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Insight: Welcome to the latest edition of Investing Plus,JPMorgan Asset Management’s regular newsletter updatingyou on key industry developments and the latest news fromwithin JPMorgan Asset Management.
In our third issue we take a look at three
areas of particular interest at the moment
for institutional investors – liability
driven investing, infrastructure
investments and total return strategies.
Firstly, Simon Chinnery, one of our most
experienced client advisers, tells us why
LDI offers solutions to funding problems
for defined benefit pension schemes,
although some doubts have been raised
over its effectiveness. Simon shows how
LDI is serving an important purpose in
linking asset performance more closely to
the actual liabilities of a scheme, rather
than against a stock market index or
against a peer group average.
Next, we explain the benefits of adding
infrastructure exposure to your portfolio,
showing how it can provide substantial
diversification benefits and access to
another source of potentially strong
returns for institutional investors. Finally,
with new and innovative strategies
continuing to appear on the investment
scene, Karen Roberton, Head of Defined
Contribution, tells us why total return
strategies should play a key role in
DC investing.
I am also happy to have the opportunity
to keep you up to date with our
institutional business, which continues to
go from strength to strength. Following
strong performance in 2005, 2006 was
another especially good year for us, with
a total of 30 new mandates won and
21 significant additional fundings made
by UK clients. One of the most gratifying
aspects of this success is that we are
winning mandates across a broad
spectrum of strongly performing
products, which is a great endorsement
of our breadth and depth of expertise.
Inside, you’ll see how client service has
contributed to our success with the
recent launch of our new and improved
institutional website.
I hope you enjoy this latest edition of
Investing Plus.
Peter Ball, Head of UK Institutional Business
Better insight + Better process = Better results
Investing Plus
For professional investors only Issue 3 – Spring 2007
Take-up of LDI in the UKFigures certainly suggest that a growing
proportion of UK pension schemes are
looking to match their assets more closely
to their liabilities. In our own JPMorgan
Liability Driven Investment Survey last
year, 31% of UK defined benefit schemes
surveyed say they were considering a
liability-driven approach to managing
their assets, although only 16% of
respondent schemes had so far
implemented a specific strategy.
Moreover, only 13% of schemes we
surveyed believed LDI to be a transient
fashion. Among the vast majority of
schemes canvassed, LDI was seen as an
essential means of managing investment
risk. One in four schemes believed that
LDI would be adopted by between 50-
75% of their peers by 2011.
Choosing the right definition of LDIThis interest in liability matching has been
driven largely by the introduction of the
FRS 17 accounting standard as well as the
funding regulation from the Pension Act
which are encouraging schemes to bring
their assets closer in nature to their
liabilities to reduce funding volatility.
For many people this is where the big
problem lies with LDI: by encouraging
schemes to reduce deficit volatility by
making their assets more ‘bond-like’, they
are in danger of losing out on the growth
potential they need to fund the pension
promise over the long term.
But the big flaw with criticising LDI is the
assumption that it means the same thing to
all people. Actually, liability-driven investing
embraces a vast range of activities from
pure cashflow matching (the most fiercely
criticised approach) to implementing a
swaps strategy to reduce inflation/interest-
rate risk, to introducing a cash-
benchmarked total return approach to
generate excess return without increasing
funding volatility.
The table below shows how UK pension
schemes are choosing to define LDI.
LDI can embrace these definitions and
perhaps many more. The biggest
challenge that trustees have is ensuring
they are offered the approach that is most
acceptable to them.
Critics are right, though, to point out that
LDI can never be a cure-all – and should
never be marketed as such. Like any
investment strategy, it involves a constant
trade-off between competing priorities.
However, every pension fund’s situation
is different so every LDI solution needs to
be flexible enough to reflect what is most
important to the scheme at any given
point in time, given its funding position,
its cashflow requirements, the available
resources of the sponsor – and the
investment expertise that the trustees have
at their disposal.
A balance of risk managementBut can LDI be instrumental in the
survival of DB schemes? The experience
of WH Smith suggests not, but the
adoption of de-risking LDI strategies
After a flourish of publicity in recent years, what do trustees make of LDI now? Is it a fad whose brieftime in the spotlight has been and gone? Is it time for defined benefit pension schemes to return tomore ‘fundamental’ issues? Or can LDI genuinely play a part in the survival of the defined benefitpension scheme? Simon Chinnery, institutional client adviser at JPMorgan Asset Management, looks at the issues as they currently stand surrounding LDI and its effectiveness.
Better insight + Better process = Better results2 | Investing Plus Spring 2007
Liability Driven Investing:LDI remains on the table
Simon ChinneryInstitutional Client Adviser
Which of the following most closely matches your definition of liability-driven investing?
Conduct and apply an asset liability modelling study 7%
Using cashflow matching strategies 22%
Using derivatives to match liabilities and LIBOR as the benchmark for assets 9%
Using liabilities as the benchmark for the management of scheme assets 53%
Managing a funding deficit over a short to long-term basis 9%
Responses of UK defined benefit pension schemes
Source: JPMorgan Liability Driven Investment Survey 2006
Better insight + Better process = Better results3 | Investing Plus Spring 2007
by blue-chip names such as BAA,
J Sainsbury and Friends Provident
suggests LDI is becoming an effective
bargaining chip when persuading sponsors
and shareholders to keep a scheme open.
It is true that the thorny issue of
longevity is unlikely to be addressed
perfectly by LDI providers in the short
term (although investment banks are
intently looking for a means to securitise
mortality risks).
Because of this, liability-driven investing
can only be one part of the solution to
helping DB schemes survive. Additional
contributions by the sponsor or even by
members are likely to remain a fact of life
for DB schemes.
But just because there are risks that a
scheme can’t wholly control through its
investment strategy (i.e. longevity risk)
doesn’t mean a scheme shouldn’t address
those risks that can be managed
reasonably effectively (i.e. interest-rate
and inflation risk).
What pension schemes must be careful
of is managing these risks at the expense
of allowing the pension scheme the scope
to continue to grow. If there is one ray of
hope for defined benefit schemes it’s the
fact that growth in equities markets have
helped deficits among the UK’s 200
largest pension schemes to halve over the
year to end-February 2007 to £45 billion,
according to AON Consulting*.
Granted, the market sell-off since then
has reclaimed a little of this progress
(and, therefore, reinforced the benefits of
the multi-asset, total-return approach
that is integrated into many LDI
solutions) but it’s a powerful reminder of
just what an appropriate growth-focused
investment strategy can achieve for a
pension scheme when market conditions
are right.
People question as well the interest rate
swaps – which are a key component of
LDI solutions – as being too expensive.
This is not the case. Buying a long term
bond costs no more in brokerage fee as
buying a swap for the same duration.
In addition, swaps offer a yield pick
up compared to gilts (currently 30bp
per year).
Lastly through FRS 17, liabilities are
discounted with AA rates, which behave
more like swaps’ rates than gilts, hence
using swaps rather than traditional gilts
can reduce the overall volatility of schemes.
Future adoption of LDIIn short, liability-driven investing is
still on course to become a mainstream
activity among defined benefit pension
schemes. We strongly believe that within
the next five years, 50 to 75% of DB
schemes (both closed and open) will
benchmark their risks and their
investment strategy primarily against
their liabilities.
Although LDI on its own cannot assure
the survival of defined benefit pensions,
we believe that the better risk management
it offers will allow many sponsors to keep
their schemes open for longer. Moreover,
LDI providers are working hard to deliver
solutions that do not mean sacrificing
substantial growth potential.
LDI will – like any investment approach
– always be a series of compromises.
But it is possible to de-risk a pension
scheme to an effective degree, while still
achieving strong asset growth to help
tackle unknowns such as longevity and
salary inflation.
Getting the message acrossWhether or not you think LDI is set for
widespread adoption in the UK, one
thing cannot be denied – the wisdom of
linking asset performance more closely
to the actual liabilities of a scheme, rather
than against a stock market index or (an
even more arcane concept) against peer
group. If the aggressive marketing of LDI
solutions has only made trustees aware
of this one important aspect – then it has
served some purpose.
* Engaged Investor, 1 March 2007.
To request a copy of the JPMorgan
Liability-Driven Survey, please
contact Sue Hale on 020 7742 5518
or at [email protected]
Alternatively contact your usual
JPMorgan Asset Management
representative.
Infrastructure investing allows investors
to benefit from the construction and
operation of a wide array of facilities
that provide an essential service, such as
transportation (roads, airports, pipelines)
or utilities (water, gas, electricity).
The focus of this article is on the
investment opportunities created by
‘user-paid infrastructure’ projects, which
include facilities that involve an explicit
payment by the user. For example, highway
tolls, landing fees or utility tariffs.
There are, however, infrastructure
investment opportunities in other areas,
such as “social infrastructure” projects,
which are generally provided by the
government and do not involve explicit
user fees. Social infrastructure investments
include public hospitals, prisons and
shadow toll roads.
User-paid infrastructure hasparticularly strong potentialAlthough social infrastructure is attracting
significant investor interest in Europe
through the Private Finance Initiative
framework, it may not offer the same
return potential as user-paid infrastructure.
This is because social infrastructure
projects have comparatively shorter-term
operating spans and limited room for
efficiency gains.
Within user-paid infrastructure there are
a number of “Core” sectors, such as toll
roads, airports, gas pipelines and electric
transmission lines, whose attributes have
a major impact on the way they are
operated and financed. These ‘Core’
attributes include:
• Capital-intensive assets with
long service lives;
• Essential service provision;
• Very high economies of scale
resulting in natural monopolies;
• Fairly low operating risks;
• Low usage risk and low elasticity
of demand;
• Predictable revenues based on
stable usage.
PPPs and acquisitions driving returnsSome particularly strong user-paid
infrastructure opportunities are currently
to be found in the US, where faced with
the prospect of diminishing resources for
roadway investment, and encouraged by
visible support from elected officials and
global interest by investors and operators,
federal and state authorities are
increasingly using Public-Private
Partnerships (PPPs).
PPPs are contractual agreements between
a public agency and a private sector
entity that allow greater private sector
participation in project delivery and
service provision. Currently the pipeline
of US PPP projects is thought to be over
US $100bn*.
Infrastructure activity in Europe has also
picked up significantly in recent years,
with the total transaction value of projects,
both equity and debt, standing at around
€140bn. However, because Europe has
a long record of privatising toll roads,
airports and telecommunication networks,
privatisation opportunities may be more
limited than in the US.
Instead, established regulatory frameworks
and market acceptance create opportunities
for massive acquisitions, such as last
years’ £11.4bn acquisition of BAA Plc by
a consortium led by Grupo Ferrovial.
Investment considerationsRegulation
Facilities such as ports, airports, toll roads,
railroads and transmission lines are similar
to public utilities in that they provide an
essential service, face little competition
and have certain monopolistic attributes.
For these reasons, some are regulated just
like utilities and, as a result, their return
magnitude is similar to a regulated utility
with a significant component of cash yield.
Better insight + Better process = Better results4 | Investing Plus Spring 2007
Infrastructure – the next asset classInfrastructure investing allows investors to benefit from the construction and operation of a wide array
of facilities that provide an essential service, such as transportation (roads, airports, pipelines) or utilities
(water, gas, electricity). Here, Peter Ball, explains the compelling investment opportunities created by
‘user-paid infrastructure’ projects.
Peter BallHead of UK Institutional Business
Efficiency gains
Infrastructure entities generally match
the long service lives of their productive
assets to long-term financing instruments,
such as long-dated debt and “patient”
equity. Among publicly traded companies,
utility stocks have traditionally been
the staple of investors seeking long-term
stability and a steady income. The added
benefit to private investors is the additional
return potential resulting from significant
efficiency gains.
Inflation hedge
Current yield is typically a significant
component of infrastructure’s total return,
which makes this asset class similar
to fixed income investments. However,
unlike typical fixed-income instruments,
infrastructure offers a hedge against
inflation. For example, many of the
public agencies operating utility and
transportation assets have an independent
authority to adjust user fees for inflation
and to pass through changes in certain
operating costs such as fuel. Also, recent
toll road concessions in the US allow toll
escalation to compensate for inflation.
Diversification benefits
Like property, infrastructure is an asset
class with low correlation with other
asset classes. This suggests that a
portfolio can reap diversification benefits
from allocating a certain portion of it
to infrastructure.
Investors should look for good regulatory frameworks indeveloped marketsBecause many, if not most, of these
infrastructure facilities are subject to some
measure of rate regulation and expect
the government regulator to preserve
their economic balance to some degree,
even in the case of termination,
a reasonably established regulatory
framework is essential.
Closely related to regulation is the need
for a stable legal system to address
regulation failures and assure a fair
representation of the rights of all parties
to project documents. Project experience
of the past decade is rich with examples
from emerging markets such as India,
Indonesia, Brazil, etc. that highlight the
circumstances impeding stable income
flows to project sponsors.
Risks of investing in InfrastructureInfrastructure assets usually have one
specialised use and don’t easily lend
themselves to conversion for alternative
use. Therefore, depending on the point
in the market cycle, it may be difficult
to liquidate an investment at an
acceptable price.
Regulation is also central to the operation
of many infrastructure assets. For a
utility-type entity, regulation directly
determines its financial performance
through the rate making process and
matters of corporate governance. Overly
restrictive or unpredictable regulation can
severely undermine investment potential.
Furthermore, although risks are not as
high for mature facilities as for green field
ones, they are still present in the rate-
setting process of regulated entities such
as transmission lines, pipelines and some
airports. Because the result of the exercise
is a fee per unit (passenger, kW, etc) there
may be a variance between forecast
revenues and what is actually achieved.
ConclusionWe expect a continuing strong demand
for private investment in infrastructure
projects due to the limited government
resources provided to them. In addition,
a multitude of concession opportunities
are expected in the US in the wake of
several recent successful transactions.
Infrastructure segments which we’ve
defined as Core have historically generated
moderate, but stable returns with a
significant current yield component.
Their ability to deliver stable returns,
along with their low correlation with
other asset classes observed to date,
provide a basis for recommending that
investors consider making some space
available within their portfolios for
infrastructure investments.
*Source: JPMorgan Asset Management.
To learn more about this compelling
asset class, please contact your
usual JPMorgan Asset Management
representative.
Better insight + Better process = Better results5 | Investing Plus Spring 2007
Putting total return at the heart of DC investing
Defined contribution pension schemes
are set to see huge growth in assets under
management as they become the main
source of occupational retirement
provision in the UK. Figures show that
the vast majority of DC contributions
go into a scheme’s ‘default’ investment
option. However, this option may
be costly in the long run for scheme
members because the funds offered as
default can often be unsuited to their
investment needs.
Therefore, DC schemes need to focus
more attention to the type of fund that
is offered by schemes as their default
investment option. Fortunately for
scheme trustees, there is a new option
emerging that can provide a one-stop
solution to these default fund concerns.
This solution comes in the form of a new
breed of investment funds known as ‘total
return funds’, which offer a very close fit
with the expectations and needs of the
vast majority of DC scheme members.
Furthermore, total return strategies can
be used successfully to meet the needs of
a wide range of DC members at different
stages in their life. Karen Roberton, Head
of DC Services provides an insight into
the merits of Total Return investing.
What do we mean by total return?‘Total return’ refers to long-only
investment strategies that aim to deliver
consistently positive returns by measuring
themselves against a cash benchmark
rather than a stock market index. Typically
the cash benchmark is one-month LIBOR
– the one-month rate of interest at which
banks lend to one another and a common
proxy for bank base rates.
Total return funds will typically have
an objective to outperform their cash
benchmark by a certain amount each year
– this can range from 1% p.a. to 6-7% p.a.
To outperform cash, a total return fund
has to take some additional risk and
therefore still has the potential to fall in
value. To address this potential for loss,
a total return fund will usually specify a
For further information about our DC Total Return Funds and our complete life fund range,
please contact your usual JPMorgan Asset Management representative or visit our dedicated DC website
at www.jpmorgan.com/assetmanagement/pensions
Better insight + Better process = Better results6 | Investing Plus Spring 2007
News in briefNAPF Annual Conference and Exhibition 2007We will be exhibiting at the NAPF exhibition on 24-25 May 2007 at Manchester Central. We look forward to welcoming those attending the conference to our stand where
JPMorgan representatives from Asset Management, Worldwide Securities Services, Transition Management and the Investment Bank will be available.
UK Pensions Awards 2007JPMorgan Asset Management have recently been short-listed in the UK Pensions Awards, to be held on 24 April, in the following categories: Currency Manager of the Year
and Alternative Investment Manager of the Year.
JPMorgan Asset Management expertise recognised in latest Citywire rankingsAustin Forey, senior fund manager within our Global Emerging Markets team has been ranked as No. 1 Fund Manager in Citywire’s Global Emerging Markets Sector, and No. 6 in the
Citywire Top 100 Fund Managers 2007. In addition, Georgina Brittain and Mark David, two of our most experienced fund managers within our UK Small Cap team are ranked joint
No. 2 in the Top 100. JPMorgan Asset Management has eight rated fund managers (over 1 and 3 years) and more AAA rated fund managers than any other asset management group.
Karen RobertonHead of DC Services
Total return – a better fit for DC member objectives
Total return Typical default
Simple objective 333 X
Low absolute risk 333 X
Growth potential 3333 3333
Explicit time/reward target 333 X
Better insight + Better process = Better results7 | Investing Plus Spring 2007
certain time horizon over which its target
annualised return can be achieved. The
higher the fund’s target excess return
above cash, the longer the specified time
that investors must be prepared to invest.
How total return funds achieve their targetThe concept of total return investing has
filtered through from the retail investment
market, rather than the institutional
pensions market. In particular, it has been
fuelled by the introduction of UCITS III
– the EU-wide directive that has given
retail-marketed funds wider investment
powers to use derivatives, hold money
market instruments and mix different
assets in the same fund.
Total return funds aim to achieve
consistently positive returns through
the combination of a number of tactics –
including diversification, tactical asset
allocation, derivative-based risk protection
and neutral cash position.
Why total return is the best optionAs the DC market grows and represents
a larger proportion of UK pension assets,
it needs to be recognised that the power
to invest or not invest shifts into members’
control. With the growth in DC, pension
scheme members are set to become far
more sensitive to downside market risk
than they were in the defined benefit
pension environment. The impact of
a future bear market on employees’
confidence in their pension provision
could therefore be far more acute than
it has been in past market downturns.
It is vital that the asset management
sector therefore finds a core investment
option that is more closely aligned with
the needs and expectations of members
than traditional ‘relative return’ investment
options that have been ‘inherited’ from
the defined benefit market. We believe
that total return funds offer a far better fit
with member expectations than traditional
DC default/core options such as index-
tracking, balanced or managed funds.
For example, total return funds offer the
potential for consistent positive return,
they actively look to limit downside risk
and they specifically ‘reward’ investors for
moving capital out of cash. Moreover,
they offer a highly explicit time/reward
trade off that can allow members to make a
much better link between their investment
goals and their time to retirement.
We do not for one moment suggest these
funds should be a wholesale replacement
for traditional relative return funds.
But by introducing total return strategies
as a default/core proposition, we believe
DC pension schemes are far better placed
to meet the objectives that are most
important to their members, especially
those who are not investment aware.
For further information on any of thenews items covered on this page,please contact Sue Hale, RelationshipManager Support, on 020 7742 5518
or at [email protected]
Alternatively, please contact your usualJPMorgan Asset Managementrepresentative.
The newJPMorgan AssetManagementUK Institutionalwebsite:Access all areasJPMorgan Asset Management has
always been recognised for its expertise
and innovative solutions. And now,
you can get access to more of it online
through our enhanced website
www.jpmorganassetmanagement.co.uk
/institutional
In addition to our brand new interactive
factsheets and daily fund prices at the Fund
Centre you can also:
• Get instant access to our weekly stock
market review and a fresh perspective on
the global economy from our top global
strategists in Commentary and Analysis.
• Go directly to the information you need
with our dedicated sections for:
» Consultants – which includes the ‘hot
list’ – the latest strategies from JPMAM,
new innovations and the latest research for
institutional investors.
» Charities – featuring our range of funds
and services in this sector. You can also
download our ‘Growing Funds for
Growing Charities’ brochure.
» Pension schemes – whether Defined
Contribution or Defined Benefit schemes
our services and solutions are outlined
here, along with the link to our dedicated
DC site which features our interactive
investor profile tool, pensions calculator
and an education in DC planning.
• Find everything you need to know about
our products and services in Investment
Expertise – whether you’re looking for
equities, hedge funds, real estate, fixed
income, multi asset strategies, and more.
Investment Funds, Investment Trusts, Pensions and ISAs
For more information, call Simon Chinnery on 020 7742 5657
or email [email protected]
www.jpmorganassetmanagement.co.uk/institutional
Better insight + Better process = Better results
JPMorgan Asset Management is perfectly positioned to
provide the essential components needed for integrated
liability-driven investment solutions – liability matching
and alpha generation.
We have over 25 years’ experience creating liability-
matching strategies, and provide access to over 200
sources of alpha generation across different asset
classes, size, style and investment processes. Together,
our liability-matching expertise and wide range of
alpha sources mean we can help match your liabilities
more closely, while generating extra returns to reduce
your funding deficit – all within your risk budget.
If you haven’t spoken to us yet about our liability-
enhanced solutions, perhaps you should.
Liability-enhanced solutions
from JPMorgan
Matching your liabilities
Reducing your funding gap
+
=
Better insight + Better process = Better results8 | Investing Plus Spring 2007
This material is intended for professional investors only. Issued in the UK by JPMorgan Asset Management UK Limited which is authorised and regulated by the Financial Services Authority and is part of the JPMorgan Asset Management marketing group which sells investments, life assurance and pension products. Registered in England. No: 288553. Registered Office: 125 London Wall, London EC2Y 5AJ.