351. Where essential services meet investment income

20 March 2025 (pre-recorded 4 March 2025)

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[INTRODUCTION]

Staci West (SW): Welcome back to the Investing on the go podcast brought to you by FundCalibre. This week we break down how essential services like water, energy grids, and transport networks can offer stable returns, inflation protection, and exposure to key global themes in a portfolio.

I’m Staci West and today I’ve been joined by Shane Hurst, co-manager on the FTF ClearBridge Global Infrastructure Income fund. Shane, thank you for joining me today to talk about all things infrastructure.

Shane Hurst (SH): Thank you. Thanks for having me.

[INTERVIEW]

SW: And this is your first time on the podcast. So I want to start with a brief introduction of the fund. So give us a little bit of an overview. What are you trying to achieve with this fund? And what type of infrastructure assets are you actually investing in?

SH: Yeah, so what we’re trying to achieve is outperformance of G7 inflation, plus 5.5% through the cycle. Our target is to really hit a 5% dividend yield with growth within the strategy. We only invest in global listed infrastructure. The portfolio itself is anywhere from 30 to 60 stocks. And ultimately what we’re trying to get to is kinda the benefits and those key characteristics of infrastructure being extracted out of those listed companies. And that really allows a portfolio to be more diversified.

Obviously have an inflation hedge, which infrastructure is very unique in the way it offers that good downside protection, and then exposure to some very, very attractive themes currently permeating through the infrastructure sector.

SW: And then what encompasses your definition of infrastructure? I’m picturing airports and toll roads and all the traditional, but is there anything else alongside of it that kind of falls into your definition?

SH: Yeah, really good question. Look for us we do have a strict definition. So on one side you have regulated utilities, whether they be electric, gas, water, utilities and they’re very much essential service monopoly type assets. You earn a regulated return off a regulated asset base. And on the other side, to your point those types of infrastructure assets, so your airports, roads, your rail assets, your ports which are more GDP sensitive, but nonetheless you have great certainty of of cash flows going forward.

I’d say what’s really important about our process more than what we do invest in is what we don’t because there’s a lot of, shall we say, infrastructure wannabes out there <laugh> that have volatile cash flows exposure to commodity prices, maybe advisory businesses, which aren’t what we would call core infrastructure. And so wouldn’t deliver that very stable risk adjusted return that we hope to deliver for our investors going forward.

SW: And you mentioned utilities there. [SH: Yeah.] So I want to pick on water, which you mentioned. [SH: Okay. Yeah.] So what makes up water infrastructure? Is it just a traditional water company? Like in the UK, we would have Thames Water, for example? [SH: Yeah.] Or is it also a waste management company? Is it a mix? Is it a combination? What is the appeal of kind of water as a utility?

SH: So you  are right. It’s not well known and it tends to be a mix of both. For us really the two areas, the two regions we would invest in water utilities would be the US and the UK.

UK water utilities have some of the best regulation in the world. I mean, most people in the UK obviously hate their water utility, which is fair enough because it obviously leads to higher and higher rates. But as an investor in those utilities, you have a huge amount of certainty. And the reason you do is because they’re absolutely essential to supplying water to a consumer. And they are monopoly assets.

So what do they deliver for us as an investor? Well, now they have certainty post a recent final decision late last year. Their assets are growing at six to 10% per annum. Which if you think about a regulated asset, that means they literally take that investment, put it into an asset base, and you earn a regulated, very stable return off it. So that’s very attractive.

And then importantly, for most investors, they deliver a dividend yield of over 5% growing at inflation. So you don’t have to do a lot to earn a reasonable return off of UK water assets. And for us in the listed world is some of the best water utilities in the UK, not Thames, which is probably the worst <laugh>. Some of the better ones, Severn Trent or United Utilities are the listed ones. And, you know, our largest position in UK water utilities is Severn Trent.

SW: And then what about US? What kind of companies in the US are appealing?

SH: Yeah, so US water utilities really there are two main ones that are large enough for us to invest in because we need the liquidity to kind of move in and out of these companies. American Water is one of them. Probably the purest exposure. And then essential utilities is the other one.

American Water is really interesting because unlike Severn Trent, that just really satisfies a specific area in the UK. American water really invests all around the country in all different jurisdictions. So it’s very much a diversified water utility. But nonetheless does demonstrate though that same kind of growth in asset base, that same very, you know, attractive characteristic that all water utilities invest in, or sorry exhibit because they are essential services.

SW: And sticking slightly with the utilities, which I’ve seen to pick on a bit, is electric exposure? [SH: Yeah.] Because once again, is the exposure in the fund to these electric companies that you might, you know, be your household suppliers? [SH: Yeah.] Is it a longer theme to the energy transition, for example? Again, maybe it’s a combination of both or something entirely, entirely different, because it’s a good allocation to this fund.

SH: So it’s our largest, yeah absolutely.

SW: What actually, when you get into that section of the fund, are you investing in?

SH: Yeah. So look electric utilities are probably the best place they’ve ever been. And you’re absolutely right. It’s, our largest exposure within the strategy. And so why is it so attractive right now? You are right. You know, decarbonisation, as much as the Donald Trump is a hater of what seems to be renewables in the US, you will still continue to see electrification.

You’ll continue to see, which is, sorry, just to explain what electrification is. It’s basically moving from fossil fuel dependence to electricity. And that electricity over time will be far more renewable and far less driven by fossil fuels. So that growth in electrification is a big positive for utilities who invest along that theme. You know, other areas like AI are very potent growth engines for electric utilities.

Just to give you a great example if you go back 20 years or even 10 years the demand for electricity was quite flat. If you look at expectations according to companies like McKinsey’s, over the next five to six years, you are gonna see data centres drive electricity growth to those data centres at 20% per annum. So, you know, that is leading to greater amounts of investment for our regulated utilities.

And then you have other areas like reshoring, so obviously post Covid, a lot of companies moved their infrastructure from places like Mexico back to the US to shorten their supply chains. And then obviously climate changes has led to the need to spend on resiliency CapEx. And so what is that? Well, basically if you have a wildfire, if you have a storm there are certain networks that are more exposed to be damaged. Resiliency CapEx is basically strengthening those grids, building them so that they can withstand five withstand storms. And again, that’s another massive boom for electric utility.

So what does it ultimately mean if I boil it right down?

Well, it means their asset bases, their earnings, their cash flows previously may have been growing at kind of low single digits anywhere from, you know, three to 5% per annum in terms of earnings or EPS growth as they call it in the US. And really around the world, to be honest, <laugh>. But going forward that EPS growth could be up at 10, 11, 12%. So that leads to greater shareholder returns, greater growth in dividends and ultimately for us hopefully you know, appreciation in share prices.

SW: And do you think this is going to be even a bigger part of the portfolio potentially going forward? You just listed so many different areas, <laugh>. [SH: Yeah.] I’m thinking most notably probably for people listening AI and technology. [SH: Yeah.] And all of the need for the infrastructure that goes with that. [SH: Yeah.] Including the electrics. Do you actually think that that is going to become a bigger, even bigger part of this portfolio?

SH: Maybe, maybe over time? It is a very large part of the portfolio and there are a number of other things within the portfolio that generate very attractive returns. And we obviously needed diversified portfolio. You can’t put all your eggs in one basket. But certainly there are still substantial opportunities that are changing. We have moved some of our US exposure, which was a very large component to Europe because you are seeing a lot of benefits coming through in Europe, but at more attractive valuations, right? So that’s really where the shifts occurring. I think the ability to have much more and electric would just skew it away from that diversified portfolio that we’d like to run so we can deliver those stable returns and dividends through the cycle.

SW: And we’ve talked now two utility examples, really. So let’s have a little example of that breadth and depth of diversification in the portfolio. So what is a kind of third area that you maybe would highlight for our listeners as a good example of that diversification that you mentioned?

SH: Yeah, so look, you know, we have talked about utilities a lot, why don’t we talk about airports briefly. Last year we increased our weight in airports overall really three main airports occupy our portfolio. ADP or airport de Paris people would be quite familiar with Paris and Paris and that will benefit as we see traffic pick up especially from areas like China. And around the world we have seen a recovery of that traffic. But that’s going to continue. In the case of airport Paris Aina, which is a Spanish airport group we own within the portfolio. And they’re gonna see improving retail trends within their retail business. And then finally Fraport, which is Frankfurt Airport, they also earn some other airports. But, you know, Fraport is an interesting one because you’re seeing a classic cash flow inflection. And that’s likely to occur in 2026.

And again, what does that mean? Well, it means you should see these businesses be able to pay dividends and obviously be able to fund their capital growth going forward in a more efficient way. So yeah, airports themselves are a very attractive sector.

One area I didn’t mention in but is has really increased in our portfolio over the last year is pipelines. These are the pipelines, the long haul pipelines that will transport oil and gas. Now we only invest in regulated or contracted pipelines, but they are seeing a huge growth. And there’s kind of two main reasons.

The first is because people thought gas as a transition fuel was gonna be short, right? I mean, they thought you could build out renewables and that could fill the gap. And clearly it can’t the way grids work, you need that stabilising factor. And so that has helped valuations. But the other area is, if you are seeing electricity growth in places like the US or around the world, the only thing people can build apart from renewables really in short time is gas fire generation, which means you have an increased demand for gas, gas infrastructure and that’s how it’s benefiting pipeline. So that’s another area of the portfolio that we think is very attractive right now.

SW: That’s interesting. We have really up to now focused on US and UK. Is that where the bulk of this remit of this fund, is this developed markets or can you go into emerging markets? Or is there not opportunity?

SH: Yeah, so look, we didn’t talk about Europe, but we have a large exposure in Europe as well. And I’d say most of our allocation is Europe, UK and North America.

Can we go into emerging markets? Yes. Our current holdings are less than 5% currently in emerging markets, they have been higher. Most of our exposures tend to be in South America, Brazil in particular because their regulation is just very, very good. And in Mexico, because they have a number of airports that are very high quality.

I’d say, why do we not own more in those areas? Frankly, we are getting very attractive returns in developed market markets. And when you think about the risk adjusted returns that we are getting, they are very, very attractive. So if you have a choice of a more attractive risk adjusted return in a developed market versus an emerging market return that may be higher risk really you’d go for the developed market likely all time, and that’s what we’ve seen over the last few years. So could that change over time? Absolutely. Has it changed? Absolutely. And at the moment we are getting very attractive returns in developed markets.

SW: And we did briefly mention Trump. [SH: Yeah.] And I’m gonna circle back to that briefly if I may. [SH: Yeah.] And do you, when you are looking at Trump coming in and you mentioned, when we talked about electrification and energy transition, but how much do the potential policy changes coming in from any new president, whether it be Trump or anyone, you know, taking into account politics. How does that play into this fund? Because a lot of infrastructure spending, especially in the US is, can be dictated by who is in the White House. And is that something that you need to consider when you’re looking at companies?

SH: Yeah, we certainly do. I think honestly that’s a bit of a misconception. [SW: Okay.] And the reason it’s a misconception is in terms of regulatory spend for our utilities, it’s mostly dictated by the states. So if you are a regulated utility in let’s pick a state, California or Louisiana, their local commission dictates how your investment path is gonna look going forward. So I think that’s an important distinction. And honestly, I mean, no one knows that unless you’re a specialist investor in space, which is what we are.

SW: I’m an American and I didn’t know that!

SH: <laugh> There you go.

SW: Learn something new every day.

SH: You learn something new every day. So that is absolutely important to understand the dynamic of utilities and why nothing’s changed really at the larger level. Now, obviously he does have influence over certain policies. [SW: Yeah.] And that can at the margin create noise and tension and different direction of investment.

So let’s look at, you know, what Trump’s doing for infrastructure positive and negative. Look, he will stimulate the US economy. He’s gonna extend tax cuts. That’s a benefit for a regulated utility because their area then grows more and obviously they earn good returns off that they invest more, et cetera. He’s imposing tariffs left, right, and centre. Where do you want to be when that happens? Where you wanna be in the safety of a domestic regulated utility? So realistically, it’s some of the best places to be are in our assets.

Now, the impact for us from the tariffs will be through our pipelines that I just talked about, where if you are gonna tax or if you’re gonna tariff oil coming in from Canada and 60% of your imports of oil come from Canada it means what’s likely going to happen is you as a consumer are just gonna pay more at the pump when you fill your car up because of the tariffs. But that could be impacted.

And I think the other area is rail companies. So again, if you think about US rail companies, they haul goods around the country that changes directions as you impose tariffs. So there are two impacts.

Look, the final one, which most people kind of gravitate to is, doesn’t Trump hate renewable assets? And it’s a very nuanced answer, right? And the reason it’s nuanced is that he hates anything that is not important to his overall agenda. And some renewables are very important, right? And again, and this is a misconception, right? Offshore wind, he hates and he doesn’t care about. And honestly we invest very little in offshore wind and it’s not very economic, right? So again, that’s an easy thing to to hate when you think about wind and solar on shore. So, you know, you see your solar farms and your wind farms on shore and you think about why he doesn’t hate it and, and why he’s been quite quiet on the incentives for those assets over 80% of the benefit of the IRA, the inflation reduction act, that was put in place by Biden has actually gone to red states. Which means that when you think about what’s happened over the last 12 months, you have, 18 to 20 as an example, house members stand up and go, hey, we support the IRA and these are Republican house members.

You think about his other objective, and this is very clear, he wants to be the leader in AI, you know, Stargate, the $500 billion investment in AI infrastructure. How do you satisfy that growth in electricity demand? Well, it’s not gonna be through coal because everyone’s retiring coal in the US, nuclear plants are about 20% of the US grid. But you take a step back and if you wanna build a new nuclear plant, it takes 15, 20 years, even in a small modular reactor won’t be in place for another 10 years. So you really only have kind of two big buckets. The first is renewables and the other is gas.

Now, we talked about gas, but what does that mean for renewables? It means he needs to continue to incentivise renewables to be built because they’re pretty much the only things that can be built right now in that fast pace to satisfy that electricity demand. So again, just to recap, when you take a step back, net net he’ll probably be a positive for the sector, which is a lot better than you can say for many other sectors.

SW: And probably not something that I would instinctually say either off the top of my head when saying positives of Trump.

SH: Yeah, absolutely. Absolutely.

SW: So, right. Okay. Well before we go down the rabbit hole of politics, which is not the aim of this podcast at all. [SH: Definitely.] It would be remiss if I didn’t mention interest rates. [SH: Yeah.] So interest rates, as many of our listeners will know, have been a headwind for infrastructure in recent years but is this picture improving, in your opinion? What are kind of the risks that investors should be aware of with this sector?

SH: Yeah, so look, I mean, there’s no doubt if you look at 2022/2023 rates moved up and that was very noisy for infrastructure. Now, again, as a pure infrastructure investor, I was gonna say zealot, but let’s not say zealot. As an infrastructure investor I’m not scared of rates moving up because inflation gets passed through. Growth is actually a benefit, right? So it’s not scary for me, but obviously there are some valuation impacts that people are concerned about in the market.

So as they move up, obviously people by and large want to invest in kind of higher risk industrial stocks away from the safety of infrastructure. So people obviously, you know, infrastructure to your point, it underperformed over the last couple of years now, I’d say what we’ve seen now and what we’re seeing going forward, central banks around the world are either on hold or cutting rates. So that is obviously a positive for rates and for bond yields.

Bond yields are likely range bound in our opinion. So you’ve seen them, you know, in the US kind of trend in like a four-ish to 4.7, 4.8 range. We think that will continue going forward. And so with that backdrop with the themes we talked about and just the attractiveness of those themes, and then valuation support, which is, valuations look very attractive in the space at the moment. We think it’s actually a very positive environment to invest in infrastructure stocks.

SW: And we have talked about a range of themes today. [SH: Yeah.] So final words. [SH: Okay.] I’m going to ask you to narrow it down. [SH: Okay.] Where do you think that the best long-term opportunities are going to be?

SH: Okay, so clearly those themes, AI, decarbonisation and the CapEx super cycle are the key themes and they will benefit mostly utilities, right? And so we think utilities in general are in the sweetest spot there’ve been I would say for the last 40, 50 years. So that would be a very attractive area to invest in and certainly why we have such high allocations there.

I think thematically you are seeing you know, pipelines benefit from that as we talked about as there is a structural increased demand for gas and that’s not going to abate anytime soon, especially in the US. And then you have idiosyncratic parts of the portfolio. You know, we talked about airports as being attractive.

We didn’t talk about toll roads, but toll roads are also quite attractive long term concession businesses. There’s a company by the name of a PA Pipe which an Australian pipeline company that is going through structural change, right? Previously they were far more highly geared, not a lot of transparency on their dividend policy and their investment policy. They’ve taken a very conservative approach and structurally they’ve changed their business going forward. So there are all these different opportunities within the portfolios.

So we are really excited about the value within the portfolio. We’re really excited about the macro environment and those themes. And as an infrastructure investor, it’s a great place to be. We don’t mind being the underdog frankly, and people thinking it’s not a great place to be because that is generally an investing where you wanna be is the place where no one wants to be right at that moment. And for us, everything’s lined up, the macro valuation and the themes.

SW: Well, on that note, I’m gonna leave it there. <Laugh> That was absolutely fantastic. [SH: Great. Thank you.] It was really interesting.

SH: Awesome. Thank you for your time.

SW: FTF ClearBridge Global Infrastructure Income is a high yielding listed infrastructure fund managed by a team of sector specialists. The fund is designed to provide a good income with stable growth and some inflation protection. To learn more about the FTF ClearBridge Global Infrastructure Income fund visit fundcalibre.com – and don’t forget to subscribe to the Investing on the go podcast, available wherever you get your podcasts.