Fourth Quarter Global Listed Infrastructure Portfolio Review
January 15, 2010
Author(s):
Portfolio Review
For the quarter ended December 31, 2009, our Composite posted a positive absolute return and outperformed the benchmark on both a gross and net of fee basis. Stock selection across all four sectors was the primary reason for relative outperformance, with utilities and transportation leading the way. A bounce in some defensive utility names that had underperformed in previous quarters helped this quarter. Transportation’s relative outperformance benefitted as much from names not held in the portfolio as those that were owned. Our decision to exclude social services from the portfolio again contributed to relative performance as that sector underperformed the others. Regionally, stock selection in North America and Asia helped relative performance, driven by transportation in Asia and energy, communications and utilities in North America.
The very strong relative performance in the fourth quarter resulted in the Composite’s outperformance versus the benchmark for the year ended December 31, 2009 on both a gross and net of fee basis. Stock selection and an overweight in transportation contributed positively to relative performance, as did the lack of social services in the portfolio. The underweight in energy and stock selection in communications detracted from relative performance for the year. From a regional perspective, the underweight in Asia was a contributor to performance as that region underperformed Europe and North America. Additionally, stock selection and an overweight in North America added to the outperformance for the year.
Market Environment
The portfolio outperformed the broader U.S. equity market1 in the 4Q09, as all four infrastructure sectors posted positive returns. Energy and transportation continued to rally as the economic outlook improved. Communications and utilities benefited as the year-end approached and investors sought to lock in gains with a move to more defensive names. For the year, the powerful rebound in the broader U.S. equity market, lead by high beta names, outpaced the portfolio’s high-quality, low-risk positioning. Sectors geared to an economic recovery (transportation and energy) performed very well, while the defensiveness of utilities was out of favor for a large part of the year.
As a new year begins, we continue to believe that an investment in infrastructure may help to provide both stability and resilience within a diversified portfolio throughout all phases of the economic cycle. Our investment strategy is to buy high-quality companies that are owners and operators of infrastructure. These companies are well-established and financially strong, providing essential services and assets to society, with low levels of revenue variability. Many of the infrastructure companies have long-term contracts with inflation protection, stable cash flow and above average yields. These attributes tend to provide lower levels of risk and volatility than the broader equity market—in other words, a rather bond-like investment but with an equity component. Add in some attractive growth opportunities across the infrastructure sectors and we believe infrastructure should be a core portfolio holding due to its relative stability, growth potential and attractive income component.
Below we discuss our outlook for the sectors within the portfolio.
Sector Outlook
Communications—We remain slightly overweight communications due to attractive valuations and yields. Fundamentals are also relatively stable with some upside potential in the enterprise market as the economy strengthens and companies begin hiring again. The area of most promise in communications continues to be the increased distribution of smart phones (i.e. iPhone, Blackberry, Droid) which is driving higher wireless data usage. This benefits companies with high exposure to wireless services, which has resulted in a significant overweight in the tower companies.
Utilities—We remain underweight utilities given concerns about an environment of weak power prices and increasing uncertainties. We have reduced our integrated European utilities positions as they tend to have greater sensitivity to power prices. We have also reduced weightings in U.S.-based integrated names, giving preference to distribution utilities that operate in regulatory jurisdictions that have exhibited reasonable policies. Within certain States, regulators remain supportive of capital spending related to renewable energy and smart grid investments. We also favor electricity transmission businesses, as there is clearly a global need for more transmission facilities, with governments and regulators supporting the projects. Comprehensive carbon dioxide emission legislation now seems unlikely in the U.S. As a result, we expect greater EPA scrutiny and continued uncertainty for coal-based generation, with natural gas being the fuel of choice.
Energy—We are slightly underweight on energy. We like the dynamics of the business going forward as natural gas is expected to play an increasingly important role in the North American energy market. The pipeline companies are able to grow earnings as they build the infrastructure that moves natural gas from several U.S. based shale formations. For the companies with some commodity exposure from exploration and production (E&P) operations, we expect that energy prices may have bottomed out in the near-term. However, fundamentals will remain weak as demand is soft and supply is in excess due to high inventories.
Transportation—We have again increased our weighting in transportation as the economy has shown signs of bottoming out. We remain overweight toll roads and marine ports as we continue to see seen signs of traffic and freight stabilization. We have become somewhat less cautious on airport services as passenger traffic showed signs of stabilizing in the 4Q09. In addition, airports have been able to agree to tariff increases despite a difficult operating environment for the airlines.
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, 2009. The benchmark is a custom index constructed by MSCI. MSCI and the names of all indices are the trademarks of MSCI or its affiliates.
1As measured by the S&P 500 Index
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