YLDE - ClearBridge Global Infrastructure Income Strategy Q1 2023 Portfolio Manager Commentary

2023-04-21 23:30:00 ET

Summary

• ClearBridge is a leading global asset manager committed to active management. Research-based stock selection guides our investment approach, with our strategies reflecting the highest-conviction ideas of our portfolio managers.
• Infrastructure trends that closed out 2022 continued in the first quarter of 2023, with energy prices stabilizing amid a warmer than expected winter and a continuing re-emergence of mobility lifting the airports and toll roads sectors.
• On a regional basis, Western Europe was the top contributor to quarterly performance, where warmer weather and lower bond yields helped performance across several sectors.
• Bank collapses will be important as bank lending standards will tighten, choking off some credit for large corporates, though we expect infrastructure companies will continue to have access to credit to maintain investment in their underlying asset bases.

By Daniel Chu, Charles Hamieh, Shane Hurst, & Nick Langley

Market Overview

Amid a growth push in the first quarter, infrastructure made solid gains but trailed global equities. Infrastructure trends that closed out 2022 continued in the first quarter of 2023, with energy prices stabilizing and even declining across Europe and the rest of the globe amid a warmer than expected winter. This kept pressure off both utilities as well as households, while a continuing re-emergence of mobility and travel lifted the airports and toll roads sectors. Bond yields too came off recent highs, supporting longer-duration assets such as renewables, which performed well. Lower yields are also positive for communication towers, though yields are still elevated, and some broad market pressure on real estate — tower companies are generally structured as REITs — is still being felt.

On a regional basis, Western Europe was the top contributor to quarterly performance, of which Portuguese renewables utility Energias de Portugal ( EDP ), Spanish gas utility Enagas ( ENGGF ) and U.K. electric utility National Grid ( NGG ) were lead performers.

EDP is an integrated utility based on the Iberian Peninsula, operating electricity distribution, generation and energy supply businesses. It has a growing exposure to global renewables through its 83% owned subsidiary EDPR, which is primarily onshore wind farms. EDP also operates electricity distribution and generation businesses in Brazil through its 50% owned EDP Brasil. EDP’s share price gain was driven by the improved outlook for 2023 earnings, as Iberian hydro recovered from earlier quarters, coupled with constructive growth targets laid out in its strategic plan update.

Enagas engages mainly in the transport, storage and regasification of natural gas in Spain, where it is a natural monopoly in gas transport and has the largest share of regasification. It also has stakes in international assets, including 30% in U.S. midstream pipeline Tallgrass as a key contributor to associate earnings. Enagas rallied during the quarter as in its FY22 results the company gave positive comments on hydrogen, Tallgrass and control of operating expenses.

National Grid is one of the world’s largest publicly-owned utilities, focused on transmission and distribution activities in electricity and gas. National Grid’s share price increased over the quarter given moderating bond rates and economic concerns, combined with improved tailwinds for the sector, including expectations of improved permitting for future projects.

Rail and energy infrastructure sectors were the main laggards. A weak outlook for the rail industry amid growing recession expectations, continued service challenges and fuel and labor cost increases are headwinds for rail currently, although we have increased our exposure here to diversify cyclicality in the portfolio and capture some relative value. Energy infrastructure trailed as last year’s tight price environment has loosened somewhat with abnormally warm weather; we have reduced our exposure through trims across our energy infrastructure holdings.

Outlook

Despite recent volatility, we are maintaining our defensive positioning as tightened financial conditions will eventually impact the economy and ultimately corporate earnings; we are starting to see some weakness in earnings from higher interest costs. The Fed and many other central banks around the world have to maintain their hawkish positions and have started to accept recessionary risks as increasingly likely but necessary to combat the stubbornly high levels of inflation. Given we have reduced our GDP sensitivity over the last 12 months, we should expect this defensive rotation to be more moderate than in 2022.

There is a large debate whether there will be a soft landing or no recession versus a deeper recession. Monitoring the economic data will be key here, and portfolio positioning will be somewhat dependent on this. The banking collapses from Silicon Valley Bank and Credit Suisse ( CS ) add a very credible datapoint toward a recessionary environment when paired with the Fed’s need to continue its monetary tightening policy direction.

Bank collapses in the U.S. and Europe will be important later in the year, as bank lending standards will tighten, choking off some credit for large corporates in particular. However, infrastructure companies raising debt in March priced deals at lower rates than expected, though slightly higher than similar deals earlier in the year. Infrastructure companies, we think, will continue to have access to credit to maintain investment in their underlying asset bases.

Portfolio Highlights

We believe an absolute return, inflation-linked benchmark is the most appropriate primary measure against which to evaluate the long-term performance of our infrastructure strategies. The approach ensures the focus of portfolio construction remains on delivering consistent absolute real returns over the long term.

On an absolute basis, the Strategy saw positive contributions from six of nine sectors in which it was invested (out of 11 total) in the first quarter, with the electric, toll roads and renewables sectors leading, and the energy infrastructure and communications sectors the main detractors.

On a relative basis, measured against the S&P Global Infrastructure Index, the ClearBridge Global Infrastructure Income Strategy underperformed during the first quarter. Overall stock selection was positive, while sector allocation detracted from relative results. Stock selection in the electric, renewables, gas, water and toll roads sectors contributed the most, while stock selection in the energy infrastructure and rail sectors detracted. An underweight to the airports sector and overweights to the gas, water, renewables and communications sectors weighed on relative results.

On an individual stock basis, the top contributors to absolute returns in the quarter were National Grid, EDP, SSE, Enagas and Iberdrola ( IBDSF ). The largest detractors were APA , NextEra Energy Partners LP ( NEP ), American Tower ( AMT ), China Resources Gas ( CGASY ) and Centrais Eletricas Brasil ( EBR ).

During the quarter we initiated positions in U.S. rail operator Union Pacific ( UNP ), Chinese gas utility China Resources Gas and U.S. communication tower company American Tower. We also exited Spanish airport operator AENA ( ANNSF ) and Brazilian electric utility Engie Brasil ( EGIEY ).

Daniel Chu, CFA, Director, Portfolio Manager

Charles Hamieh, Managing Director, Portfolio Manager

Shane Hurst, Managing Director, Portfolio Manager

Nick Langley, Managing Director, Portfolio Manager

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