ClearBridge Global Infrastructure Income Strategy Q3 2022 Portfolio Manager Commentary

Highway viaduct at dusk

SimonSkafar

By Daniel Chu | Charles Hamieh | Shane Hurst | Nick Langley


Europe’s Energy Crunch Raises Political Risks

Market Overview

The third quarter was dominated by central banks’ efforts to fight inflation through tightening monetary policy. As the Fed and other central banks continued to raise rates, bond yields rose across the globe. In addition to challenges from high inflation, high gas prices due to falling Russian gas supply caused all types of restrictions to be imposed in Europe, while a new U.K. prime minister introduced a number of unfunded tax cuts, causing bond yields to rise and the pound to fall. Drought is also coming to be a larger issue in Europe. China, meanwhile, continues to be pressured by COVID-19-related lockdowns.

Nearer-term macroeconomic concerns tended to outweigh one major development for infrastructure and global decarbonization during the quarter: the U.S. Inflation Reduction Act was announced in August and should be a major tailwind to our contracted renewables and utilities globally. We believe this is going to be industry transformative. One thing it accomplishes: from an economic perspective there is no reason to build anything other than renewables from now on. Much of this is due to tax credits. Production tax credits ((PTCs)) for solar/wind are available until 2032 or until a 75% reduction in greenhouse gases is achieved (based off 2022 numbers). Either way, this is expected to be a tailwind for investment for well over a decade.

Portfolio Performance

On a regional basis, Latin America was the best performer during the quarter, of which Brazilian electric utility CPFL Energia (OTC:CPFEY) and Mexican airport operator Grupo Aeroportuario del Pacifico (PAC) were the lead performers.

CPFL Energia is one of Brazil’s largest distribution and generation companies, with a 13% market share in distribution and a 3% market share in generation. CPFL’s distribution assets include eight separate federally regulated concessions and generation assets consisting of a mix of hydro and renewable assets that are underpinned by long-term take-or-pay contracts. During the quarter, the Brazilian central bank decided to halt interest rate rises after numerous quarters of aggressive monetary policy. This sent a positive signal to the market that the rate cycle could be turning, leading to outperformance by Brazilian rate-sensitive stocks like CPFL.

Grupo Aeroportuario del Pacífico is Mexico’s largest airport operator with a portfolio of 13 airports focused in Mexico’s Pacific region with an additional airport in Jamaica. Once again, the company delivered encouraging traffic growth and solid quarterly results leading to strong relative performance during the quarter.

From a regional perspective, Western Europe was the main detractor for several reasons. In addition to rising bond yields, an ongoing energy crisis, recession fears and pressure from the war in Ukraine, utilities suffered from fear of sector intervention amid several economic and political uncertainties, such as in Italy, where upheaval from Mario Draghi’s resignation and the subsequent election of a right wing government led by Giorgia Meloni has also weighed on gas utility Snam (OTCPK:SNMRF).

Political uncertainty in the U.K., amid negative headlines of high costs of living and drought, also combined to create risks for water companies, the most severe of which is nationalization. This environment weighed on U.K. water utilities United Utilities (OTCPK:UUGRY) and Pennon (OTCPK:PEGRF); U.K. electric utility National Grid (NGG) traded down in sympathy.

Outlook

The outlook for interest rates and inflation continues to cause volatility in markets as investors digest expectations of a global slowdown in growth in conjunction with central bank tightening, with elevated volatility in the U.K. and Europe as a result of sustained high energy prices.

Inflation continues to sustain itself at higher levels, requiring central banks to refrain from loosening policy even as the economic outlook deteriorates. A recession continues to be part of consensus expectations, and its timing and extent remain the largest risk to investors.

Amid these challenges, there is no change to our view that while the rough road continues for equities, user-pays infrastructure and utilities, which provide essential services with stable cash flows and dividends and have a number of strong tailwinds, such as the U.S. Inflation Reduction Act, will remain attractive to investors in the months and years ahead.

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 negative contributions from all nine sectors in which it was invested (out of 11 total) in the third quarter, with the electric, gas and toll roads sectors the leading detractors and the rail, airports and communications sectors the least negative.

On a relative basis, measured against the S&P Global Infrastructure Index, the ClearBridge Global Infrastructure Income Strategy underperformed during the third quarter. Overall stock selection and sector allocation detracted from relative results. Stock selection in the gas, energy infrastructure, electric and water sectors, overweights to the renewables and communications sectors and underweights to the energy infrastructure and airports sectors detracted the most. Conversely, an underweight to the ports sector and stock selection in the renewables and toll roads sectors proved beneficial.

On an individual stock basis, the positive contributors to absolute returns in the quarter were CPFL Energia and Grupo Aeroportuario del Pacifico. The largest detractors were National Grid, Snam, APA (APA), Enagas (OTCPK:ENGGF) and Transurban (OTCPK:TRAUF).

During the quarter we initiated a position in U.K. water utility Pennon and closed positions in U.S. electric utility Constellation Energy (CEG), Mexican airports Grupo Aeroportuario del Pacifico and Grupo Aeroportuario del Sureste (ASR), Mexican electric utility CFE Capital and French communications company Eutelsat (OTCPK:EUTLF).


Past performance is no guarantee of future results. Copyright © 2022 ClearBridge Investments. All opinions and data included in this commentary are as of the publication date and are subject to change. The opinions and views expressed herein are of the author and may differ from other portfolio managers or the firm as a whole, and are not intended to be a forecast of future events, a guarantee of future results or investment advice. This information should not be used as the sole basis to make any investment decision. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither ClearBridge Investments, LLC nor its information providers are responsible for any damages or losses arising from any use of this information.

Performance source: Internal. Benchmark source: Standard & Poor’s.


Original Post

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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