JP Morgan: Low Bond Yields, Equity Volatility Spurs Asset Allocation Tipping Point

(June 13, 2012) — The investment environment is undergoing a “new normal” with asset allocation, according to a whitepaper by JP Morgan’s Joseph Azelby, Michael Hudgins, and Bernie McNamara.

While equities have lagged over the most recent 10 years, with an annualized total return of 2.9% as of December 2011, “real assets” is one category that is fast gaining acceptance as an essential portfolio component. According to JP Morgan, the performance of global real assets bridges the gap between fixed-income and equity, noting that the asset class is characterized typically by investments in tangible “hard” assets that provide a blend of stable income, equity-like upside potential, inflation hedging, and lower volatility. In addition, the sector typically provides low correlations to the two current “traditionals”—equities and fixed income.

“These are difficult times for investors with volatile equity markets, low growth prospects in developed markets, and the threat of inflation,” McNamara told aiCIO, speaking about the whitepaper he co-wrote and published in May. “With those circumstances, we’re finding that investors are looking to other solutions.”

McNamara added that real assets have been traditionally embraced by the Canadian and Australian markets. “If you look at their relatively small populations compared to their geography and land mass that they occupy, they need to look for creative ways to fund infrastructure projects and they’ve been more active and open to private investment to help,” McNamara said.

How does the US compare? Within the US, larger pension plans (generally $12 billion or more in assets) are at the forefront of investment in real assets, with greater resources and expertise to invest in the sector. Meanwhile, smaller funds (with $1 billion or less) are more timid to invest in the sector, but are gradually becoming more comfortable with the asset class, McNamara said.

Recent shifts in allocation have largely been tactical (i.e., cyclical) moves between the equities and bonds or, more recently, a gradually increasing strategic (i.e., structural) tilt to alternatives, including real estate, infrastructure and private equity, according to the paper.

“But a convergence of slowly emerging trends and rapidly changing realities has given rise to concern over the ability of equities and bonds to realize the absolute and/or risk-adjusted investment performance necessary to cover liabilities for pension funds or meet wealth creation targets for other investors,” the paper noted.

According to JP Morgan, global real assets will soon migrate from being an “alternative” to being a “traditional,” playing an equally critical role in asset allocation as fixed income and equities.