Global Listed Infrastructure July 2021 Monthly Commentary

The listed Global Infrastructure Strategy was flat for the month in US$ terms; rose c.2 in A$ as the strategy is unhedged and the A$ fell, and underperformed our preferred index, for the first time in a while. The 10 year-note in the US declined in yield, rose in price, and investors rotated back to ‘growth’ stocks.

In Europe, Nordstream 2, the pipeline to take gas from Russia to Northern Germany, was approved by all, and in Asia, a Covid resurgence and more anti-liberal legislation from the Chinese Communist Party impacted Asian equities quite severely. In the USA an Executive Order signalled that the Surface Transportation Board (STB) would be investigating the Railroad and Shipping industries to prevent and reduce monopolistic power. This affected Norfolk Southern (NSC), Union Pacific (UNP) and to a lesser extent UPS, and FedEx. NSC and UNP both had solid profit results and NSC increased their dividend by 10%, usually a sign of management confidence and a trigger for continued outperformance.

The STB is the agency that allowed the existing US structure in the 1990s, and our guess is that this is a general pronouncement to specifically target a Canadian company’s bid for a US Railroad’s assets – Canadian National and Kansas City Southern – and not the start of a dismantling of the industry structure in general. US domestic maritime shipping is largely governed by the Jones Act which requires goods shipped from one US port to another to be on US built ships and to use US crews. The Jones Act is unlikely to be revoked as it will simply be perceived as an anti-union action.

These stocks had bounced back somewhat by month end and we have reviewed our thesis and remain holders. We don’t have exposure to US maritime shipping companies.

The worst performing stocks were ONEOK, a pipeline company, UPS, AES, the US Electric Utility, and Rubis, the French headquartered energy transport and storage company. The last of these reported slowing volumes in May and blamed Covid. The share price has continued to fall, and the stock is now on a P/E of about 11x and a sustainable dividend yield of about 5%. Notwithstanding political risk from its operations in Africa and the Caribbean, this looks attractive especially as the revenue is based on a ‘pass-through’ model which provide an excellent hedge against rising commodity prices. We’ll hold and probably add to the active position vs the benchmark.

We also saw significantly positive returns from Asian stocks such as ENN, China Longyuan Power, Nippon Yusen (again) and Kintetsu World Express. The Chinese market was spooked by comments and regulations on not only the Chinese tech stocks but also private education companies; and yet elsewhere, such as trade, it is open for business and the rhetoric is ‘business as usual’.

For more detailed comments on the situation in China see our Asian Small Cap commentary here https://www.delftpartners.com/news/announcements/asia-small-companies-july-2021-monthly-commentary.html

As for inflation, we say ‘yes, it is here; it never went away if measured properly; is going to be more apparent and harder to conceal and investors should hedge themselves as the new rhetoric from the central bank geniuses that brought you three crashes and unsustainable debt in the last 20 years, is that inflation is good for you’.

Scant statistical evidence exists on the relationship between listed Infrastructure and inflation, if only because there hasn’t been a prolonged period of 3%+ inflation with the existing set of companies in the universe, but we can use sophisticated risk models to help identify if the portfolio and asset class has the required characteristics to perform better than non-Infrastructure stocks when prices in general rise. Initial checks of the risk exposures of the market capitalisation weighted universe versus the general global equity universe, using the Northfield risk model, shows that there is meaningful ACTIVE exposure to the traditional inflation hedges of oil and other commodities.  In other words, infrastructure will probably do better than much else when (shock horror) inflation is on the landing pages of all news websites.

Sentiment is shifting slowly but materially and palpably back to stocks perceived as cheaper and safer. This includes infrastructure companies.

We sold Nippon Gas in the month and reinvested in Kamigumi, a Japanese warehouse and transport logistics business on a P/E of 14x and a yield of 2.5%.

We have just over 50 companies in the portfolio and are spread diversely by sector and geography. Our largest sector underweights are in Telecom stocks including the cell phone tower owners and operators, and our largest overweights are in Utilities, especially gas related, and Energy. Our active risk against the benchmark is about 5% which means we can expect to perform within + / - 5% of the benchmark most of the time on an annual basis. Currently we are adding significant positive return to the benchmarks, so the risk we take is proving successful.

Our trailing 1 year return is about 25% in US$ and an active return of about 10%, so it’s been an exceptionally good period. Longer term we anticipate continued outperformance of both the strategy and the infrastructure asset class.

Delft Partners July 2021