ClearBridge Global Infrastructure Value Strategy Q2 2022 Portfolio Manager Commentary

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Clean energy A plus point in the sale

Market overview

User-pays infrastructure and utilities continued to perform well amid strong equity selling as their stable cash flows, growing dividends, essential service nature and ability to withstand inflation offered a safe haven in a volatile quarter.

The volatility came from many areas. As COVID-19 has become endemic in most of the world, its effects in China, which has maintained a zero-COVID policy and persisted in lockdowns, has hampered global growth. The Russian invasion of Ukraine continues to have an impact on commodity prices and supply, which, although felt more in Europe, is also affecting the rest of the world. Central banks around the world are removing liquidity from markets by raising rates and tightening monetary policy to fight inflation, which increases the risk of policy error. With the hawkish turn of central banks, the likelihood of global recessions has increased. This meant a difficult quarter for the markets, with the MSCI AC World index down sharply (-15.66%). Throughout the volatility, the ClearBridge Global Infrastructure Value strategy showed its defensive characteristics, outperforming global equities while trailing the S&P Global Infrastructure Index slightly (-7.66%).

Portfolio performance

The main contributor for the quarter was American Tower (AMT), a major independent owner, operator and developer of wireless communications and broadcast infrastructure. The company has 41,000 locations in the United States and an additional 139,000 locations in 19 countries, primarily in emerging markets (75,000 in India, 40,000 in Latin America and 18,000 in Africa). Stocks outperformed as investors grew fearful of a looming recession and positioned their portfolios in relatively economically isolated companies such as the towers. American Tower also successfully raised equity to fund a recent acquisition, lifting an overhang that had weighed on the stock’s performance.

Utilities with clean energy portfolios also made a positive contribution in a weak quarter for the markets, with the strong performance of US electric utilities Constellation Energy (CEG) and Clearway Energy (CWEN) . We bought shares of Constellation Energy earlier this year following its spin-off from Exelon (EXC). Constellation represents the former competitive power and energy generation business of Exelon, and with 21 GW of nuclear capacity across 13 plants, it is the largest carbon-free energy producer in the United States. with the benefit of any other federal/state nuclear grants given, and so far it has played out.

Clearway Energy owns and operates contracted renewable power generation assets in the United States as well as conventional generation and thermal infrastructure assets. Shares continued to strengthen after news that TotalEnergies (TTE) and Global Infrastructure Partners are joining forces to acquire 50% of Clearway, helping provide a longer runway for growth projects.

Amid signs of slowing growth, more economically sensitive user-pay infrastructure such as rail and airports have been among the main detractors. US rail operators Union Pacific (UNP), the largest publicly traded rail company in North America, and CSX (CSX), among the top five North American rail companies, were down on fears of a slowdown economic growth and the implications for the outlook for rail freight volumes. In addition, Union Pacific lowered its operating margin forecast for the year due to inflation and labor shortages.

Spanish airport operator Aena (OTCPK:ANNSF) was also a major detractor in the quarter. Aena is the monopoly owner of the Spanish airport system, operating all 46 airports under a dual-till regulatory regime. Aena also manages London Luton Airport, with a 51% stake. Shares declined as the expected summer passenger recovery was dampened by rising flight cancellations due primarily to staffing limitations combined with growing fears of a recession and its potential impacts on future passenger volumes.

Outlook

We believe the road will be difficult for equities, with risks related to recession fears, global political tensions, the removal of liquidity from the system, high inflation and slowing growth. At the same time, infrastructure and utilities are seeing a number of tailwinds and are at very attractive valuations in our view.

Tailwinds include transport infrastructure benefiting from the resumption of mobility as we enter summer in the Northern Hemisphere and COVID-19 becomes more endemic in most parts of the world. Decarbonization, a generational theme, is accessible in many ways, whether through contracted renewables, global regulated utilities, or even midstream pipelines that are beginning to facilitate an energy transition through hydrogen or carbon. carbon capture and storage. There are several ways to access this very dominant theme within our portfolio.

Energy security remains an issue, particularly in Europe, and we are seeing the acceleration of the movement towards decarbonization and increased investment in energy infrastructure benefit more our pipelines and utilities. Utilities around the world continue to strategically implement changes to improve the consistency of their future cash flows. We’ve seen this historically with US companies like Exelon, but we continue to expect companies like Public Service Enterprise Group (PEG) and European utilities to simplify their businesses as well. Communications infrastructure also remains attractive with continued data demand and strong 5G tailwinds generating strong cash flow and demand.

There is no change in the dynamics of listed and unlisted infrastructure: we see that private infrastructure capital continues to flow into listed markets to find assets at attractive prices to acquire. Currently, with over $300 billion to $400 billion in dry powder, or capital awaiting investment, unlisted players will benefit companies in our listed infrastructure universe as those companies sell these assets, often non-core interests or minority, for far more than where they currently trade. On average, we have seen these selloffs come in at around a 30% premium to where they are currently trading or their implied value.

We actively positioned the portfolio in a volatile market, taking advantage of an attractive entry point to buy American Water (AWK), which holds a portfolio of high-quality regulated U.S. water utilities with EPS growth prospects above average, driven by upgrading and expansion investments and complementary acquisitions. We sold off UK power utility National Grid (NGG), adding to the existing position NextEra Energy (NEE), where we see better risk-reward potential. We also channeled funds from the sale of French toll road operator Eiffage (OTCPK:EFGSY) to existing holding company Aena, a Spanish airport operator where we see a better risk-reward ratio.

Portfolio Highlights

We believe that an inflation-linked absolute return benchmark is the most appropriate primary metric to assess the long-term performance of our infrastructure strategies. The approach ensures that portfolio construction remains focused on delivering consistent absolute real returns over the long term.

On an absolute basis, the Strategy recorded negative contributions from the nine sectors in which it was invested (out of a total of 11) in the second quarter, with the power, rail, communications and airports sectors being the main ones. detractors and renewable energy, gas and water sectors the least negative.

On a relative basis, measured against the S&P Global Infrastructure Index, the ClearBridge Global Infrastructure Value strategy underperformed during the second quarter. Overall, stock selection detracted from performance, while sector allocation contributed positively to relative results. Stock selection in the renewable energy and energy infrastructure sectors, an underweight to the airports sector and an overweight to the rail sector aided relative performance, while stock selection in the rail and highways sectors tolls and an underweight in the toll roads sector detracted.

On an individual stock basis, the top contributors to absolute returns in the quarter were American Tower, Constellation Energy and Clearway Energy. The biggest detractors were Union Pacific, Aena, Cellnex Telecom (OTCPK:CLNXF), CSX and SSE (OTCPK:SSEZF).

In addition to the portfolio activity discussed above, we exited US power company Dominion Energy (D) and US. energy company Williams Companies (WMB).


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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.

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