Fund Research

JPMorgan Global Core Real Assets

Last update 31 July 2019

Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by JPMorgan Global Core Real Assets . The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

Summary

JPMorgan Global Core Real Assets Limited (JARA) is a proposed investment company that will aim to generate an attractive income and total return by investing across real assets sectors which are usually only accessible to institutional investors. The target yield is 4%-6%, from a 7%-9% total return.

JARA will invest as a Limited Partner (LP) in private, perpetual life strategies run by the J.P. Morgan Global Alternatives Group. These will invest in private assets across, core global infrastructure, core real estate (US and Asia Pacific) and core global transportation sectors, which together will make up c. 80% of the portfolio. The remainder will be invested in publicly listed real asset securities, through segregated mandates investing in REITs (all-tranche) as well as infrastructure and transportation securities. The bespoke segregated mandates will provide flexibility, liquidity and compliment the private asset returns.

JARA’s aim is to provide a defensive income stream from high quality real assets with low correlation to major equity markets and a low volatility, thanks in part to their low cross-correlations. The “core” nature comes from the high quality of the underlying assets, and the fact that the managers believe these assets should generate steady returns through the cycle by generating two thirds of the return through highly predictable, mostly contracted sources of income.

The investment company will target a quarterly dividend payment. The target asset allocation would have generated income of over 5% last year, which compares favourably to the current listed infrastructure and property sector averages. In contrast to trusts in these sectors, JARA’s income will be generated from outside the UK (95% of the target portfolio), providing diversification for existing investors in these peer groups and exposure to assets that are currently difficult to access in a listed format.

The asset allocation of the portfolio will be managed by the Alternatives Solutions Group (ASG) with portfolio insights and design led by Jamie Kramer with assistance from Jason DeSena and Pulkit Sharma. This team has a history of structuring custom solutions incorporating Real Asset capabilities spanning over 10 years, with an objective-driven portfolio design process tailored to the individual preferences of investors and their consultants. ASG advise on and build multi-alternative portfolios for institutional clients from the $145bn of assets managed by the J.P. Morgan Global Alternatives Platform. JARA opens up this real asset pool to the UK wholesale and retail market for the first time.

J.P. Morgan are targeting a minimum raise of £100m with a cap of £500m. The expectation is that the trust will be 80% invested by six months, and 100% by 12 months, with the ramp-up being due to the investment queues currently present with the underlying private strategies.

The management fee will depend on the amount raised, with a 98bps maximum falling to 91bps if £500m is raised. There are also performance fees on two of the underlying strategies. We expect the OCF ex performance fees to come in at around 1.2% to 1.3%, which compares to an average OCF ex performance fees of 1.24% in the listed infrastructure sector, although as JARA grows this has the capacity to reduce markedly.

Kepler View

This is an opportunity for wholesale and retail investors to gain access to the return and income-generating potential in an investment universe usually only accessible to institutions due to high minimums and structure limitations. The combination of the defensive qualities and yield they offer makes JARA an interesting proposition, we believe, particularly in the current market environment in which yields on fixed income look compressed and the global economy is closer to the next downturn than expansion.

We expect few investors in the UK have significant private global infrastructure and property investments outside the UK, and diversifying the risks in the domestic economy seems particularly attractive at this juncture. Furthermore, the significant diversification across 500 plus assets would be hard to achieve without access to the JPMorgan real assets platform.

Bull bear
Offers diversifying sources of income with the ability to shift strategically to maintain a yield
Some of the diversification benefits of investing in real assets may be lost as the shares will trade on the stock market

Offers access to sectors, asset classes and geographies hard to find elsewhere
Amalgamation of exiting strategies, no full control over asset allocation

Historic asset class returns suggest low correlation to markets and low beta, which could be attractive as we near the end of the cycle
There are performance fees on two of the underlying strategies which may deter some


Portfolio

JPMorgan Global Core Real Assets Limited (JARA) will aim to generate an attractive income and total return by investing in a diverse range of real asset sectors which are usually only available to institutional investors.

JARA will invest as a Limited Partner (LP) in private, perpetual life strategies managed by the J.P. Morgan Global Alternatives Group. These private assets will make up c. 80% of the portfolio, with the remainder being invested in publicly listed real asset securities, through segregated mandates investing in REITs as well as infrastructure and transportation securities. This latter sleeve provides liquidity to the trust as well as helping approve overall risk-adjusted returns.

The aim is to provide a core real assets portfolio spread globally, with the scope for further diversification should opportunities arise. The three areas of concentration will be Global Infrastructure, US and Asia-Pacific Real Estate, and Global Transportation, with the target allocation presented in the graphic below. The expectation is for the trust to be 80% invested within six months and 100% invested in six to twelve months, with the lag due to the investor queues each of the underlying LP structures currently has.

Target asset allocation

Source: JPMAM

The c. 80% allocated to private real assets should provide attractive diversification benefits to equity and bond investors. Over the past 20 years, according to JPMAM calculations, the correlation and beta to major equity markets of the real asset universe would have both been around 0.3. The diversification potential should be a key attraction for UK investors in our view, in that the portfolio offers access to asset classes not normally held by the UK wealth management or retail communities. The US and Asia Pacific real estate in particular offers intriguing diversification from the UK commercial property sector, which is struggling under concerns about the Brexit negotiations and the secular changes in the retail and office sectors. The infrastructure and transport strategies also offer diversification from the UK-centric exposures of the listed fund sectors. In total, there is only a 5% exposure to the UK in the indicative portfolio, with this latter exposure coming from the infrastructure allocation.

Geographic allocation

Source: JPMAM

The diverse strategies have been chosen both to benefit from the areas where JPMAM has a strong presence, but also to benefit from the differing characteristics and appealing diversification they offer to one another. The cross-correlations between the real asset sectors have been low in the past, as the below cross-correlation historical data illustrates. Although correlations can change, the management team believe that the blend of assets they have chosen will continue to illustrate attractive diversification and low volatility comparable to equities (for more detail on back-tested returns see the performance section).This is especially relevant a many of the underlying cash flows are long term and contracted in nature.

cross-correlations of real asset sectors


Global equities
global bonds
us core re
european core re
apac core re
global infra
global transport
liquid real assets
Global Equities
1







Global Bonds
-0.1
1






US Core RE
0.2
-0.2
1





European Core RE
0.5
-0.4
0.7
1




APAC Core RE
0.3
-0.3
0.6
0.7
1



Global Infrastructure
-0.1
0.4
0.3
0.1
-0.2
1


Liquid Real Assets
0.5
0.2
0
0.4
0.3
0.3
0.2
1

Source: JPMAM

In concentrating on “core” strategies, the intention is to build a high-quality, income focused portfolio which should be more resilient in market downturns and generate steady returns through the cycle. This should, along with the low cross-correlations, mitigate much of the volatility in the different real assets strategies. To the same end, the allocations will be shifted on a strategic basis rather than making any attempts to time the market. The aim is to benefit from the alpha generated by the underlying portfolios, each of which has a high-quality bias, rather than through tactical asset allocation, which is often difficult to execute in illiquid assets, although the relative value approach should lead to some counter-cyclicality. Historic data demonstrates that more conservative, core real assets strategies have tended to outperform non-core strategies over the long-term – an outperformance which is especially pronounced in the later parts of a market cycle.

The core real estate allocation is split between US and Asia Pacific exposure. In both geographies, the strategies aim for “quality”. This means select larger assets (benefitting from the scale of J.P. Morgan as an investor), in primary markets with strong growth demographics and economic drivers. The approach to leverage is conservative, lease lengths long and occupancy rates high. The Asia Pacific strategy is relatively new, launched in 2016, and has biased itself to Japan and Australia initially, aiming to expand into the highest-quality locations in the region over time.

In the infrastructure strategy, the “core” focus amounts to selecting assets with high visibility of cash flows, chiefly by being regulated (a significant portion of the cash flows from this strategy are determined within a regulatory framework) or with very long-term contracts. In the former bucket are generally utilities, and in the latter energy generation and storage facilities. There is also an allocation to ‘fixed’ transportation assets, focusing on mature locations often underpinned by long-term contracts (these are airports and seaports, for example).

The core transport strategy focuses on air, land and sea transportation assets. Each area has unique drivers and characteristics. The aim is to select the assets which are most strongly backed by demand growth, with long useful lives which can be placed on long term leases with high quality counterparties. The target yield for this strategy is the highest (see table in performance section), reflecting what the managers believes to be the favourable dynamics which currently exist in this market. This is principally due to a need for capital from large specialized investors, which aren’t as prevalent in the transport sector.

ESG is integrated into the investment process on all the underlying strategies. As the fund with the longest track record, the US core real estate strategy has led this process, and has in fact been ranked first out of 196 diversified strategies assessed by the independent GRESB assessors. The infrastructure strategy was voted number 2 in its category.

The portfolio won’t be hedged, so it is worth noting that there will be significant dollar exposure in particular, predominantly from the U.S. real estate strategy and Transportation strategy.

Currency allocation

Source: JPMAM


Gearing

No gearing will be applied at the trust level. In the core real asset LP strategies to which the trust will allocate, there is gearing, however. JPMAM estimate an average leverage of 25% to 35% on core real estate, 35% - 60% on core infrastructure assets and 40% to 60% on core transportation assets. The look through gearing is at around 30% on the indicative portfolio, a relatively conservative level.

Returns

JARA will aim for a total return (net of fees) of 7% to 9% per annum, of which 4% to 6% is intended to be paid in dividends. We have included below a table of the manager’s target returns for each allocation, where available. In the case of US real estate, the target is outperformance of the NFI-ODCE index, so we have calculated the average return over the past 20 years for that index, although this does not imply it is the return the manager expects.

return targets (gross, not including fees)


Target return
Target yield
Strategic Property Strategy US
>8.6%

Strategic Property Strategy Asia
8%-10% (gross)
5%-6% (gross)
Infrastructure Investments Strategy
8%-12%
5%-7%
Global Transport Income Strategy
10%-12%
8%-10%
Core US All Tranche REITs Strategy
7%-8%

Listed Real Assets
10% - 11%
4%-5%

Source: JPMAM, Kepler calculations

Analysing the correlations and covariances of the various sub-sectors of real assets is one of the focuses of the work of the Alternatives Solutions Group (ASG), explored in more depth in the Management section. Their work shows the target asset allocation has generated attractive total returns over the past fifteen years with relatively low volatility and drawdowns.

HISTORIC RETURNS (BACKTESTED)


Global Equities
Global 60% equities / 40% bonds
Global Real Estate
JARA (representative portfolio)
Historical Gross Returns
9.4%
7.8%
9.4%
10.8%
Historical Volatility
16.9%
11%
11%
10.2%
Gross returns per unit of risk
0.6
0.7
0.8
1.1
Max Drawdown
-38%
-21%
-28%
-15%
% of time over UK CPI + 3%
77%
69%
77%
85%

Source: JPMAM

The 10.7% gross returns minus 1.3% in charges (for rationale see charges section), would suggest a historic net return higher than the 7%-9% return target of the trust. In our view, this relative caution about future returns given the secular changes in the global economy over the period is warranted – given the global demographic and debt situation, the risk-free rates off which yielding assets are priced are likely to be lower than in recent cycles. Notably, the volatility of back-tested returns was only 60% of global equities, and the maximum drawdown less than 50%. Of course, like returns, back-tests of volatility and drawdowns may not be borne out in future performance.

Dividend

The trust will pay a quarterly dividend once fully invested. The aim is to pay 4% to 6% out of a long-term target NAV total return of 7% to 9% (net of fees) on the basis of the initial offer price. In the first twelve months following the date of admission, the target initial dividend yield will be 2%-3%. We understand back-testing suggests the target weights of the portfolio would have generated net yield of over 5% last year. The team are targeting a net yield of 4%-6% from the real estate investments, 5% to 7% from infrastructure and 8% to 10% from transportation. One of the benefits of a diversified portfolio such as this is that the yield cycles should not move in step, meaning there is scope to shift allocations into higher yielding sectors when the outlook warrants it to maintain the yield. While a 4% to 6% yield is not exceptionally high, it is very much in line with the current yields on offer in the alternatives sectors, but one might argue is significantly more diversified, and therefore likely to be sustainable for longer.

AVERAGES FOR LISTED ALTERNATIVES SECTORS (as at 23 May 2019)


Yield
(Discount) / Premium
JARA
4%-6% (target)
1.5% (launch costs)
Property (UK commercial)
4.7%
-2.9%*
Infrastructure
4.6%
9.6%
Property (UK sector specialist)
4.5%
5.3%
Property (Europe)
4.3%
-2.6%*
Infrastructure (Renewables)
4%
7.8%

*JARA has no exposure to UK or European property

Source: AIC

As we mention above, the yield has to be seen in the context of the diverse sources of income that contribute to it. The portfolio is designed to generate consistent returns through the cycle, offering access to income generating assets with (in aggregate) less exposure to capital losses in equity market falls. This could prove to be valuable in the coming years should the 10-year equity market expansion after the global financial crisis turn to recession at a point in the future.

Management

The primary responsibility of managing the Company's portfolio will be undertaken by JPMAM's Alternative Solutions Group ("ASG"). Jamie Kramer is the Head of ASG and is supported by Pulkit Sharma and Jason DeSena. These individuals will be responsible for providing insight and analytics to the ASG Investment Committee who approve and implement the allocation. The investment process combines a top-down asset allocation approach across Real Assets with bottom-up expertise from specialist teams across JPMAM. The Investment Committee maintains ultimate responsibility for asset allocation and overall performance. ASG are largely based in New York and advise on and build multi-alternatives portfolios for around 55 institutional clients based on proprietary research, data and analytics. They allocate to the products managed by the J.P. Morgan Global Alternatives Group, which amount to $145bn of assets.

One of the key selling points of this trust is that it brings a universe of investment usually restricted to institutions to smaller wholesale and retail investors. Here the trust benefits from the scale of J.P. Morgan Asset Management in this space. Investors in a relatively small trust will be able to allocate to less liquid, geographically diversified and more specialised sectors thanks to the scale of the underlying strategies.

The scale of resources ASG can bring to asset allocation decisions is correspondingly large. ASG has access to a huge range of performance time series (over 200) for alternative assets which are often expensive or difficult to access, along with the modelling and analytical tools they have developed over a decade of practice.

The team foresee adding extra asset classes to the mix in the future should they become available and fit with the objectives of the trust. JPMAM, as such a large player in this space, expect to have early access to new opportunities as they come up and have the resources to build out offerings in attractive sectors as they develop. Indeed, the Asia Pacific property allocation foreseen at launch is one such recent example. The broader J.P. Morgan Global Alternatives team have been building out their exposure here since 2016 in the light of the good fundamentals they see supporting the asset class in the coming decades.

Discount

The board will have the authority to buy back up to 14.99% of the company’s shares when they are trading on a discount. Whether buybacks do much to control discounts is contentious. More effective over the long run is likely to be the continuation votes which will be held every five years, starting at the fifth AGM.

However, this may not be a pressing or immediate problem. Investors have been willing to pay a premium for the defensive income-generating properties of many infrastructure and real assets in recent years. Notably, the infrastructure trusts are trading on a 9.6% average premium, according AIC stats, and the renewable energy infrastructure trusts 7.8%. In the property sectors, the situation is more complex. Specialist assets with defensive qualities and a clear story are trading on significant premiums, although more generalist UK and European commercial property funds have been less in favour thanks to the macro-economic situation (Brexit, European slowdown) and the exposure to the retail sector in a period of disruption. We believe the opportunity to diversify property exposure away from the UK and Europe into Asia Pacific and the US could be highly attractive to investors given this context too, and given the scarcity of alternative routes the trust could also attract a premium rating.

Charges

Investors will pay the management fees of the underlying strategies and segregated mandates plus an extra 5bps in asset allocation fees. Based on the proposed initial asset allocation, and according to JPMorgan’s estimates, at £200m the total management fee will be 98bps, at £300m 97bps, at £500m 91bps and at £1bn 87bps. Given the scale of the JPM ALTs platform, there seems to be the capacity to grow JARA rapidly given the scale of the underlying strategies and their capital deployment profiles.

Assuming the £200m figure, this would be in line with the specialist infrastructure funds, according to JPM Cazenove stats, but of course for a much more varied portfolio of harder-to-source assets. Here the trust benefits from the access to JPMAM’s vast internal resources – for example, the Listed Real Assets Managed Account (non-REIT property exposure) charges just 25bps for a fully bespoke customisable mandate.

There are performance fees on two of the underlying strategies. On the infrastructure fund, the fee is 15% of the returns over a 7% hurdle over a rolling three-year basis, capped at a 13.5% return. On the transport fund, the fee is the same but with no cap.

The manager estimates that ongoing charges would be roughly 34bps if the net asset value on launch was £150m. By our calculations, the overall OCF is therefore likely to be in the region of 1.2% to 1.3%, which compares to the average OCF’s ex performance fee of the listed property sector average of 1.88%, the listed infrastructure sector of 1.24% % and the renewables infrastructure average of 1.14%.

ESG

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