Income Strategy September Commentary

Overview

General equities performed strongly during the quarter, supported by ongoing policy stimulus and an improved economic outlook. Our Global Listed Infrastructure funds underperformed general equities during this period but outperformed most key benchmarks.
Economic data continued to show signs of a strong rebound from the COVID-19-induced lows of the second quarter, albeit the rebound moderated. COVID-19 infections continued to spread in many regions, resulting in targeted changes to mobility restrictions, particularly in the U.S. and emerging markets and more recently Europe. As such, market expectations for a V-shaped economic recovery tempered during the quarter. Government stimulus was further extended in many regions, including the landmark €750bn European Recovery Fund. Stimulus, easy monetary policy, expectations of bond rates remaining low for a significant period and positive news flow around vaccine development all combined to support financial markets. Concerns around rising inflation risk continued given the accommodative monetary policy but is offset by the significant economic slack globally.
Political relations, particularly related to China, continued to deteriorate, whilst Biden remained the favourite to win the U.S. presidential election. The global commitment to decarbonisation gained further momentum with Biden’s climate change policies, which includes a proposed $2 trillion green stimulus plan over 4 years, Europe’s enhanced carbon reduction target of 55% by 2030 and China’s pledge of net-zero by 2060.

Portfolio Performance

On a regional basis, North America was the top contributor to quarterly performance (+4.51%), of which Canadian renewables utility Brookfield Renewable Partners (+1.75%), U.S. renewables utilities NextEra Energy Partners (+1.01%) and Clearway Energy (+0.75%) were the lead performers.

Brookfield Renewable Partners (BEP) is a pure-play renewables operator and developer headquartered in Canada, focused on international hydro, solar, wind and storage technology. The investment community continues to support the renewables theme and recognises BEP as a leader in the space. Additionally, BEP’s investor day was well-received, with the company guiding to double-digit funds from operations growth outlook through 2025, driven by a combination of a robust development backlog, and some acquisitions.

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 dropdown of assets from NEE and we anticipate this should allow NEP to provide 12%–15% annual dividend growth to 2024. NEP did well during the quarter due to the improved possibility of Joe Biden winning the U.S. presidential election. If he is elected, the outlook for renewables growth improves further. This will enable NEP to continue with its impressive annual dividend growth objectives of 12%-15% beyond 2024.

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. Investors have been constructive on growth initiatives Clearway announced earlier this year.

Turning to Asia Pacific, Australian electric utility AusNet Services also performed well, contributing +0.45% to quarterly performance.

AusNet Services (AST) owns and operates energy infrastructure in Australia, including the electricity transmission network in Victoria, an electricity distribution network that delivers electricity to over 720,000 consumer connection points in Eastern Victoria and a gas distribution network that delivers natural gas to about 700,000 consumer connection points in Central and Western Victoria. AusNet’s share price increased during the quarter as the market began to appreciate its cost efficiency and transmission capex opportunities, and the stock recovered following a period of weakness after it rebased its dividend in May 2020.

Chilean water company Aguas Andinas was the largest detractor from quarterly performance (-0.58%).

Aguas Andinas is a South American water company that supplies drinking water and provides sewerage and treatment services to residential, commercial and industrial customers in Chile. Volumes have been impacted from the pandemic due to restrictions and the economic fallout as a result, as well as Chile suffering from a severe drought. In addition, civil unrest continues following mass protests in 2019.

All returns are in local currency.

Positioning and Outlook

On a regional level, the Strategy’s largest exposure is in the U.S. & Canada (38%) and consists of exposure to utilities (36%) and economically sensitive sectors (2%).

For the RARE Infrastructure Income Strategy, the primary quantitative tool in portfolio construction is excess return, on which RARE’s stock-ranking system is based. The RARE Income Strategy also uses yield quality as a secondary measure.

As such, driven by valuation, the Investment Committee initiated positions in U.S. electric utilities Southern Company and Public Services Enterprise Group.

The fund also used the opportunity to crystallise some gains by exiting holdings U.K. water company Pennon and Canadian electric utility Hydro One. The fund also exited out of U.S. electric utility CenterPoint Energy and Chinese port operator China Merchants Port Holdings.

Quarterly Stock Highlight

This quarter we review U.S. electric utility Duke Energy.

Duke Energy (DUK) is among the largest electric power companies in the U.S., serving approximately 7.2 million customers in the Carolinas, the Midwest and Florida, as well as natural gas distribution services in Ohio and Kentucky. DUK’s commercial business is invested in renewable generation.

DUK’s tariffs/revenues are regulated by its respective state utility commissions and its electric transmission assets are regulated by the Federal Energy Regulatory Commission (FERC).

DUK is a discounted U.S. regulated utility, as the market is cautious about upcoming regulatory events, such as rate cases in North Carolina. We believe resolutions on these risks, combined with its recent $2.5 billion equity issuance in the fourth quarter of 2019, will enable DUK to achieve its targeted 4%–6% annual EPS growth target through 2022.

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