are spread across the United States and the Asia-Pacific region. These areas see differing macro and social drivers, which further helps diversify JARA’s returns. The portfolio also has approximately a 5% allocation to real estate debt, which provides a slightly more defensive position as these investments are further up the capital structure and typically provide more income.
The vast majority of JARA’s investments are private assets, which has been proven beneficial as private asset prices have been less volatile than in the public markets. However, maintaining exposure to public assets helps increase liquidity and allows for active portfolio rebalancing.
Dynamic exposure to secular growth investment themesIn addition to traditional types of diversification – sector, geography, private vs. public – JARA also invests in assets with exposure to several broad secular growth themes, including the energy transition, e-commerce acceleration and emerging core sectors.
Investments in assets related to the energy transition are roughly 10% of the portfolio and include renewables but also other solutions that can help meet the challenge of decarbonising utilities or improving energy ratings on real estate buildings. Assets that are essential to the continued growth of e-commerce account for about 24% of the portfolio. The portfolio has a number of investments across the supply chain and logistics, from warehouses to containerships.
Both the energy transition and e-commerce acceleration are supporting the growth of assets in the emerging core sector, which is currently about 6% of the portfolio. For example, increasing use of wind turbines creates the need for wind farm maintenance vessels while rapid digitisation across many industries is driving demand for data centres.
Holdings evolutionThe interaction of secular growth themes and changes in the macroeconomic environment requires a dynamic approach to real assets investing that is reflected in a significant evolution in the company’s holdings since the end of 2021. For example, infrastructure investments in utilities and renewables are expected to reach about 80%, up from roughly 60%-70% in the middle of 2021, while new investments in liquified natural gas (LNG) are on track to rise to around 5%.
Another change in the portfolio reflects our evolving approach towards container ships. We had been adding these assets in 2021 and have expanded this further by adding exposure to container leasing as well. The containership industry benefits from long-term leases and an oligopoly market structure with just a handful of big players.
We believe real estate will continue be a large part of the portfolio and contribute to returns in 2022, although we expect to ultimately see an increasingly prominent role for infrastructure and transportation over time. Regardless of the macroeconomic environment, we will continue to take a dynamic, diversified approach to real asset investing.
Conclusion: Real assets means real returns Real assets, including real estate, infrastructure and transportation assets, have historically demonstrated a low correlation to equities and bonds while generating a stable income with a link to inflation. JARA’s dynamic and diversified real assets exposure can bring diversification benefits to investors’ portfolios, as well as providing a predictable yield and the opportunity to earn a real return in the current high inflation environment.
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