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Commentary: Global Infrastructure Value Strategy

Decarbonization and 5G Among Infrastructure Drivers

First Quarter 2021

Key Takeaways
  • Infrastructure underperformed equities for the quarter, largely due to higher weights in rate-sensitive stocks among infrastructure sectors.
  • On a regional basis, North America was the top contributor, led by strong showings from energy infrastructure.
  • Looking ahead, we are constructive on a global recovery and see clear drivers for economically sensitive user pays assets as mobility increases, policy support for renewables as well as key catalysts for U.S. utilities, whose valuations look attractive.
Market Overview and Outlook

The Strategy underperformed infrastructure indexes, which underperformed equities for the quarter, largely due to higher weights in rate-sensitive stocks among infrastructure sectors.

The quarter saw rapid increases in both bond rates and inflation expectations as the economic recovery continued, strongly aided by a quickening vaccine rollout and massive levels of government stimulus. Consensus growth expectations were revised higher during the quarter. Inflation is expected to increase in the coming months due to transitory effects before returning to a more normalized rate. Bond rates are expected to increase in a more orderly path for the remainder of 2021 before settling around 2.0%–2.5% for the U.S. 10-year Treasury note.

Vaccine rollouts continued to accelerate in many regions, driving optimism about reductions in mobility restrictions, despite increasing COVID-19 cases in regions such as Europe. Improved mobility is expected to impact the second half of 2021 and is required for the recovery of the services sector, which lags the largely recovered goods sector. This will drive further increases in revenues for transport assets.

Stimulus remained plentiful, particularly in the U.S. with the Biden Administration’s $1.9 trillion stimulus plan approved during the quarter and closely followed by a proposal for a $2 trillion infrastructure bill, broadly defined. Strong levels of stimulus will continue to support economic growth.

Portfolio Performance

On a regional basis, North America was the top contributor to quarterly performance, of which U.S. energy infrastructure company Cheniere Energy and Canadian energy infrastructure company Enbridge were the lead performers.

Cheniere Energy is an energy infrastructure company that owns and operates U.S. liquefied natural gas (LNG) export facilities. Cheniere delivered a strong fourth quarter that resulted in upgrades to the company’s forward 2021 guidance. Cheniere should benefit from an improving LNG contracting environment following the strong cyclical recovery

Enbridge owns and operates one of the largest oil and gas pipeline networks in North America. The company also owns regulated gas distribution utilities in Ontario, Canada. The first quarter saw the market giving the energy sector credit for its leverage to the eventual economic recovery as COVID-19 vaccines get rolled out through 2021.

Elsewhere in the region, U.S. rail operator Union Pacific also performed well. Union Pacific is the largest listed railroad company in North America. Despite impacts from the polar vortex, Union Pacific was the beneficiary of a market shift into high-beta stocks, further bolstered by Biden’s stimulus package and potential infrastructure bill.

 

"We have found there is actually little correlation between infrastructure and utility performance versus inflation."

 

Turning to Western Europe, French toll road operator Vinci also performed strongly. Vinci operates half of France’s toll road network under long-term concession agreements, a growing portfolio of airport concessions and a global contracting business. The market is giving the transport sector credit for its leverage to an eventual traffic recovery as COVID-19 vaccines get rolled out through 2021.

Danish renewables utility Orsted was the largest detractor from quarterly performance. Orsted is the global industry leader in the offshore wind industry, with about 30% market share. Over the past few years, Orsted has gradually exited its fossil fuel activities and more recently its energy distribution and retail business, transforming itself into a green solutions provider. It is a pure play in renewables with over 90% of its earnings from regulated and contracted activities in 2019–25. A green recovery in the EU with a hydrogen strategy to combat climate change should be long-term drivers for Orsted. Shares saw weakness driven mainly by a global renewables selloff, while the high price paid by BP for British seabeds in February increased some market fear of more intensified competition in offshore wind by oil majors.

Positioning and Outlook

On a regional level, the Strategy’s largest average exposure was in the U.S. & Canada (52%) and consisted of exposure to regulated and contracted utilities (30%) and economically sensitive user pays infrastructure (22%).

During the quarter we initiated positions in U.S. electric utility Alliant Energy, French toll road operator Eiffage, Japanese rail operator East Japan Railway and Canadian energy infrastructure company Pembina Pipeline. We exited Orsted, Italian gas utility Snam and U.S. electric utility Edison International.

Looking ahead, we are constructive on a global recovery. Vaccination progress and mobility improvements will benefit road, rail and airport exposures, as well as midstream/energy infrastructure as GDP increases. U.S. utilities remain very attractive from a valuation standpoint, with some companies having very key catalysts to play out over the next quarter. Decarbonization, which has growing policy drivers, permeates the entire portfolio in various forms, most directly through contracted renewables. Communications towers will benefit from the 5G rollout, which is starting to see momentum building following the completion of the recent C-Band auctions and master lease agreements and amendments with carrier customers such as Verizon.

Global bond yields were up in the quarter in the U.S., Australia and Europe, begging the question of what happens to infrastructure with higher inflation. Given the large amount of stimulus put through by President Biden, and more expected in the U.S. and globally, we think there will be some type of cyclical inflation. But, in the longer term, our view is still structural. Inflation remains around 2%. This ends up not meaning much for utilities and infrastructure: inflation gets passed through in the case of utilities through their cost of capital, while user pays infrastructure assets with concessions, contracts, tariffs and tolls end up passing through inflation as well. We have found there is actually little correlation between infrastructure and utility performance versus inflation. Moreover, looking at the last 30 years, those periods of strongly rising bond yields have been the best periods to position the portfolio and have led to strong returns for infrastructure assets in the subsequent periods (Exhibits 1–3).

 

Exhibit 1: Infrastructure Performance After Rise in Yields: 6 Months

Source: ClearBridge Investments, FactSet.

Exhibit 2: Infrastructure Performance After Rise in Yields: 12 Months

Source: ClearBridge Investments, FactSet.

Exhibit 3: Infrastructure Performance After Rise in Yields: 24 Months

Source: ClearBridge Investments, FactSet.

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 delivered gains across five of nine sectors in which it was invested (out of 11 total) in the first quarter, with the energy infrastructure, gas and communications sectors the leading contributors and the renewables sector the main detractor.

On a relative basis, measured against the S&P Global Infrastructure Index, the ClearBridge Global Infrastructure Value Strategy underperformed the benchmark during the first quarter. Overall sector
allocation detracted from performance and was partially offset by stock selection. In particular, overweights to the renewables and rails sectors and an underweight to the gas sector detracted. Stock selection in the toll roads and gas sectors was also detrimental. Conversely, an underweight to the airport sector and stock selection in the rail and renewables sectors proved beneficial.

On a regional basis, the U.S. and Canada was the sole contributor, while Western Europe was the largest detractor.

On an individual stock basis, the largest contributors to absolute returns in the quarter included Cheniere Energy, Enbridge, Union Pacific, NextEra Energy Partners LP and Exelon. The primary detractors from absolute returns were positions in Orsted, Brookfield Renewable, Getlink, Edison International and Clearway Energy.

Charles Hamieh

Portfolio Manager
24 Years experience
11 Years at ClearBridge

Shane Hurst

Portfolio Manager
24 Years experience
11 Years at ClearBridge

Nick Langley

Portfolio Manager
27 Years experience
15 Years at ClearBridge

Related Perspectives

  • 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. 

  • Past performance is no guarantee of future results.

  • Performance source: Internal. Benchmark source: Morgan Stanley Capital International. Neither ClearBridge Investments, LLC nor its information providers are responsible for any damages or losses arising from any use of this information. Performance is preliminary and subject to change.

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