Income Strategy June Commentary

Overview

General equities rebounded strongly during the quarter supported by policy stimulus and the easing of mobility restrictions. Global infrastructure, including our Global Listed Infrastructure funds, underperformed general equities during this exceptionally strong rebound.
During the quarter governments unveiled unprecedented fiscal stimulus aimed to support economies during the coronavirus pandemic. Lockdowns gradually eased during the quarter, although in key geographies such as the U.S., risks of a second wave are increasing, and lockdown measures are beginning to be re-introduced in some regions. The significant fiscal stimulus provided substantial support to equity markets.
Hard data showed meaningful improvements from the rapidly induced coronavirus lows at the start of the quarter. Purchasing manager indexes, retail activity, employment numbers and economic growth showed signs of recovery, although all remained well below pre-COVID-19 levels, keeping economies under stress raising the risk of insolvencies as stimulus is dialled back. Political risk remains elevated as governments attempt to manage the impact of such large synchronous health and economic events.

Portfolio Performance

On a regional basis, North America was the top contributor to quarterly performance (+5.80%), led by U.S. electric utilities NextEra Energy Partners (+1.06%), Clearway Energy (+0.98%), TerraForm Power (+0.79%) and Dominion Energy (+0.66%).

NextEra Energy Partners (NEP) is a growth-oriented contracted renewables company formed by its sponsor and general partner NextEra Energy (NEE) to own, operate and acquire contracted renewable energy generation assets located in North America. Growth comes from the dropdown of assets from NEE and we anticipate this should allow NEP to provide 12%–15% dividend growth to 2024. NEP recovered strongly in the second quarter after selling off significantly more than peers in the first quarter, largely due to liquidity needs, we believe.

Clearway Energy primarily owns and operates contracted renewable generation assets in the U.S. It also owns and operates conventional generation and thermal infrastructure assets. The expectation of PG&E coming out of Chapter 11 and its subsequent release of cash for Clearway’s Californian generation assets, gave the market confidence the company would materially lift their dividend.

TerraForm Power is an owner and operator of contracted and regulated generation assets in the renewables (wind and solar) space. The portfolio of assets TerraForm owns spans North America and Western Europe (primarily Spain). The share price of TerraForm rallied as the company is nearing the close of its acquisition by Brookfield Renewable Partners LP.

Dominion Energy is a high-quality U.S. diversified energy infrastructure company that owns a premium-quality regulated electric company based in Virginia and a growing portfolio of FERC-regulated natural gas transmission assets, state-regulated local gas distribution companies and midstream gathering and processing operations across the Midwest, Eastern and Rockies regions of the U.S. Investor sentiment continues to improve following the passage of Virginia’s Clean Energy legislation, which unlocks multiyear investment opportunities for Dominion’s electric utility subsidiary.

In Asia Pacific, Australian toll road operator Transurban (+0.66%) also contributed to quarterly performance.

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 owns several toll roads in North America, predominantly in the area surrounding Washington, D.C. Transurban’s share price performed strongly during the quarter as mobility restrictions eased, allowing traffic to return to Transurban’s toll roads.

Canadian electric utility Emera was the largest detractor from quarterly performance (-0.08%).

Emera is a listed Canadian utility that generates 95% of its earnings from its regulated operations in Florida and Nova Scotia. The stock was down slightly on general market movement.

All returns are in local currency.

Positioning and Outlook

On a regional level, the Strategy’s largest exposure is in U.S. & Canada (37%) and consists of exposure to utilities (35%) and economically sensitive sectors (2%).

For the Infrastructure Income Strategy, the primary quantitative tool in portfolio construction is Excess Return, on which the stock ranking system is based. The Income Strategy also uses Yield Quality as a secondary measure.

As such, driven by valuation the Investment Committee initiated a position in Brazilian electric utility CTEEP.

The Strategy also used the opportunity to crystallise some gains by exiting holdings in Canadian gas utility AltaGas and U.S. electric utility Atlantica Yield.

Quarterly Stock Highlight

This quarter we review U.S. gas utility Williams Company.

Williams owns and operates natural gas pipelines and associated midstream assets in the United States.

Williams natural gas pipeline and midstream assets are either regulated or under long-term contracts.

The many issues Williams faced have been resolved through recapitalisation, board changes, stabilised volumes and strategic asset sales. Since then, the business has been significantly de-risked. Going forward, we expect the company to generate significant amounts of free cash flow as they have approached the end of their investment cycle. At current prices, the dividend yield is well above peers and valuation is attractive. We believe the market underestimates the value and stability of the free cash flow that underpins the dividend.

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