If you just stick to the headlines, then the big story this year in the US is how President Donald Trump’s policies will affect the infrastructure market – even if the answers to that question have been slow to emerge.
Spend a while talking to JPMorgan Asset Management’s Anton Pil – managing partner for the firm’s $130 billion global alternatives business, which includes infrastructure, real estate, private equity and hedge funds – and you’ll find that the real story is “the change in Federal Reserve policy that’s coming down the pipe”.
The Fed, as it’s colloquially known, announced at its September meeting that it will begin rolling back its $4.5 trillion balance sheet collected as part of its Great Recession stimulus package.
The central bank has twice raised the benchmark interest rate in 2017, and another hike to 1.25 percent could happen by year end. All the while, efforts are being made to stoke low inflation numbers up to the Fed’s long-term 2 percent target.
If this comes to fruition, infrastructure will be a good place for investors to be in, argues Pil, who co-heads the firm’s alternatives business along with managing partner Chris Hayward.
“Changing and evolving monetary policy in this country is going to continue, and I think it’s going to have profound implications for broader asset classes,” he explains. “If that results in a broad repricing of fixed-income asset classes, then what can you own in a portfolio that’s a counterbalance to a predominantly equity exposure?”
“The question is, when values have been rising, have they been rising because of discount factors or the underlying business dynamics?”
His answer is infrastructure, a “potential hideout” for long-term investors such as defined-benefit pensions, which make up the majority of LPs invested in JPMAM’s North America-based infrastructure business.
That’s why Pil says JPMAM is positioning its $20 billion infrastructure
business for growth and foresees managing a programme “multiples of that amount” over the next five to 10 years.
“The concern most investors have, whether justified or not, is that a change or turn in global liquidity is going to do a repricing of fixed-income asset classes,” he says. “The need for stable, predictable cashflows, and, in some contexts, regulated cashflows, is going to become much more critical.”
Infra vs inflation
Infrastructure provides stability throughout economic cycles that few other asset classes can match. This quality has driven its reputation among LPs as a safe-haven investment. Many are allocating a portion of their portfolio to assets that will generate predictable returns for years down the road.
The asset class earned this image in the aftermath of the global financial crisis. “People who invested in infrastructure did okay,” Pil says.
He should know. Having spent his entire 22-year career at JPMorgan, Pil brings a well-rounded experience to the business, having started by managing emerging markets fixed income and most recently as head of JPMorgan’s Private Bank Global Investment Opportunities group. He even spent a summer working on an oilrig off the coast of Angola.
“It allows me to sometimes take a much more holistic view on these asset classes than people who may have actually done the same asset class for their entire careers,” Pil explains. “It allows us to have a much broader conversation with clients about how infrastructure should fit into their portfolio and why.”
But the asset class has not been tested since the Fed introduced its stimulus package and pumped liquidity into the market. It also hasn’t been through high inflation.
“There’s generations of investors now that have never experienced inflation in the marketplace,” Pil says, adding the last high inflationary period occurred in the 1970s and ‘80s. Back then, a sputtering economy led to easy-money policies from the Fed, which led to inflation. The rate peaked in 1980 at 14 percent and averaged 3.5 percent over the decade. Even Pil hasn’t navigated financial markets in the inflationary period he described.
To be clear, inflation rates are not yet on the rise in a meaningful way. The Bureau of Labor Statistics reported a 2.2 percent rate in September after four months below the Fed’s 2 percent target. But the Fed’s preferred benchmark – the personal consumption expenditures price index excluding food and energy – has consistently underperformed its 2 percent inflation target for five-plus years.
That is leading to vigorous debate inside and outside the Fed. Minutes from the central bank’s meeting on 19-20 September showed many participants concerned about a persistent low-inflation environment, which might have implications for a rate rise in December and the three hikes forecasted for 2018. Over the summer, a group of economists aptly called ‘Fed Up’ lobbied for the central bank to raise its 2 percent target.
“If we do see inflationary pressure pick up in the US, especially if it’s above expected, that could be a defining moment for infrastructure,” Pil says. “We have products in every asset class that will perform well for clients at different points in the cycle. Infrastructure is absolutely critical for the part of the cycle where you see inflationary pressures pick up.”
That’s important, because it cements the idea that infrastructure can be a bedrock of institutional portfolios and is well suited for a changing economy. It also wouldn’t hurt JPMAM’s infrastructure portfolio.
“We believe that our cashflows will increase about 80 percent of what inflation goes up. In other words, what you will earn over time will also rise with inflation,” he explains. “[I’m] not necessarily saying every part of this asset class will outperform, but generally this asset class will perform better than most.”
Contracted or regulated
JPMAM’s strategy is centred on core and core-plus infrastructure in OECD markets and focuses on maximising an asset’s value through performance rather than deals and exits.
“The pendulum is swinging back towards core, core-plus, diversified exposures,” Pil says. “There was a time for more opportunistic investing, but I would say for the next three-to-five years, the focus on diversified cashflow, generative, stable, total-return type investing is going to be key.”
At the heart of it, on the equity side, is the open-ended JPMorgan Infrastructure Investments Fund, valued at $6.1 billion as of 31 March, according to documents from the City of Fresno Employees Retirement System. IIF is targeting 8 percent to 12 percent returns and is generating a 6.6 percent net IRR over one year and 6.9 percent for five years (see next page for more information).
Pil would not be drawn to talking about the fund and JPMorgan Asset Management declined to provide any information about its funds or investments for this article. All fund data were obtained from publicly available information.
But he did explain the infrastructure equity programme launched in 2006 as a “natural extension” of the firm’s infrastructure debt financing activities. “The markets have evolved somewhat over the last two decades, not necessarily away from debt markets, but I think they have complemented debt markets with much bigger and deeper private equity markets,” Pil says. “At this point, we’re much more strategic holders of assets than financial investors in assets.”
“If we do see inflationary pressure pick up in the US, especially if it’s above expected, that could be a defining moment for infrastructure”
Pil adds that his team looks for assets they can structurally improve over time. This is part maximising infrastructure’s long-hold potential and part a reaction to the US market. “There’s just not that many blockbuster deals in the US,” he explains.
So the deals they do invest in are assets or companies that can be built up, operated and improved. “You’re not dependent on the next billion-dollar infrastructure deal to put money to work. We can put money to work in much smaller bite sizes,” Pil says.
The sectors JPMAM favours are apparent. More than 75 percent of its equity generates contracted or regulated cashflows. In the US, that has led to a focus on renewable energy and utilities. Examples include a $275 million investment in water production and treatment company SouthWest Water in 2010 and $110 million in long-term energy contracts for wind projects in Washington and Texas.
JPMAM’s strategy is to be the largest or co-largest shareholder in all its investments, according to City of Fresno ERS documents.
What isn’t of as much interest yet are transportation assets, making up 24.5 percent of its portfolio, according to the pension documents. They are too GDP-sensitive for JPMAM, Pil says.
“What filters out a lot of our investments is oftentimes we don’t feel like we’re getting compensated for the risk embedded in it,” he explains.
The infrastructure group is not completely opposed to investing in US transportation, but he’d like to see more case studies before these assets occupy a larger portion of their portfolio.
“A lot of the opening of new sectors in the US will probably end up being highly GDP dependent, and what history has shown is being the first investor in the US has rarely done you any favours,” Pil says.
On the other hand, he’s not so worried about increasing asset valuations. That’s exactly JPMAM’s game. According to Pil, infrastructure valuations should be rising, just like equity and fixed-income markets have risen. He says it would be “disappointing” if the asset class never went up in value.
“The question is, when values have been rising, have they been rising because of discount factors or the underlying business dynamics? I’m a lot less interested in assets that have gone up simply because you’ve changed the discount factor or their future cashflows. That is much less interesting than businesses where we can see clear synergies or improvements.”
The next cycle
Pil’s insistence that changing monetary policies will have a bigger impact on the US infrastructure market than anything he’s heard from politicians may be because JPMAM’s strategy does not rely on a great opening of the PPP market.
Their focus on utilities and renewables are two sectors that have grown without the PPP model. That’s because these assets are already economically viable, Pil says.
However, he is explicit about what he expects government’s role to be in
infrastructure. That is “to provide a clear roadmap” for how projects should be
procured. He isn’t sure there’s been enough clarity on that front yet.
“By backing a leadership role with some of its own assets, the federal government can provide a blueprint for the broader country on how to incorporate private capital into public expenditures,” Pil says.
Whatever the result may be, the US infrastructure market is indeed changing. They’re called economic cycles because conditions are never stagnated forever. What effect the current administration has on the market is a different story.
JPMAM is right that infrastructure is the asset class that can allow investors to ride out many kinds of uncertainty. It makes sense it will become a more permanent fixture in an expanding number of portfolios.
But whether the next few years will be infrastructure’s defining moment is yet to be seen. Like anything with monetary policy, there are too many ‘what ifs’. The one constant, though, is that the asset class is here to stay.