“The listed infrastructure market generally provides much more depth in regulated utilities and user-pays assets, offering high-quality core infrastructure assets that are more liquid. Listed infrastructure investors also have more flexibility and can optimise their portfolios in terms of sectors, regions and market cap spectrums,” notes Shane Hurst, portfolio manager, ClearBridge Investments.

“Infrastructure portfolio composition can also be optimised for other investor preferences, such as choice of underlying asset risk exposure, sensitivity to short-term price volatility and opportunistic use of market mispricing and arbitrage,” he adds.

In the context of falling but still high inflation, tight monetary policies and slowing growth, infrastructure benefits from having resilient, inflation-linked revenues.

Hurst says “Due to the essential nature of infrastructure assets, demand is relatively stable, providing lower volatility than traditional equities and resilience of infrastructure revenue during various business cycles.

“Even at times of economic weakness, consumers continue to use water, electricity and gas, drive cars on toll roads and use other essential infrastructure services. Many infrastructure companies have regulation or contracts linked to inflation. As a result, infrastructure companies’ financial performances benefit from inflation with a lag of a few months to a few years.

Longer term, infrastructure should see a number of tailwinds, such as decarbonisation.

Hurst adds “The Inflation Reduction Act (IRA) and other global policy support will be industry transformative. A major takeaway from the global policy support for an energy transition is that there is no reason to build anything other than renewables from now on due to subsidies available and that greater opportunities now exist within our universe as coal-exposed utility companies accelerate their net zero plans.”

He says “Supply chains are shortening and changing trade routes and adjustments to supply chains to bring production closer to home, either through reshoring or near-shoring, are driving demand for new transport infrastructure as well as power infrastructure. The IRA is also bringing new green technology and other industries from abroad to the U.S., to benefit from the tax credits available, driving support for or growth of infrastructure businesses.

“In addition, 5G continues to be a tailwind for infrastructure as significant capex is required to improve and “densify” cellular networks as we move into the Internet of things (IoT) era, driving significant investments in wireless tower businesses, generally undertaken under long-term inflation-linked contracts,” Hurst says.

The ClearBridge RARE Infrastructure Income Fund is one of the few infrastructure strategies in the market with a sustainable income focus.

Hurst notes “This fund is a truly global portfolio with country exposure spread out across developed and emerging markets (most peers are heavily focused in the U.S.). This is a result of the breadth and depth of the investment team which allows them to source for global opportunities that are often times not well covered by others.”

The fund invests in a diverse range of global listed infrastructure securities across a number of infrastructure sub-sectors and geographic regions.

“We focus on user-pays assets (toll roads, railways, airports) and regulated assets (utilities, electricity, renewables) with long-term contracts; these essential services provide revenues and earnings that are resilient through up and down markets. Their revenue streams should be supported by either regulations or long-term concession contracts, which offer good predictability on their cash flow and dividends. This helps the fund meet its income target while providing attractive upside/downside capture versus more volatile global equities, and thereby offering an attractive asymmetric return profile,” says Hurst.

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As investors assess the outlook for inflation and the impact of higher interest rates on their portfolios, ClearBridge Investments says there appears to be little or no correlation between various listed infrastructure assets and movements in inflation over the past 30 years.

In recent central bank commentary, Federal Reserve Chairman Jerome Powell said inflation has come in ahead of expectations and could end up higher than the Fed’s current forecast of 3.4% for 2021 – up from 2.4% forecast three months ago. Powell also said the Fed expects to start raising interest rates next year, with two increases by 2023 anticipated.

Reserve Bank of Australia Governor Philip Lowe said he expects the June quarter consumer price index to rise temporarily above 3.0% due to the unwinding of some pandemic-related price reductions. But beyond that point, inflation pressure will be subdued, according to the Reserve Bank of Australia.

Portfolio Manager Shane Hurst from ClearBridge Investments says: “Looking ahead, we are constructive on a global recovery and see clear drivers for economically sensitive user-pays assets. In addition, increased mobility and policy support for renewables will be key catalysts for US utilities.”

Hurst says investors should consider infrastructure assets in two broad categories: user-pays assets and regulated assets. When it comes to user-pays assets, such as toll roads, rail networks and airports, revenue is dependent on how many people use the asset. As such, as economic growth recovers, so do the cashflows of the underlying infrastructure assets.

“With regulated assets, such as water, electricity and gas, returns allowed by regulators will typically increase if interest rates rise.”

Hurst says: “Given the large amount of stimulus proposed by US President Biden, and more expected in the US, and globally, we think there will likely be some cyclical inflation. But in the long term our view is that inflation will remain around 2%.

“Either way, rising inflation does not significantly affect utilities and infrastructure assets. Inflation generally gets passed through in the case of utilities via their cost of capital, while user-pays infrastructure assets with concessions and contracts will pass through inflation via tariffs and tolls.

“We have found there is little correlation between listed infrastructure and utility performance and inflation. Looking at the past 30 years, those periods of strongly rising bond yields have been one of the best periods for active managers to position their portfolios to take advantage of market dislocations. This has led to strong returns for investors of infrastructure assets in subsequent periods following the rate rise,” says Hurst.

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Terrence Murphy

Using approaches such as direct discussions with senior management and proxy voting, asset managers have the powerful ability to drive change in the environmental, social and governance (ESG) practices of public companies, according to ClearBridge Investments^[1].

With US$184 billion globally in assets under management, ClearBridge Investments is a top 20 shareholder in more than 275 public companies. It conducts over 1,000 meetings with the companies in which it invests every year. As an active equity investor, it voted on every eligible shareholder proposal at companies in its client portfolios; last year, that amounted to 16,832 proposals.

ClearBridge Investments’ newly released 2021 Impact Report^[2] catalogues its partnering with companies around ESG issues as wide-ranging as diversity and inclusion, sustainable infrastructure and fossil fuels, among other hot button topics.

“In a year like no other, the global pandemic starkly highlighted the social and economic inequalities in our society. At the same time, it reinforced the value of our decades-long efforts to prioritise ESG factors in our investment approach,” said Terrence Murphy, CEO of ClearBridge Investments.

“We’ve been an ESG investor for over 30 years and it’s exciting to see interest in ESG accelerating globally,” Murphy added.

“New regulations such as the European Union’s Sustainable Finance Disclosure Regulation are giving investors the ability to identify the asset managers whose ESG efforts are delivering positive benefits while companies are realising the public expects them to foster transparency while channelling capital toward a more sustainable economy.”

Rather than simply screening out companies not deemed socially responsible, the investment process at ClearBridge Investments uses a proprietary framework that identifies key ESG considerations for each sector and subsector, focusing on the issues that truly matter for each company. In addition to informing stock selection, these assessments help the firm track progress and drive engagement with company management.

Shane Hurst, Portfolio Manager (global infrastructure strategies) says it is imperative to incorporate an ESG and sustainability framework into any process that analyses infrastructure assets.

“ESG has always been vital for infrastructure as an asset class. The need to lower carbon emissions is not going away, nor is the importance of upgrading and building new infrastructure to achieve lower emissions targets. And part of the world’s response to the pandemic, the urgency of balancing stakeholder’s interests in business operations is a positive for the infrastructure sector.

“Partly, this is because infrastructure companies are well-positioned to manage a balance of stakeholder and shareholder interests that is a key tenet of the corporate response to the pandemic. The tilt toward managing stakeholder interests has been accentuated by the COVID-19 crisis, as companies have found themselves needing to help employees, customers and the general public during these difficult times.”

“Taking a holistic view of ESG is fundamental to our bottom-up investment process, and a crucial part of the way we invest is through that lens of sustainability,” Hurst says.

A meta-study by the New York University Stern Center for Sustainable Business show that ESG and strong financial performance are positively correlated. The study also found that improved financial performance due to incorporating ESG becomes more noticeable over longer time horizons.

“Active voting is also key to influencing change.  These factors have been at the heart of our approach to ESG integration, and it is encouraging to see data confirm them,” Hurst said.

———-

[1] “ClearBridge Investments” refers to ClearBridge Investments Limited (AFSL 307727) (formerly known as RARE Infrastructure Limited) and its authorised representative ClearBridge Investments, LLC.
[2] https://www.clearbridgeinvestments.com.au/perspectives/clearbridge-2021-impact-report/

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The PRI was formed in association with the UN to foster good governance, integrity and accountability in investment globally. It works to understand the investment implications of environmental, social and governance (ESG) factors and to support its international network of investor signatories in incorporating these factors into their investment and ownership decisions.

“The movement to increased awareness and adoption of ESG principles in the investment process is one of the most dominant trends in global equity markets today,” said RARE’s Senior Portfolio Manager Shane Hurst.

“Taking account of environment, social and governance factors when assessing companies for the allocation of investment funds is of course desirable from a societal point of view. However, it also aligns with investor interests, as more and more research indicate companies with good adherence to ESG principals are generally higher financial performers than those with poor adherence,” said Hurst.

The PRI 2020 Scorecard for RARE Infrastructure is:

• Strategy and Governance: A
• Listed equity – incorporation: A+
• Listed equity – Active ownership: A

“RARE Infrastructure was established as a specialist global listed infrastructure investment manager in 2006 and was founded on a culture of client focus, research-driven authentic active management and ESG integration. We joined the PRI in 2010.

“ESG and broader sustainability considerations have always been crucial for infrastructure investors. These companies have long balanced the needs of stakeholders and shareholders while the assets themselves play a central role in combating climate change.

“Our investment process has integrated ESG risks and opportunities since day one with the implementation of sustainability evolving continually. The most recent upgrade to RARE’s UNPRI scorecard for Incorporation and Active Ownership recognises our mindset of continuous improvement in this area,” noted Hurst.

RARE aims to deliver long-term inflation-linked capital growth by providing investors access to the risk/return profile of unlisted infrastructure through the listed market.

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“Both our global listed infrastructure Value and Income Funds showed enhanced performance during October against a backdrop of positive equity markets,” said RARE Senior Portfolio Manager Shane Hurst.

“Although the yield curve in the US has moved away from an inversion path in recent weeks, we continue to believe that defensive strategies are a prudent course for investors and that listed infrastructure presents opportunities for investors looking to preserve and grow capital at the same time as looking for downside protection.

“Uncertainty has become more pronounced in recent times as the global economy has slowed.

“Global manufacturing weakness, low inflation, low economic growth and geopolitical tension has the world on edge.

“However, while there is plenty to worry about, global equities are still an engaging proposition as it is unlikely that the US economy, with record low unemployment, will dip into recession any time soon.

“Central banks are once again providing monetary stimulus, and fiscal stimulus is starting to come through.

“Retreating to cash or bonds runs the risk of missing out on potentially meaningful returns over the next year.

“In this environment, we believe investing in global listed infrastructure allows investors to navigate market volatility while remaining invested in equities. Infrastructure companies, when selected appropriately, can provide excellent visibility over revenues and dividends driven by stable earnings of the underlying assets, regulation and long-term contracts.

“A maturing business cycle means that quality assets that deliver growing earnings will be sought after and attract more capital as investors become more defensively positioned. As demonstrated by the chart below, listed infrastructure provides downside mitigation while participating on the upside. Investors can also see that a shallower drawdown leads to an earlier recovery.

“This downside mitigation can, over the long term, translate into a strategy that provides superior risk,” Mr Hurst said.

UK water sparkles in October for RARE

For both the RARE Infrastructure Income portfolio and the RARE Infrastructure Value portfolio Western Europe was a top performer in terms of regions in October. United Utilities, the largest listed water company in the UK, was a lead performer in both portfolios. United Utilities manages the regulated water and wastewater network in northwest England operating under a license with indefinite length.

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The list now comprises:

• BT Wrap
• Panorama
• Asgard
• Xplore Wealth
• Hub24
• Netwealth
• Powerwrap
• Praemium

As at 30 June, 2019 units in the RARE Infrastructure Fund (Class A) recorded an average income distribution of 6.8% p.a. and a total return of 10.8 % p.a over 3 years.

This performance exceeds the fund’s performance benchmark, the G7 OECD Inflation index +5.5%, by 3.4% p.a.

RARE Portfolio Manager, Shane Hurst said: “The investment objective of the Income Fund is to provide investors with a regular and stable income of 5%+ p.a. through an investment cycle comprised of dividends, distributions and interest, plus capital growth from a portfolio of global listed infrastructure securities.

There is growing consensus that we are in the late stages of the economic cycle, as increasing market volatility, lower economic growth, and greater uncertainty becomes more pronounced. The Reserve Bank’s recent cuts to official interest rates is evidence of this.

The Fund is ideally suited to this environment because the infrastructure companies RARE invests in provide more predictable cash flows, even during periods of market slowdown or recession.

The Fund’s current holdings are diversified across regions and infrastructure sectors with electricity the largest single sector, making up 50% of the portfolio and the USA and Canada the single largest region at 37%”.

This fund is “Recommended” By both Lonsec and Zenith and rated “Superior” by SQM Research.

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