A conversation with Charles Hamieh, MD and Portfolio Manager of Global Infrastructure Strategies at ClearBridge Investments.
Q: How can investors balance the desire for yield, diversification and sustainability in their portfolios?
An allocation to listed infrastructure not only provides reliable and growing income but also diversification across sub-industries and across various political and regulatory regimes. The return drivers and risks facing the different sub-sectors within this asset class are fairly unique and differentiated from other equity sectors and as such may offer genuine diversification.
Here, specialist listed infrastructure investment managers have a sustainable competitive advantage, applying their specialist sector knowledge with a focus on long-term outcomes. They ensure capital providers are compensated with the appropriate returns that is aligned with the long-term nature of regulation and contractual structures.
Q: What are the key risks for income investors for the rest of 2022?
High inflation remains a risk for global markets, on account of ongoing supply chain disruptions, the Russia-Ukraine crisis and the start-and-stop lockdown cycle in China as they continue to adhere to a “zero-Covid” strategy. The outlook for interest rates and inflation will continue to spark bouts of volatility in markets as investors digest expectations of a slowdown in global growth in conjunction with central bank tightening that has been more hawkish than investors previously anticipated. Also, there is a growing risk that potential policy mistakes sparked by an overly aggressive tightening cycle, coupled with stiffer headwinds for growth, could tip the economy into a recession, although this is not our base case.
Q: How is the current rates cycle impacting your outlook for income opportunities?
Given our base case of slowing growth, higher inflation and rising interest rates, our playbook for infrastructure is to watch for a transition from a growth orientation, in which we prefer higher exposure to economically sensitive user-pays infrastructure and lower utility weightings, to a more defensive positioning as growth fades and utility underperformance unwinds.
We think this will be a measured process through 2022, although we remain cognisant that the transition from a growth posture to a defensive one may accelerate should the outlook worsen faster than expected. We would look for defensive growth exposure through communications and high-growth utilities, including renewables, and ensure that our position in utilities exhibit strong correlation to inflation.
Q: What are the key markets or sub-asset classes that can now potentially provide investors with resilient income?
In this current environment, investors should expand the search for income beyond just the traditional sources of yield. While both global equities and real estate investment trusts (REITs) can provide competitive yields relative to bonds, both have revenues and, ultimately, dividends that are closely linked to economic activity.
Here, listed infrastructure has an edge as a long-term income solution, as revenues are generally linked to the asset base of the companies and are also underpinned by regulations and long-term contracts. The stability of earnings derived from these underlying assets allow infrastructure companies to provide predictable income distributions over time and offers investors excellent visibility for revenues and dividends. Through listed infrastructure, investors can access a more resilient source of income, where growth is linked to the asset base of the companies rather than the business cycle.
Against an uncertain macroeconomic backdrop, the certainty of future earnings, the durability of dividends and the sustainability of growth will be key. Listed infrastructure significantly outperforms other equities on this measure, with large trends such as decarbonisation providing a long-term secular tailwind.
Q: Which sectors and geographies look appealing to you at the moment?
The impact of rising bond yields tends to be more pronounced for longer-duration assets. Within listed infrastructure, duration varies across sub-sectors. For instance, toll roads and concession assets generally exhibit longer duration and are therefore more sensitive to changes in interest rates. Utilities, however, tend to be shorter duration as their assets are repriced by regulated returns at frequent intervals, making them relatively less sensitive to movements in bond yields over the medium term. Accordingly, short-duration utilities may look attractive given the current macro dynamics.
Even so, these characteristics may vary markedly across sectors and regions, underscoring the importance of understanding the regulatory and contractual nuances governing the earnings of these companies. For example, utilities in the UK and parts of Europe and Australasia have a more direct link to inflation, where returns and asset bases are indexed to inflation annually. Accordingly, these utilities should do well in a low-growth, high-inflation scenario, supported largely by its earnings certainty and direct inflation pass-through. In comparison, utilities in North America and certain parts of Europe, have an indirect link to inflation, with pass-through mechanisms that typically lag as regulated returns are adjusted only when the utility files for its rate case.
