Infrastructure indexes and global equities both traded down in October as expectations grew that interest rates would remain higher for longer than previously expected.
Slowing inflation and reasonably strong economic data have led investors to reassess their expectations of a recession in 2023. China, meanwhile, is experiencing economic challenges as progress in its reopening is being disrupted by difficulties in the Chinese property sector.
Inflation continues to moderate, although concern remains around the level of wage inflation and more recently a surge in oil and gas prices, making it difficult for central banks to loosen policy quickly. As expectations for a higher-for-longer interest rate backdrop gain traction, financial conditions continue to tighten, placing further stress on economic growth. Consensus continues to moderate its expectations for a recession, with the possibility of a recession remaining the largest risk to investors.
Our global listed infrastructure strategies outperformed infrastructure benchmarks and global equities for the month.
On a regional basis, the U.S. and Canada (+1.71%) was the top contributor for October, with U.S. electric utility Public Services Enterprise Group (+0.38%) the lead performer. Public Services Enterprise Group (PEG) operates the largest utility business (~90% of earnings) in New Jersey, along with a generation business (~10% of earnings) comprising nuclear assets. During the month, PEG received a good outcome on the extension of its gas replacement capex program, which came in above the current run rate of investments.
Elsewhere in the region, U.S. communications company American Tower (+0.28%) also performed well. American Tower is a leading independent owner, operator and developer of wireless and broadcast communications infrastructure. The company has 41,000 sites in the U.S. and a further 139,000 sites across 19 countries, predominantly in emerging markets (75,000 in India, 40,000 in Latin America and 18,000 in Africa). Shares did well on the back of stronger than expected results, with management increasing guidance as a result.
Turning to Western Europe, the UK water sector recovered after robust regulatory capital value growth ambitions shown in the proposed AMP8 business plans (2025-2030) met with high acceptance by customers, recognising needs for bill increases. This, coupled with more certainty that allowed returns by Ofwat in PR24 would be likely higher than the Final Methodology released last year, given increased bond yields, helped the sector. Additionally, political scrutiny on the sector receded somewhat, with the AMP8 business plans meeting little negative press. UK water companies Pennon (+0.46%) and Severn Trent (+0.27%) were among top individual contributors for the month. Severn Trent also benefited from the clearing of an overhang through a successful equity placement.
Australian toll road operator Transurban (-0.21%) and Japanese rail operator West Japan Railway (-0.20%) were the largest detractors. Transurban owns a suite of intra-urban toll road assets that dominate the Australian toll road network in the three state capital cities on the Eastern Seaboard. Additionally, it has several toll roads in North America, predominantly in the Washington D.C. area. Transurban has a high inverse correlation with Australian interest rates and was negatively impacted by the yield increase during the month.
West Japan Railway (JR West) is one of Japan’s largest passenger railway operators. JR West operates the Shinkansen high-speed rail lines near Kansai, as well as commuter trains within the Osaka metropolitan network. JR West’s share price fell with the large move up in Japanese 10-year bond yields.
With our investment thesis in Italian gas utility Italgas largely played out, and with limited catalysts going forward, we exited our position in the company to create a funding source for other opportunities.
All returns are in local currency.
Despite recent volatility, we are maintaining our defensive positioning as we believe the impacts of tightened financial conditions will eventually affect the economy and ultimately corporate earnings (we are starting to see weakness in earnings from higher interest costs). The Fed and other central banks around the world have to maintain their hawkish position and have started to accept recessionary risks as increasingly likely but necessary to combat the stubbornly high inflation.
Our overarching view is that utilities can handle higher interest rates in the intermediate term. In a slowing growth environment, we believe their predictability of earnings makes utilities attractive compared to general equity sectors where earnings uncertainty results in less confidence among investors and higher volatility.
We think utilities valuations, like infrastructure broadly, are attractive now, and, versus the more optimistic consensus narrative, our contrarian view is that the risks of a recession remain considerable.
Watch Portfolio Manager Nick Langley discuss the drivers of recent listed infrastructure performance and highlight how stabilising real yields and strong company fundamentals are improving the outlook for the asset class.Read full article