Second Quarter Global Listed Infrastructure Product
July 15, 2009
Author(s):
Portfolio Review
Our defensive position was a detractor to performance for the quarter ended June 30, 2009. Given the economic environment, we maintained defensiveness in both utilities and communications. However, during the quarter, the higher beta utility and communications stocks rallied and the more defensive oriented stocks underperformed. Additionally, our underweight in energy was a negative contributor as energy stocks also participated in the rally. The decision to exclude social services from the portfolio contributed to relative performance in the quarter, as that sector underperformed the others. Additionally, we moved from an underweight to an overweight position in the transportation sector which added to performance. From a regional perspective, stock selection in North American energy and utilities companies was a negative contributor to relative performance.
Year to date through June 30, 2009, we are ahead of the benchmark on a gross of fee basis (and essentially flat with the benchmark on a net of fee basis). Stock selection in the transportation and utilities sectors contributed to our relative performance, as did the exclusion of social services. However, the underweight in energy and stock selection in communications offset the positive performance. Looking at regional contributions, stock selection in Europe contributed to relative performance as did our underweight in Asia, which reversed its positive performance in the 4th quarter of 2008 to be the worst performing region for the first half of 2009. Stock selection in North American holdings was a detractor to relative performance.
Market Environment
The rally that began in March 2009 continued throughout most of the second quarter. Sector rotation to higher beta names hurt our performance relative to the broader market, as our defensive stance was unhelpful in the quarter. Also, sectors geared to an economic recovery did well (transportation and energy). The strong second quarter rally essentially wiped out the relative outperformance of the previous nine months that resulted from the defensive positioning of the portfolio. While we have trimmed some of the defensive names in the portfolio, we are somewhat cautious about the sustainability of the market rally.
The infrastructure asset class consists of several non-homogeneous sectors which respond differently to economic cycles. Each exhibits separate and distinct performance behavior, producing varying growth, yield, risk and economic profiles. For any given stage of the economic cycle, there will be divergent performance across the infrastructure sectors and, in some cases, across the underlying companies within each sector. We have the ability and flexibility to position the portfolio based on economic conditions. However, the stage of the economic cycle is only one of the many considerations made when determining portfolio weightings. Our investment philosophy is based on fundamental analysis and the goal is to find the most attractive companies in all sectors, throughout all economic cycles.
Sector Outlook
CommunicationsAs we enter the late stages of the recession, demand for communications services is clearly showing signs of weakness. The enterprise market is being impacted by the high levels of unemployment and will remain soft until a recovery is firmly in place. In the U. S., consumers are replacing their wireline service with wireless service at a rapid pace. The same level of service substitution has not been seen in Europe where wireless is still significantly more expensive than wireline. As a result, wireline service for the integrated European carriers has shown more resiliency than in the U.S., while the opposite is the case for U.S. carriers. The area of most promise in communications continues to be the increased distribution of smart phones (i.e. iPhone, Blackberry, Palm Pre) which is driving higher wireless data usage. This benefits companies with high exposure to wireless services. Despite revenue pressure, cost control measures and reductions in capital expenditures have helped to support free cash flow and dividends. Valuations remain attractive among the companies within the communications sector. However, we currently believe more compelling opportunities exist in utilities and transportation. Thus, we have moved to an equal weight in communications.
Utilities
We continue to favor utilities due to their defensive nature. We have, however, reduced our level of defensiveness as the deceleration of the economy has slowed. In the U.S. the focus is on the potential for Congress to pass legislation aimed at decreasing carbon dioxide emissions and increasing renewable energy production. The House has passed a version and the Senate is currently debating. The Administration is firmly behind the effort, but it is uncertain as to whether a comprehensive bill will be passed this year. The biggest debate is around the carbon dioxide component. The renewable portion appears to be less controversial and it is possible that it may go forward even without the carbon-piece. We are overweight those companies that can capitalize on the trend toward renewable energy. Additionally, we continue to maintain exposure to diversified utilities that have relatively higher betas and should benefit when the economy turns.
Energy
We remain underweight in the more commodity sensitive names, i.e. companies with exploration and production (E&P) operations, making them somewhat susceptible to variations in oil and gas prices. We expect energy fundamentals to remain weak in the near-term as demand is soft due to the economy and supply is in excess due to high inventories and continued production activities. We do have exposure to Canadian-based pipeline owner/operators, which are less commodity oriented. Our holdings have highly visible growth via U.S. and Canadian pipeline projects that will materially add to earnings over the next two to three years.
Transportation
The transportation sector consists of airport services, marine port, and toll road companies. We have moved to an overweight in transportation, specifically the toll roads, as we have seen signs of traffic stabilization. We are still cautious on airport services given continually weak consumer demand. Our only marine port holding has been less impacted by the weakened economy due to the steady demand for its liquid storage and stability provided by its storage contracts.
Past performance is no guarantee of future results. Performance is calculated in US dollars and includes the reinvestment of dividends and other earnings. Indices are not available for direct investment and index returns do not reflect the deduction of any fees. Gross composite returns are net of trading costs. Net composite returns are calculated by subtracting our highest separate account investment management fee from gross composite results on a quarterly basis in arrears. Investment advisory fees are described in Part II of our Form ADV. This material has been prepared using sources of information generally believed to be reliable; however, its accuracy is not guaranteed. Opinions represented are subject to change and should not be considered investment advice or an offer of securities.
Our Composite’s benchmark is the MSCI World Infrastructure Capped Index, a market capitalization index measuring the performance of global listed developed market infrastructure equity securities by capturing broad and diversified investment opportunities across telecommunications, utilities, energy, transportation and social infrastructure sectors. The weights of the telecommunications infrastructure and utilities sectors are each fixed at one-third of the benchmark, and the energy, transportation and social infrastructure sectors have a combined weight of the remaining one-third. Benchmark sector weights are recapped to one-third on a quarterly basis. Due to differing investment characteristics, we do not intend to invest in one sector contained in the benchmark, the social infrastructure sector; this sector comprised less than 5% of the benchmark as of December 31, 2008. The benchmark is a custom index constructed by MSCI. MSCI and the names of all indices are the trademarks of MSCI or its affiliates.
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