Commentary: Global Infrastructure Income Strategy

• Strong outperformance of infrastructure versus global equities comes against a backdrop of rising rates, contracting balance sheets, limited fiscal response, elevated geopolitical risk and potentially slowing global growth.
• Energy infrastructure in North America led Strategy performance, driven by higher natural gas prices, while higher energy prices also drove greater focus on renewable energy utilities.
• Our base case is slowing growth and higher inflation in 2022; given this, and current valuation signals, we continue to transition the portfolio to less economically sensitive utility assets.

The ClearBridge Global Infrastructure Income Strategy trailed the S&P Global Infrastructure Index, which returned 7.27% for the quarter, while both handily outperformed global equities as measured by the MSCI All Country World Index (-5.36%).

Strong outperformance of infrastructure versus global equities comes against a backdrop of rising rates, contracting balance sheets, a fiscal response which is limited at this point in the cycle and, at the same time, elevated geopolitical risk and potentially slowing global growth. In this volatile environment, the characteristic stability of infrastructure — resilient cash flows, strong dividends growing well above inflation as well as the pass-through of inflation — came to the fore.

On a regional basis, the U.S. and Canada were the top contributors to quarterly performance. Canadian energy infrastructure company Pembina Pipeline, U.S. energy infrastructure companies Williams Companies and Enbridge and U.S. renewables utility Brookfield Renewable were among the lead performers.

Pembina Pipeline provides transportation and midstream services for the energy industry in North America. The hiring of Scott Burrows as permanent CEO and Jaret Sprott as COO and reaffirmation of its corporate strategy boosted investor sentiment. Shares also rose amid a strong natural gas pricing environment, which caused midstream companies — such as Williams, which owns and operates natural gas pipelines and associated midstream assets in the U.S., and Enbridge, which owns and operates one of the largest oil and gas pipeline networks in North America — to continue to perform well.

Brookfield Renewable is a pure-play renewables operator and developer headquartered in Canada, focused on international hydro, solar, wind and storage technology. As more private and public institutions announce ambitious carbon reduction initiatives, Brookfield Renewable’s globally diversified, multi-technology renewables business makes it an attractive partner. Brookfield’s development pipeline stands at 18,000 MWs, providing confidence the company can meet its targeted double-digit cash flow growth through to 2025. The market narrative around the energy transition and energy security, along with increasing fossil fuels prices which have driven greater focus on switching to renewables, helped Brookfield shares in the quarter.

"Communications infrastructure remains attractive, as companies continue to deploy greater capital spend to support the strong tailwinds from 5G." 

Turning to Latin America, CPFL Energia, a Brazilian integrated electric utility, was a lead contributor. CPFL 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 concessions that are federally regulated and generation assets consisting of a mix of hydro and renewable assets that are underpinned by long-term take-or-pay contracts. CPFL was up due to a combination of the Brazilian market rebound and improved hydrological conditions: rain is essential for CPFL’s hydro power plants and, after a severe period of drought, Brazil started off its rainy season with exceptionally good precipitation.

U.S. communications company Crown Castle International was the largest detractor from quarterly performance. Crown Castle is the leading independent owner and operator of wireless communications infrastructure in the U.S. with a portfolio of approximately 40,000 towers. The stock underperformed as, driven by rising interest rates, investors rotated away from defensive into more value-oriented sectors. Communications infrastructure remains attractive, however, as companies continue to deploy greater capital spend to support the strong tailwinds from 5G.

Rising interest rates and inflation made for volatile markets following the outbreak of the conflict between Ukraine and Russia. We expect this volatility to continue as the market digests the impact of the war on inflation and global growth. Geopolitical risks, ongoing COVID-19 disruption, supply chain issues and high inflation continue to reduce expectations for economic growth, although a recession is still not our base case.

Our base case is rather for slowing growth and higher inflation in 2022; given this, and current valuation signals, we continue to transition the portfolio to less economically sensitive utility assets. Amid higher inflation and interest rates, utilities tend to be shorter duration: their assets and returns are reviewed at frequent regulatory resets, making them relatively less sensitive to movements in bond yields over the medium term. While inflation causes volatility in equity markets, over the medium term inflation will have little effect on infrastructure assets, which act as an inflation hedge due to the largely pre-programmed way — through regulation and contracts — they can adjust to inflationary environments.

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 delivered positive contributions from eight of the 10 sectors in which it was invested (out of 11 total) in the first quarter, with the electric, energy infrastructure and gas sectors the leading contributors and the communications sector the main detractor.

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 contributed positively to relative results, while sector allocation detracted. Stock selection in the electric and airports sectors and an overweight to the gas sector aided relative performance, while stock selection in the gas and toll roads sectors, an overweight to the communications sector and an underweight to the energy infrastructure sector detracted.

On an individual stock basis, the largest contributors to absolute returns in the quarter were Pembina Pipeline, CPFL Energia, Williams Companies, Enbridge and Brookfield Renewable. The largest detractors were Crown Castle, Ferrovial, EDP-Energias de Portugal, Iberdrola and Enagas.

During the quarter we initiated a position in Canadian electric utility Emera and received shares of U.S. electric utility Constellation Energy following its spin-off from holding U.S. electric utility Exelon, which we exited. We also exited Canadian infrastructure company Brookfield Infrastructure.