07233_Insto Newsletter_V5

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


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.


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.


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


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


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

+

=


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.

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07233_Insto Newsletter_V5