America’s energy environment presents a 10-year investment opportunity
Delivering a sustainable yield while preserving (and even growing) capital is the holy grail of income investing.
Infrastructure assets, given their stable cash flows and the often highly regulated environments in which they operate, have the potential to deliver such outcomes.
The key, however, is to look globally rather than just locally, to have an active approach and appropriate timeframe, and to have a robust framework for identifying opportunities and managing risk.
In this wire, managing director and senior portfolio manager at ClearBridge, Shane Hurst, very kindly allows me to peel back the curtain on the team's investment philosophy and how they deliver outcomes for their investors via the RARE Infrastructure Income Fund.
Hurst also highlights some key aspects of the ClearBridge process that have allowed the team to consistently better its dual mandate of a total return greater than G-7 inflation plus 5.5% through the cycle, while targeting a 5% income level through the cycle.
The universal problem
ClearBridge has a long-only global infrastructure strategy, managed by a four-person investment committee – which is one of the largest dedicated infrastructure teams in the industry. In terms of philosophy, Hurst identifies “using the liquidity of listed markets to extract the characteristics of infrastructure. That's stable cash flows, dividends, diversification, the hedge on inflation, and generational tailwinds, such as decarbonisation.”
As for the problem ClearBridge is trying to solve for investors, it’s a universal one, and that is:
“To deliver stable income and risk-adjusted returns that are not linked to the business cycle,” says Hurst.
The team also leverages into several big themes, including decarbonisation, the thirst for data, and the differences from the valuations of unlisted infrastructure assets, “and where that ends up is listed infrastructure assets trading at a big discount, toward their unlisted valuations currently.”
Standing out from the crowd
The main point of difference is that ClearBridge takes an unlisted approach to investing in listed markets.
“Most infrastructure strategies don't do that, they just target a total return outcome. But obviously, there's a huge demand for that income, so we explicitly target it,” says Hurst.
The other key differentiator is that ClearBridge has a very distinct definition of infrastructure and an index unaware approach. This allows the fund manager to leverage its expertise to build its own universe, maintain research coverage across approximately 150 companies globally, and simply select the best opportunities regardless of index composition or geography.
“What that does is, that leads to very unique alpha generation”, says Hurst.
Worried about yields?
As the following chart shows, since the start of the year, we've seen one of the most aggressive spikes in bond yields since 1994. I asked Hurst what this means for the infrastructure asset class, and what he expects over the next 12 months.
He notes that in most cycles, historically, when there has been a jump in bond yields, defensive assets have tended to underperform. Yet we have not seen that this time around.
"Because in most cycles, that jump in bond yield comes with strong growth. This time it is a little bit different because of strong inflation whilst the outlook for growth has been weak”, says Hurst.
He also argues that for infrastructure and utility companies – which can pass through inflation to the end customer – things are still positive.
The other point that Hurst makes is that whilst central banks are tightening into a slowing growth environment, and the market is concerned about recession, that is a positive for companies with stable cash flows, i.e., utilities and defensive assets.
In the longer term, Hurst and the ClearBridge team are less concerned about the impacts of inflation and higher yields, which stems from their long-term, high-quality focus;
“Assuming inflation has peaked or levelled off, which is largely our view, and central banks can somewhat contain inflation, which is also our view. I think bond yields will largely stay range bound globally”.
A critical part of the ClearBridge process
Aside from the dual mandate (a total return outcome as well as a 5% income level) mentioned above, Hurst identifies risk management as being crucial to ClearBridge’s process, noting the best-in-class downside protection of a beta of 0.5.
Being index unaware, risk management takes on even greater importance, and the ClearBridge team has sharpened its edge over the years by building a multifactor risk model that can price risk on a stock, on an asset, on a sector, or on a theme basis.
“The way we construct our universe produces lower volatile outcomes, because we exclude those high volatile assets and they don't get anywhere near the portfolio. That allows us to look forward and think, ‘Okay, what risk do we want to take into the portfolio? What risk don't we want to take?’
What's on the radar?
In terms of a major topic being discussed in the ClearBridge war room, Hurst identifies the US Inflation Reduction Act passed in August, and the US$370 billion set to be invested in energy security and climate change over the next decade.
“We're looking at where it benefits, and where it may disadvantage our portfolio. In terms of benefits, solar and wind producers and developers will have 10-year credit extensions, which is obviously very, very valuable for those assets within our portfolio”, says Hurst.
Hurst also notes that green hydrogen will now become more competitive, whilst nuclear energy producers should also receive a benefit by way of a tax credit. ClearBridge has exposure to both of those asset types in the portfolio.
The other key benefit that Hurst notes is the ability to create headroom in customer bills by having these subsidies. This, in turn, will allow companies “to retire more coal plants, roll in more capital spend on renewables, and create greater growth for our utilities,” says Hurst, noting that is the much longer-term benefit.
... and what are you buying and selling?
Hurst highlights US utility Public Service Enterprise Group (NASDAQ: PEG) as a recent investment. Based on the east coast of the US, PEG has delivered strong growth as a regulated utility and can pass on higher rates, within a constructive regulatory environment.
“They have nuclear assets that will benefit from subsidies, and we don't think people have really captured it in their valuations, and certainly in the share price,” says Hurst.
In terms of selling, the team have been reducing their position in ASX-listed Atlas Arteria (ASX: ALX). “We sold it on a full valuation, and on the belief that IFM, who is making a play to take over the business, won't meaningfully increase their bid.”
When asking Hurst about how far up the risk curve ClearBridge needs to move in order to achieve its objectives, he emphasised that:
“We don't need to move up the risk spectrum to achieve our income objectives. And the reason we don't is, income is generated by these essential service companies, that don't operate within business cycles”.
Hurst also said that, given the size and scope of the opportunities within its universe, there are plenty of opportunities to reallocate in order to achieve objectives, rather than take on more risk.
"When you're constructing a portfolio within a universe that's $2.2 trillion in size, we have plenty of opportunities to reallocate, to make sure that we extract good total return outcomes, but also, that secondary outcome of a stable income, and a growing income through the cycle,” he says.
As for what is robbing Hurst of sleep, he points to consumer bill pressure. “Whether this manifests into less constructive regulation, less constructive political environments, or less constructive growth, for our companies, that’s what keeps me up at night.”
Hurst also notes the previously mentioned Inflation Reduction Act as a point of concern, simply because many of the stocks that ClearBridge holds have run hard – up as much as 20% in a month. Whilst it is a good problem to have, the question now begs, “How do we strike that balance between the very strong, long-term benefit, and how much is currently being priced?”
Access Infrastructure Income
The Clearbridge Infrastructure Income Strategy aims to provide investors with long-term inflation-linked capital growth over an economic cycle with a focus on providing reliable income. For further information, please visit their website. (VIEW LINK)
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