Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
A Q&A with RARE Infrastructure – Following a volatile year
Traditional infrastructure has been impacted heavily during the pandemic as human movement is restricted to all but its basic levels. The RARE Income Fund has been the standout performer within the Infrastructure fund peer group, due to its high weighting in defensive utility assets. We took the opportunity to digest RARE Infrastructure’s latest portfolio insights to gain a better understanding on how the sector has evolved.
- What were the biggest contributors in Q2 and how is the portfolio positioned post COVID-19?
Overall, we continue to position the portfolio with a bias towards more defensive utility assets which have a narrower range of return outcomes and visible cash flow profiles underpinning future dividends.
The top contributors to Quarterly Performance
| Stock Name | Contribution | End | Sector | Country |
| Nextera Energy Partners | +106bps | 5.2% | Contracted renewables | USA |
| Clearway Energy | +98bps | 4.4% | Contracted renewables | USA |
| TerraForm Power | +79bps | 4.1% | Contracted renewables | USA |
| Transurban | +66bps | 4.2% | Toll Roads | Aust |
| Dominion Energy | +66bps | 4.2% | Electric | USA |
| Past performance is not a reliable indicator of future results |
Source: RARE Infrastructure Income Representative Mandate. Data as at 30 June 2020. All returns are in local currency.
Contracted renewables were the strongest contributor to returns (+330bps) followed by electric utilities (+266bps) and North American midstream (+158bps)
- Can you provide some insight into the apparent overweight to contracted renewable infrastructure assets?
NextEra Energy Partners (NEP) is a market leader in renewable energy throughout the US. It is expected to be a beneficiary of clean energy transition in the US, with large expected growth from increasing penetration of renewable energy to the overall energy mix.
NEP’s portfolio consists of wind, solar and natural gas pipeline assets. The weighted average contract duration is approximately 20 years. Growth comes from dropdown of assets from its sponsor and general partner, NextEra Energy (NEE) and we anticipate this should allow NEP to provide12-15% dividend growth to 2024.
Clearway Energy primarily owns and operates contracted renewable generation assets in the US, with a portfolio consisting of wind, solar, thermal generation and natural gas pipeline assets. These assets operate under long-term PPA contracts providing stable and predictable cash flows. Clearway’s parent company, GIP, has a development pipeline spanning 9GW, providing additional growth optionality.
Energias de Portugal (EDP) is an integrated utility based in Iberia, operating electricity distribution, generation, and an energy supply business. It has a growing exposure to global renewables, through its 83%-owned subsidiary EDPR, mostly being onshore wind farms, and operates electricity distribution and generation businesses in Brazil through its 50%-owned EDP Brasil. We estimate quasi-regulated renewables to represent around two-thirds of the total value of EDP, while the regulated Iberian networks represent c.10%. The renewables projects are mostly contracted and supported by tariff subsidy or green certificate mechanisms, underpinned by PPA agreements.
- US energy infrastructure and global toll roads seemed to recover, what is your current view?
North American midstream names Williams Companies, AltaGas and Gibson Energy all bounced from oversold levels at the end of Q1. The IC took the opportunity to sell out of its AltaGas exposure. Given the Team’s views of the impact of ESG and sustainability considerations on future cash flows and ultimately valuations, weight to North American midstream continued to decline over Q2, ending at 4.8%.
The view for Toll Roads on the other hand was that as restrictions on the movement of people were eased, Toll Roads would be amongst the first sectors to benefit. Social distancing challenges on public transport would likely see an increase in commuter traffic. The Strategy holds both Transurban and Atlas Arteria combined at 5.1% weight and both were up strongly for the quarter.
Transurban (TCL) owns a suite of intra-urban toll road assets that dominate the Australian toll road network in the three-state capital cities on the eastern seaboard. Additionally, they have several toll roads in North America, predominantly the Washington DC area of Virginia, USA. Transurban’s share price performed strongly during the quarter as mobility restrictions eased, allowing traffic to return to Transurban’s toll roads.
What were the largest detractors from performance during the quarter?
| Stock Name | Contribution | End Weight | Sector | Country |
| Emera | -8bps | 3.5% | Electric | Canada |
| Eutelsat | -4bps | 0.3% | Comms | Europe |
| United Utilities | 2.0% | Water | UK | |
| Sydney Airport | 1.2% | Airports | Australia | |
| Edison International | +1bps | 2.5% | Electric | USA |
| Past performance is not a reliable indicator of future results |
Source: RARE Infrastructure Income Representative Mandate. Data as at 30 June 2020. All returns are in local currency.
There were only two companies which detracted a combined -12bps for the quarter.
- Can you discuss two companies that have driven 2020 performance?
Emera is a listed Canadian utility that generates 95% of its earnings from its regulated operations in Florida and Nova Scotia. There were no material announcements during Q2 with the stock only down marginally.
United Utilities (UU) is the largest listed water company in the UK, managing the regulated water and wastewater network in the northwest of England. In late May, the company prudently announced that the dividend policy for the next five years was under review due to economic uncertainties around the COVID-19 pandemic.
- Edison International didn’t seem to ride the recovery, why did is underperform during Q2?
EIX is the parent company of Southern California Edison (SCE), one of the largest electric utilities in the United States and Edison Energy, a non-regulated energy services company. SCE serves more than 14 million people in California.
The share price of Edison fell during the quarter as peer PG&E’s post-bankruptcy equity raise was an overhang for Edison shares. A top-up to the position contributed positively ensuring the overall performance contribution was a small positive. EIX is a solid regulated utility, operating in a favourable state regulatory environment. We believe Edison International is poised for a turnaround following the various wildfire mitigation measures put in place in the recent years including California legislation AB1054 passed in 2019.
- What changes occurred during the quarter?
The Investment Committee was active during the quarter, exiting AltasGas as well as Atlantica Yield and cutting exposure to United Utilities which had held up well during Q1 and EDP. This funded the increase in Latam, including a new position in CTEEP which is one of the leading regulated electric power transmission concessionaires in Brazil. Also increased were positions in US companies EIX (as mentioned), utility Duke Energy and contracted renewable company Clearway Energy, as well as Italgas (IG) which is an Italian regulated utility that is engaged in the distribution of natural gas in Italy.
