YLDE - ClearBridge Global Infrastructure Value Strategy Q2 2023 Portfolio Manager Commentary
2023-07-30 01:50:00 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.
- On a relative basis, measured against the S&P Global Infrastructure Index, the ClearBridge Global Infrastructure Value Strategy outperformed during the quarter.
- Rail companies in the U.S. and Japan were among top contributors in the quarter, while listed U.K. water companies came under pressure due to company-specific operating issues at an unlisted sector peer.
- Consensus remains divided on recessionary expectations, with the duration and depth of a global recession remaining the largest risk to investors; against this backdrop, we maintain our defensive positioning.
By Charles Hamieh, Shane Hurst, Nick Langley, & Simon Ong
Water Wanes, Rails Rebound
Market Overview
Global equity markets ended the quarter up strongly, albeit with highly varied sector returns, with tech stocks driving gains, especially given the enthusiasm around AI. The ClearBridge Global Infrastructure Value Strategy outperformed infrastructure benchmarks such as the S&P Global Infrastructure Index, while both trailed the MSCI All Country World Index during the risk-on quarter. Global yields continued to push higher, meanwhile, with large yield curve inversion now common, especially in the U.S.
AI has been a major theme in broad equity market returns in 2023, and the technology has several applications in infrastructure as well. In gas distribution, AI can use analytics to identify issues such as leaks or structural deficiencies, rather than a utility continuously allocating maintenance capex. In the electricity grid, AI can assist with grid dispatch — the allocation of electricity through the network according to market needs — in terms of timing and location. In renewables, AI can improve safety by predicting and preventing issues while ensuring timely maintenance and emergency response; for example, it can monitor the structural integrity of wind turbines and the temperature of solar panels to identify potential problems before they cause damage or failure. Traffic flow on toll roads can also benefit when there is very high penetration of autonomous vehicles, which use AI.
Electric utilities and rail sectors led the Strategy in the quarter, with top contributor Centrais Eletricas ( EBR, Eletrobras) rising sharply. Eletrobras, one of Brazil’s largest integrated utilities, saw a rebound in share price as the chances of re-nationalization now appear increasingly unlikely. This will allow Eletrobras to continue as a private company and give it the chance to deliver on its lucrative turnaround plans.
U.S. rail operator CSX also performed strongly. CSX is one of the five leading North American rail companies, with over 21,000 miles of rail, covering 23 states and 40+ ports. Shares delivered positive returns following quarterly results in which the company showed strong improvements across key quality indicators and improvements in its operating ratio. Rail names in Japan, such as Central Japan Railway, which operates high-speed passenger trains (Shinkansen) linking Tokyo with Nagoya and Osaka and a network of commuter lines centered in Nagoya, as well as East Japan Railway, Japan’s largest passenger railway operator, rallied with Japan reopening its borders post COVID-19.
The renewables sector, meanwhile, had a challenging quarter, where Energias de Portugal ( EDPFY ) was the lead detractor. EDP is an integrated utility based in Iberia, 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 was dragged down by weakened global renewables sentiment, which hurt EDPR’s performance and in turn EDP, which has about two-thirds of its value coming from EDPR. In addition, drought across Portugal in April and May caused concerns over power output for EDP’s hydropower plants there.
U.K. water companies also underperformed as concerns about some specific operating issues among unlisted water companies, Thames Water in particular, impacted the listed sector. The main detractor here was Severn Trent ( SVTRF ), a regulated U.K. water utility that provides water and wastewater services to the Midlands and Wales, serving over 4.5 million households and businesses. Severn Trent pulled back primarily on the back of rising bond yields in the U.K., which hurt performance of regulated utilities. This was accompanied by rising concerns of political and regulatory scrutiny on the U.K. water sector on sewage overflows and pollution, which was aggravated by the financial collapse of unlisted sector peer Thames Water.
Outlook
The combination of peaking interest rates and inflation continues to cause volatility as investors weigh the probability of a global recession against reasonably strong economic data, while China is experiencing volatility as its economy reopens post the easing of COVID-19 restrictions.
Inflation continues to moderate, but remains at an elevated level, with recent data showing economic strength is making it difficult for central banks to loosen policy quickly. Although maintaining a tightening position is common across most economies, varying economic circumstances may see monetary policy diverge in the extent of tightening. Consensus remains divided on recessionary expectations, with the duration and depth of a recession remaining the largest risk to investors.
Against this backdrop, we maintain our defensive positioning. Across regulated utilities, fundamentals are still very strong with strong asset base growth driving very attractive free cash flow and cash flow that is being deployed into capex or being paid out to investors. We are also looking for more select opportunities to increase exposure to high-quality user-pays assets in sectors such as airports, passenger and freight rail, and toll roads.
The outlook for infrastructure remains positive. Infrastructure’s focus on cash flows and underlying earnings make it a very attractive sector as economic conditions deteriorate. With inflation elevated and its path uncertain, the sector continues to act as a strong inflation hedge, where the pass-through of inflation is enshrined in regulation or concession agreements. And longer term, infrastructure’s exposure to decarbonization, onshoring of industry and the explosion of data demand bodes well for the long-term asset base growth and the nearer-term cash flow generation and dividend story.
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 four of nine sectors in which it was invested (out of 11 total) in the second quarter, with the electric, rail and toll roads sectors leading and the water and renewables sectors the main detractors.
On a relative basis, measured against the S&P Global Infrastructure Index, the ClearBridge Global Infrastructure Value Strategy outperformed during the quarter.
Overall sector allocation and stock selection contributed positively. An overweight to the rail sector and underweight to the airports sector along with stock selection in the electric and toll roads sectors contributed the most. Conversely, stock selection in the renewables, energy infrastructure and water sectors detracted.
On an individual stock basis, the largest contributors to absolute returns in the quarter were Eletrobras, CSX, Constellation Energy ( CEG ), PG&E ( PCG ) and Terna ( TERRF ). The largest detractors were EDP, Entergy ( ETR ), Severn Trent, NextEra Energy ( NEE ) and American Tower ( AMT ).
During the quarter we initiated a position in Italian electric utility Enel and exited U.S. gas utility Southwest Gas ( SWX ), French toll road operator Vinci and Spanish airport operator AENA ( ANYYY ).
Charles Hamieh, Managing Director, Portfolio Manager
Shane Hurst, Managing Director, Portfolio Manager
Nick Langley, Managing Director, Portfolio Manager
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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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ClearBridge Global Infrastructure Value Strategy Q2 2023 Portfolio Manager Commentary