Investors seeking to grow and maintain their income in an era of rising inflation and yields may wish to consider listed infrastructure companies, according to ClearBridge’s Shane Hurst.
Hurst, manager of the £851m Legg Mason IF ClearBridge Global Infrastructure Income fund, says that when inflation starts to bite, infrastructure assets can simply pass it along to their users through price increases.
He highlighted Australian-listed toll road company Transurban as an example.
“They annually increase their tolls by a measure of inflation,” he said. “It's not always exactly inflation, but a measure of inflation.
“If you look at a company like a UK water utility, they actually adjust it through their asset base. If you look at Crown Castle, which is an owner of communications towers in the US, their contracts – 25-year contracts – basically inflate every single year.
“I always find it curious when people get fixated on inflation as it relates to infrastructure, because it is a pretty clean pass-through.”
Rising inflation in developed markets tends to be accompanied by rising growth. Hurst said this is positive for infrastructure and utility companies – because of more traffic on roads and through airports, and in the case of utilities, more capital to spend and expand.
“For us, it is really a fantastic inflation hedge,” he said. “When we tested it, we went back over 30 years and found there really is no correlation between movements up and down in inflation and the movements of listed infrastructure.”
One possible threat to income-seeking investors is that central banks hike interest rates – an eventuality that seems to be drawing closer as the economy recovers.
But before central banks raise rates, bond yields will likely move up.
Hurst explained: “Bond yields now sit at 1.35 per cent, but as you start to reduce tapering – possibly towards the end of the year – what you'll likely see is bond yields moving up.
“They'll probably continue to move up until you hit that point where people believe they have factored in growth and inflation expectations.
“As bond yields move up, what you tend to see in the earlier part of the cycle or the mid part of the cycle is utilities perform worse than broader equities.”
He said this is because these utilities companies are perceived as far more defensive, and investors typically want higher growth exposure at the beginning of the cycle.
On the other hand, Hurst pointed out that toll roads, airports, ports and rail all tend to perform as well as equities – and sometimes better – because they are geared to GDP growth.
He said this contrast in performance between different types of infrastructure companies provides something of a hedge against rising interest rates.
Hurst also pointed out his infrastructure fund is regionally diversified: “We have exposures to the US, Europe, Australia, emerging markets, and we are diversified by sector and asset class.
“What that means is you're exposed to different cycles at different times, so while bond yields for example may be rising in the US, they could be falling elsewhere.”
Hurst has tilted his portfolio away from utilities and towards roads, rail and other GDP-sensitive areas, which do better in rising bond-yield environments. However, almost half of its top-10 positions are still in utilities, as in these cases he has found “extreme dislocation”.
“That's what we've done at the moment with some of our US utility exposures which have some very strong idiosyncratic drivers, but have been sold off into larger amounts,” he revealed.
“We believe the market has overly discounted these and when you hit that point of bond-yield rises slowing, these stocks tend to perform better after that for six, 12, 24 months.”
The five FE fundinfo Crown-rated Legg Mason IF ClearBridge Global Infrastructure Income fund has delivered a total return of 55.5 per cent since launch in July 2016, compared with 55.29 per cent from the IA Global Equity Income sector.
Performance of the fund since launch
Source: FE Analytics
It currently yields 5.38 per cent and has an ongoing charges figure (OCF) of 0.85 per cent.