Preparing for the new world

Possessing the ability to provide higher income than bonds and superior risk-adjusted returns to equities, real assets are likely to shed the ‘alternative’ modifier to become a mainstream asset class, JPMorgan Asset Management (JPMAM) wrote in a 2012 report, titled The Realization. It forecast that portfolio allocations would rise from between 5 to 10 percent currently to as much as 25 percent in the next decade.

The asset management arm of Wall Street firm JP Morgan, however, did not limit itself to merely releasing a report. Instead, it set in motion a process of internal restructuring to prepare for the change it had predicted.

Part of that restructuring included the creation of a new sub-division within the bank’s asset management Global Real Assets unit: OECD (Organization for Economic Cooperation and Development) Infrastructure Equity and Debt.

Paul Ryan, previously co-head of public finance banking at JPMorgan’s investment banking business, was brought on board in March 2013 as chief executive of the newly-created group.

“You really need to understand the mindset of public authorities, working back from demand for the asset, the physical asset, and the public authorities’ public policy goals,” Ryan explains, referring to the abilities he was able to hone having spent the previous seven years meeting with state and local governments and revenue authorities five days a week.

“You also need to understand – on the other side of the table – public pensions and other LPs [limited partners] that we represent and invest on behalf of; understand their constraints and try to pull the two together.”

The OECD unit that Ryan heads is focused, as its name implies, on OECD countries and building a diversified portfolio across the UK, Europe, the US and Ryan’s native Australia, focusing purely on core infrastructure and targeting a yield of five to seven percent and internal rates of return in the range of 10 to 12 percent.

Currently, the portfolio that JPMAM-Global Real Assets has built is underweight in the US and heavily concentrated in the UK and Europe.

RESETTING TARGETS

“That’s something we’re looking to change with a view to continue diversification and to take advantage of opportunities in what we think is an increasingly attractive US market,” he says.

“I came on board to really begin to drive a much sharper focus in the US given those existing relationships and the transactions I’d done with the public sector [in my previous role],” Ryan explains.

A few months after Ryan’s appointment, Matt LeBlanc joined JPMAM’s Global Real Assets division as chief investment officer for OECD Infrastructure Equity in July 2013.

He arrived at the firm with 18 years of experience in energy finance and private equity.

LeBlanc’s background in power generation, midstream and utilities – sub-sectors which Ryan considers to be much more transactable in private-to-private deals than transportation – “brings a critical component, we think, to rounding out the US effort with a view to then getting the portfolio balance in the US at the right level,” Ryan points out.

“When Paul [Ryan] asked me to come and meet with Joe Azelby [JPMAM’s head of Global Real Assets] and learn more about the platform and potentially come over, it was really the opportunity to do two things,” LeBlanc explains.

“The first thing was to come to a platform that had been overweight in Europe and the UK and focus on taking advantage of the competitive advantage JPMAM has with its collective experience here in the US, but also the footprint of our strategy and the ability to be a truly long-term investor with its open-ended approach,” he continues.

Being a long-term investor meant switching gears for LeBlanc, who had spent more than 10 years at ArcLight Capital as principal of private equity investments, in charge of power and energy investments.

“In previous roles, I’d be teeing up assets to be owned by long-term investors […]. Now, as a long-term investor you’re really doing two to three deals a year to deploy capital annually in the range of $750 million to $1 billion,” LeBlanc says.

He further underscores the difference between his old role and his current one by stating that JPMAM is not ‘a deal shop.’ The two to three deals JPMAM chooses to do a year must fit its criteria.

“Ninety percent of what we see goes past us,” LeBlanc says. “Less than two percent of what we’re looking at we really dig into and we’re only doing a subset of that.”

LeBlanc points to the power, energy and midstream sectors as areas in which JPMAM is looking to participate.

“From my perspective, in power generation alone, assets that are owned by financial sponsors or foreign strategics that are going to be getting out of the markets – that’s $150 billion of assets in the next two to three years,” LeBlanc notes. “These are closed-end funds that have to sell and strategics that have designated these assets as non-core. Power generation in the US alone represents three times the amount of capital raised by infrastructure managers over the last couple of years.”

Aside from having a global, open-ended platform, another significant component of JPMAM’s strategy is active management.

HANDS-ON APPROACH

“These are real businesses, with thousands of employees and millions of customers and you need to actively manage them,” LeBlanc remarks. “Corporate governance done in the right way is another area of focus we have on this platform,” he says.

And what does that mean exactly?

“One of the big decisions you have upfront on an acquisition is: ‘Is this the right team for the longer term?’ And that’s a decision you have to make pretty quickly,” Ryan responds.

JPMAM also focuses on the board structure – including having independent directors with the appropriate skill sets.

As for active management, that involves more than going to board meetings, it’s about taking on problems that arise and working to resolve them – not just “patting yourself on the back for the wins you’re having,” as Ryan puts it.

“It’s not about putting your own people on every board – it’s about creating the right governance in terms of structure and people, incenting management teams to follow a strategy that delivers against our return promise,” Ryan goes on to explain.

Through this hands-on approach, JPMAM builds relationships with the management teams it has in place at its nine portfolio companies. This then allows the division to build on its existing platforms.

“The ability to expand and grow an existing platform is a very powerful proposition in terms of risk-return,” Ryan stresses.

“You’re using a management team that you know and trust, that you’ve been through a growth cycle with before, but now you may be doing it in a different jurisdiction or on a different scale,” he says. “But the relationship already exists between us and the management team, which takes a lot of risk off the table versus acquiring a new business with a new management team.”

MAXIMISING RESOURCES

Summit Utilities, a regulated natural gas distribution business which JPMAM acquired in 2007, serves as a good example of this approach.

“We bought the company, it operated purely in Colorado, and was focused on delivering gas to rural areas outside Denver, expanded into Missouri and most recently into the state of Maine,” Ryan says, describing it as a sustainable and attractive investment.

Part of the reason the description is justified is because the expansion meant bringing natural gas to a state – which tends to have long and heavy winters – where less than five percent of residents have access to natural gas. In terms of home heating alone, that translates into a 50 percent reduction in the heating costs of an average family or about $1,500 per winter, according to Ryan.

Local businesses and the local economy also benefitted through the creation of new jobs and lower energy costs, helping businesses in the state to become more competitive.

“So that’s an existing management team expanding into Maine, putting a significant amount of capital to work in an environment that didn’t really see any competition,” Ryan sums up.

The case of Summit Utilities also speaks to the Global Real Assets team’s strong belief in always assessing the demand side of the equation.

“We think to get core infrastructure right, you really need to understand demand for the asset and that’s arguably been overlooked historically,” Ryan says, citing brand new toll roads with no revenue and no track record that have been classified as core, but which in essence are “a non-core asset”.

“Leverage has also gotten some assets into trouble, but demand is something we think is fundamental,” Ryan asserts – as is revenue visibility.

Where to invest, however, is just as important as choosing the right asset.

“There are a lot of jurisdictions where you have to spend the money and you have to go back and ask the regulator to get a return on that capital,” LeBlanc explains. “That just doesn’t make sense to us.”

Ryan agrees: “If a jurisdiction doesn’t need your money or is concerned about giving you your return on capital – you really shouldn’t be there.”

Having said that, Ryan is quick to acknowledge the flip side of that statement when asked for his opinion of the US P3 market and its evolution.

Although reluctant to use the word ‘evolution’ himself, he admits that the US P3 market is growing. For that market to grow further requires public authorities to find a way of involving the private sector and its expertise effectively.

But the private sector also needs to understand that “it’s not really about buying an asset or taking over an asset – you have to really respect public policy and the public sector’s goals for the assets,” Ryan emphasises.

“You’ve got to respect labour and labour’s role, which is critical, and when you can connect those dots which are: construction at the right time in the cycle; sustainable development in the eyes of customers and users; public policy being respected and private sector involvement consistent with public policy; then I think you’ve got a pretty systematic model,” he says.

Additionally, the ability for the US public sector to attract large pools of capital systematically as opposed to on an ad hoc basis or opportunistically again comes back to revenue visibility.

“Public pensions allocating [to infrastructure] looking for yield and returns of 10 to 12 percent with a visibility on revenue, that opportunity has to be created,” he points out.

READY TO GO

While JPMAM’s new OECD team will focus on increasing investments in the US, both Ryan and LeBlanc agree that some of the best opportunities come out of geographies where you’d least expect them.

“So, we’re excited about what will come out of a recovering southern Europe – and for that matter a recovering Australia – in terms of core infrastructure,” Ryan says.

LeBlanc adds: “We’re being very selective in these other geographies and sectors where we’re overweight today, but at the same time we’re finding good opportunities around platform companies in the sectors and geographies we understand because the networks are strongest there and our teams have found some pretty interesting things.”

While JPMAM’s new OECD team will focus on increasing investments in the US, both Ryan and LeBlanc agree that some of the best opportunities come out of geographies where you’d least expect them.

Asked whether the restructuring of JPMorgan Asset Management is complete, Ryan says it is – for the most part. “We made some changes 12 to 14 months ago and we’ve gotten approval to add a couple of heads at the moment, which we’re excited about,” he explains.

“But in terms of stability, strategy, direction of where we’re headed, portfolio construction and where you can expect us to spend our time – we’re good to go.”