A new report from J.P. Morgan Asset Management, “Real Assets’ Role in Public Pension Portfolios,” explores the use of real estate and infrastructure investments. The firm concludes that these asset classes can enhance returns and reduce volatility.
J.P. Morgan says that public pension plans’ funded status has been well below pre-financial crisis averages. As of June 30, 2018, unfunded state pension liabilities were $1.6 trillion, according to Moody’s Investors Service research.
“The ratio of active participants to annuitants dropped from 2.4x in 2001 to 1.4x in 2016,” J.P. Morgan says. “The aging of the U.S. public pension system has caused persistent net cash outflows, raising the importance of income-producing assets.”
The firm says that core real assets include well-leased properties in major developed markets, regulated utilities and other infrastructure sectors with predictable cash flows. In addition, transport assets—maritime vessels, aircraft, rail cars, etc.—that feature long-term contracts with high-credit quality counterparties can be considered to be core real assets.
“Amid the current challenges facing pension plans, core real assets’ hybrid characteristics can play a key role in portfolios, providing the opportunity for a stable, volatility-reducing income stream along with the potential for equity-like upside from price appreciation,” J.P. Morgan says. “Whether acting as a replacement for volatile public equities or for low-yielding fixed income assets, core real assets may enhance the efficiency of public pension portfolios.”
Further, the firm recommends that pension plans obtain the assets to fund core real assets by selling public equities and/or fixed income.
“Determining the most appropriate real asset investment substitution and allocation will largely be defined in the context of investors’ funded status, current exposure to real assets and tolerance for the lower liquidity of core real assets relative to traditional financial assets,” J.P. Morgan says. “We think both increasing and diversifying the core real asset allocation can yield meaningful outcomes for plan sponsors. Adding core real assets to a pension portfolio can help plan managers—whether their objective is risk reduction, return enhancement or both.”
The full report can be downloaded here.