Investment Strategy

Worried about inflation? A new breed of real assets may be right for you.

Mar 28, 2022

Investors are increasingly turning to nontraditional real assets for diversification, inflation protection and yield.

Let’s face it, the current market environment can seem a little daunting. Amid slowing economic growth, higher inflation and low but rising interest rates—as well as the market volatility spurred by the war in Ukraine—it often helps to go back to basics. Whatever your investment goals and risk tolerance (and whatever the market winds) you’ll likely now want these three components in your investment portfolio: Diversification, inflation protection and yield.

Nontraditional real assets—“hard-backed” assets outside of traditional real estate sectors—can deliver on all three fronts, as more and more investors are coming to appreciate. Nontraditional real assets include core infrastructure, transport (“moving infrastructure”), timber and nontraditional real estate (such as self-storage, healthcare and student housing).

How can these assets provide the diversification, inflation protection and yield that investors need? With typically low correlation to traditional asset classes (notably equity and fixed income), nontraditional real assets provide valuable diversification in a portfolio. Inflation protection and yield can come from steady, predictable cash flows, generated by long-term (10-year-plus) leases and services contracts. Often these contracts may cover essential services, with volume minimums and inflation-linked pricing. In addition, nontraditional real assets may also offer investors a way to align with their Sustainable Investing goals and concerns.

From airport hangars to data centers: What do you actually own?


Infrastructure—Power generation, utilities, energy networks, data centers: These often include regulatory and/or contractual frameworks, usually correlated to inflation, as well as government concessions and long-term contractual revenues with investment grade counterparties.

Transport—“Moving infrastructure” such as aircraft, ships and railcars: These are critical components of global supply chain networks, often with long-term leases to firms with good credit ratings.

Timber—Timberland, a natural carbon-capture solution, is managed, harvested, and replanted. Logs produced address high demand for housing, especially in the United States.

Nontraditional real estate: Sectors include student rental housing, self-storage, healthcare facilities.

Real assets for decarbonization and the energy transition


Increasingly investors are turning to nontraditional assets to align with Sustainable Investing goals and trends—most notably the ongoing energy transition from fossil fuels to renewables. As more and more companies look to offset their carbon footprint, and as governments commit to transition to a lower carbon world, “decarbonizing” assets— from plants and trees to methane removal systems— are in growing demand.
 
Timberland could become even more valuable. Thanks to developments in science and technology, the carbon sequestered by trees can now be quantified. That makes it easier for companies to use their timber holdings to offset their carbon footprint.

Today, we find interesting investment opportunities in combining renewable energy with natural gas investment. To maintain energy networks’ reliability during the transition from fossil fuels, we anticipate that spending on green infrastructure will be complemented by investment in nonintermittent natural gas and, to some extent, battery technologies.

The energy transition has brought new attention to the broader universe of “New World” infrastructure. It includes data centers and satellite internet networks as well as energy transition infrastructure such as upgraded electric grids and increased electric vehicle (EV) charging capacity. While many investors may still think of infrastructure in the traditional sense (bridges, airports, and toll roads), that’s only one part of the story today.

Finding opportunities in disrupted supply chains


Although nontraditional real assets have offered investment opportunities for decades, the current environment may be especially attractive.

Credit today’s disrupted supply chains. Current shortages of ships, which carry 90% of global trade, as well as reduced container capacity, have driven lease rates and asset values to historic highs. We think these trends may likely persist over the next two decades.

The pandemic has also created infrastructure challenges at ports, with a surging demand for both trucks and truck drivers. (Some 70,000 U.S. truckers left the force in the wake of the outbreak of COVID-19.) More truck, train and warehouse capacity will be needed to support the growing volume of cargo entering ports.

Over the next year or so, shipping delays and port congestion may likely continue to lift profits for owners of nontraditional real assets. Even after pandemic-related supply chain constraints ease, a tight supply of transportation assets may well persist.

How to invest in nontraditional real assets


How can you find the nontraditional real asset fund that’s right for you? First, you’ll want to invest in a manager who can identify promising and appropriately priced assets. As more capital moves into the space, you want to be sure that you’re not overpaying, even for a highly desirable asset.
 
A good manager will be an able operator and steward of nontraditional real assets. In our view, a manager needs the size and scale to “package” these assets—bringing together thousands of utilities in one investment portfolio, say, so that the fund on offer is sufficiently large and well-diversified.

Leverage (using debt to increase returns) is another important issue. In part because investors are still so hungry for yield, some real asset managers are boosting leverage to increase the funds’ yields. There’s nothing wrong with leverage, but it should be held at appropriate levels.

All of which is to say—manager selection is key. Indeed, we find wide dispersion between top- and bottom-performing real asset managers. Among U.S. noncore real estate managers, for example, there is 12 percentage point difference between top- and bottom-quartile manager returns (from 6.0% to 18.3%).1 Choose carefully to make sure you can reliably draw on the diversification, inflation protection and yield that nontraditional real assets can provide.

We can help

Finding the right alternative strategy depends on your goals. We specialize in alternative investments and believe they can be essential building blocks in your portfolio. But navigating this universe of complex investments requires in-depth understanding to gauge the risks and identify potential high return opportunities.
 
For a thoughtful analysis of how nontraditional real assets might fit into your portfolio and best align with your family’s goals, reach out to your J.P. Morgan team and our alternative specialists are available.

 

 

 

1Source; Lipper, NCREIF, Cambridge Associates, HFRI, J.P. Morgan Asset Management, Data is as of August 13, 2021.Global equities (large cap) and global bonds dispersion are based on world large stock and world bond categories, respectively. Manager dispersion is based on annual returns of global equities, global bonds, and U.S. core real estate over 10 year period ending 2Q 2021. Hedge Fund returns are based on annual returns from Feb 2011-Jan 2021. U.S. non-core real estate, global private equity and U.S. venture capital are represented by 10-year horizon internal rate return (IRR) ending 1Q 2021. Past performance is no guarantee of future results. It is not possible to invest in an index.

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