Global Listed Infrastructure Monthly review and outlook

Global Listed Infrastructure delivered strong returns in July, as lacklustre economic data sparked investor hopes that interest rate rises may increase at a slower pace than previously assumed. The FTSE Global Core Infrastructure 50/50 index gained +4.7% while the MSCI World index^{^} ended the month +7.9% higher.

The best performing infrastructure sector was Railroads (+10%), with North American freight rail operators gaining on improved investor sentiment. The establishment in the US of a Presidential Emergency Board, aimed at averting the risk of a national freight rail strike, was also positive at the margin. The Energy Midstream (+8%) sector climbed against an uncertain geopolitical backdrop. During the month, Russia’s state-owned energy company Gazprom reduced the amount of natural gas sent to Europe via the Nord Stream 1 pipeline, pushing gas prices higher and buoying North American Liquefied Natural Gas (LNG) exporters. The worst performing infrastructure sector was Toll Roads (flat). Having performed well during June’s market turbulence, the sector paused for breath in July.

The best performing infrastructure region was the United Kingdom (+8%) reflecting a rally in utilities/renewables stocks as wholesale power prices rose. The worst performing infrastructure region was Japan (-2%) as the prevailing “risk-on” mood saw investors favour higher beta sections of the market.

^{^} MSCI World Net Total Return Index (USD) is provided for information purposes only. Index returns are net of tax. Data to 31 July 2022. Source: First Sentier Investors/Lipper IM. All stock and sector performance data expressed in local currency terms. Source: Bloomberg.

The Portfolio invests in a range of listed infrastructure assets including toll roads, airports, railroads, utilities and renewables, energy midstream, wireless towers and data centres. These sectors share common characteristics, like barriers to entry and pricing power, which can provide investors with inflation-protected income and strong capital growth over the medium-term.

Toll roads represent the portfolio’s largest sector overweight, via positions in European, Asia Pacific and Latin American operators. We believe these companies represent exceptional value at current levels, with traffic volumes proving significantly more resilient than those of other transport infrastructure assets. Toll roads are also likely to fare relatively well in a higher inflation environment. Many toll roads have concession agreements that specify how prices can be increased, with an option to follow the inflation rate or an agreed percentage — whichever is higher.

The portfolio is also overweight Railroads, primarily via exposure to large cap North American freight rail operators. These firms are unique and valuable franchises. Their wholly-owned track networks are high quality infrastructure assets which can never be replicated. They typically operate under duopoly market conditions, with significant numbers of captive customers such as grain, chemical and auto producers giving them strong pricing power over long haul routes. Lack of capacity in the trucking sector (freight rails’ main competitor), along with the onshoring of industrial production back to the US, are expected to provide additional drivers of demand for these stocks.

A substantial portion of the Portfolio consists of high conviction Utilities/Renewables holdings. The Portfolio’s focus is on companies with the scope to derive steady, low risk earnings growth by replacing old fossil fuel power plants with solar and wind farms, and by upgrading and expanding the networks needed to connect these new power sources to the end user. Technology advances and lower costs for utility-scale battery storage will enable renewables to represent an ever-greater share of the overall electricity generation mix. In the medium term, the roll-out of electric vehicles is then expected to provide an additional boost to utilities — first via investment opportunities associated with linking EV charging stations to the grid; and then via higher overall demand for electricity. The Inflation Reduction Act, should it be signed into law, would represent a material tailwind for these themes within the US.

Underweight exposure to the Energy Midstream sector has been maintained. Strong gains across the sector during the past year have moved these stocks to lower rankings within our investment process; and we remain conscious of the structural headwinds that many of these companies may face as Net Zero initiatives gather pace.

Source: Company data, First Sentier Investors, as of 31 July 2022.