Battleground: Infrastructure in post pandemic world
In this article we compare infrastructure heavyweights Magellan and ClearBridge (previously known as RARE Infrastructure) and their strategies. While Magellan and its CEO Hamish Douglass need no introduction, the house’s infrastructure fund is run by Gerald Stack. He joined Magellan in 2007 and is concurrently head of investments, head of infrastructure and portfolio manager; he leads the team responsible for managing Magellan’s infrastructure portfolios and providing research coverage of companies within the infrastructure, transport and industrials sector. Magellan has roughly $100 billion in funds under management.
On the other side, ClearBridge Investments is a global equity manager committed to delivering superior risk-adjusted investment performance. Early this year RARE Infrastructure Limited changed its name to ClearBridge Investments Limited, joining with fellow Franklin Templeton firm ClearBridge Investments LLC, with no change to its investment philosophy or infrastructure team. The infrastructure fund is led by Nick Langley and his team. ClearBridge (US) manages US$177 billion.
A comparison of style
Both strategies seek to build high-conviction portfolios of between 20-40 stocks and deliver stable returns from the growing asset class. Conviction is clearly crucial in what is at times a somewhat concentrated sector, with less than 500 investments in the listed infrastructure universe at any given time. Magellan highlights its “conservative” definition of core infrastructure, seeking to avoid any commodity price risk within its investments. Its primary benchmark is the S&P Global Infrastructure Index, with an additional performance fee measure being the yield of the 10-year Australian government bond, effectively making the strategy an absolute-return focus.
The story is similar for ClearBridge, but with an increased willingness to include both developed and emerging market infrastructure assets and an absolute return benchmark. The fund benchmarks itself against an inflation-plus index, measured as the average inflation of the G7 economies plus 5.5%. This represents the return that many would suggest is required for an investment in listed infrastructure assets, given the perceived risk.
Long-term returns for both strategies have been solid, delivering around 7% per annum over the journey. It is in the short term where their performance has diverged, with ClearBridge doing significantly better in navigating the incredibly difficult period that was 2020. The standout point has likely been ClearBridge’s ability not only to minimise the drawdown in March 2020, but also, to not pivot too heavily to lower-risk assets and miss out on what was a swift recovery.
One of the most important considerations for investors is fees, with both broadly similar, around 1%, in line with the global average and reflecting the significant research required to navigate the sector. That said, Magellan also charges a performance fee of 10% of outperformance over the higher of the S&P Global Infrastructure Index and the 10-year Australian government bond yield, which is currently around 1.60%.
Top holdings and commentary
Not surprisingly, given the concentration of the sector, there are a few overlapping holdings within the top tens, including energy construction group Vinci, but the holdings differentiate quickly after that. Where Magellan holds its largest exposure in toll roads (17%) and integrated power (16%), ClearBridge is focused on electricity distribution (33%) and railroads (12%).
As at the end of February, the fund returned -1.9% for the month, under-performing the MSCI AC World Index, which returned 2.40%. Over the year, the fund lost just 1.1% in value, which was better than the S&P Global Infrastructure Index (which lost 7.1%) but worse than the MSCI AC World Index, which gained 27.2%.
It was a tough month for the team, which underperformed general equities due to the reflation trade, as well as concerns around rising inflation and bond yields. The rotation out of growth and into value caught them by surprise. “Markets were squarely focused on the risks of rising inflation, as vaccine rollouts, significant levels of fiscal stimulus, the Federal Reserve’s change in its inflation targeting methodology and its willingness to let the economy ‘run hot’ have raised expectations for a recovering economy. The result was a rapid increase in 10-year bond yields and market concerns about the risk of breakout inflation that may ultimately impact equity valuations,” ClearBridge said.
Over the year, the sector as a whole was hit hard during the pandemic, after key assets such as toll roads, airports, bridges and all forms of public transport were forced into a deep freeze. The infrastructure sector on average returned -16.43% year to date. On that basis, ClearBridge’s return of -11.40% for the year was a respectable figure.
On all counts, this was a disappointing result from a fund manager that many consider the “top dog.” The poor performance came across the board, with Magellan’s Global Open Class fund also recording its worst year in a decade, and under-performing the MSCI World Ex Australia index.
Most of the outperformance enjoyed during the second half of 2019 was all but given back following the pandemic. The manager was unable to position itself to stem losses, despite saying it was protecting investors on the downside. The under-performance has led to a slashing of performance fees by 70% in the first half of 2021. According to The Australian, Hamish Douglass “rejected criticism of Magellan’s investment strategy and warned that markets have very little margin for error, with mutations of the coronavirus still posing the main risk.”
For the month of February, the fund returned -2.3% which was lower than the S&P Global Infrastructure Index’s -0.5% move. Over the year the result was the same. The fund delivered a loss of -10.1% versus the index’s -7.1%. In a note to clients, UBS said ”Key retail funds continue to deliver soft performance relative to respective benchmarks, and while near-term performance may remain volatile, our concerns now increase around the impact on its long-term track record and potential implications on net flows going forward.”
Magellan is, however, known for its consistent outperformance. If the last two months of last year were removed, Magellan says the performance wasn’t too bad.
All things considered, 2020 was a year like no other, dominated by one thing; COVID-19. Winners of the year were stocks that assisted people during lockdowns and helped defend against the disease. This included companies tied to face masks, e-commerce, buy-now-pay-later platforms and rubber gloves. COVID losers were stocks tied to travel, airlines and REITs, were all but bulldozed. The start of 2021, however, has seen a dramatic fall in the number of COVID-19 cases as vaccines begin to be distributed on a global scale. A rise in bond yields is saying that the end of the downturn is near, and a return to normality is not far.
Many of the unloved, beaten-down value stocks are expected to benefit from this economic recovery. Whether Magellan or ClearBridge RARE, a tilt to infrastructure should pay out handsomely when things turn around in 2021.