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Fund in Focus: Global Essential Infrastructure

In this episode of Fund in Focus, investment advisor Nick Peters is joined by Tim Humphreys and Paul Johnston who are the co-fund managers of the Marlborough Global Essential Infrastructure Fund.


Fund in Focus: Global Essential Infrastructure Oct 2023


[00:00:00] Nick Peters: Hi, my name's Nick Peters, investment advisor at Marlborough and welcome to this week's podcast, where I'm joined by Tim Humphreys, fund manager of the Marlborough Global Essential Infrastructure Fund. I also had a chance to catch up with one of Tim's colleagues, Paul Johnston, who co-manages the fund with him.

[00:00:27] Tim, thanks for joining us.

[00:00:28] Tim Humphreys: Absolute pleasure. Nice to be here.

[00:00:30] Nick Peters: First of all, perhaps just introduce Ausbil and the investment team.

[00:00:35] Tim Humphreys: So Ausbil are an Australian based fund manager. We run $16bn, predominantly in Australian equities. We've been around for 27 years, so a very long track record of delivering out performance.

[00:00:48] And the parent company for Ausbil is New York Life Investment Management, so very strong paid parent, run over $650bn in assets under management and a very good company within Ausbil in terms of the location in Australia.

[00:01:04] Nick Peters: And the team that helps you manage the fund?

[00:01:07] Tim Humphreys: We're a team of four people, very experienced in investing and also infrastructure, so we have an average of over 20 years looking and investing in financial markets and an average of 15 years focusing on global listed infrastructure.

[00:01:22] So very deep knowledge of the companies and sectors in which we invest, which we think is crucially important when you're investing in these companies.

[00:01:30] Nick Peters: And now turning to the fund, perhaps just give us an overview of the philosophy and what it's trying to achieve?

[00:01:35] Tim Humphreys: Yeah, definitely. We're trying to achieve a fund that really focuses on the characteristics of infrastructure that we think are most appealing to investors.

[00:01:45] So when people think about infrastructure, they think about companies that deliver very long-term stable cashflow growth, they think about downside protection when markets fall. Particularly today, we're thinking about inflation protection, not only in protecting from inflation, but capturing the benefits of inflation, so that's something else that we're thinking about.

[00:02:06] So the fund that we've built tries to really accentuate and distill the characteristics of infrastructure down into the fund. And we think that's quite differentiated from our peers who tend to have a broader definition of infrastructure and introduce things like cyclicality and also exposure to commodity and power prices, which we think should be left out.

[00:02:29] Nick Peters: And before we sort of dig deeper into the fund, perhaps maybe explain to listeners why infrastructure is such a good diversifier in a multi asset portfolio?

[00:02:39] Tim Humphreys: Well, it's a good diversifier for a number of different reasons and I think one of the key reasons is just that stability of cashflow through an economic cycle.

[00:02:48] So when we look at companies that are regulated, the regulation allows them to grow cashflow, year on year, even when there's an economic crisis. So when we look back to the financial crisis of 2008-2009, we particularly looking for companies that were able to grow their cash flow through that crisis because we think that's a really good template if there is a crisis going forward.

[00:03:13] So that ability to compound positive cash flows year on year and not be significantly impacted by the cyclicality of the broader economy, we think is a crucial benefit because over the longer-term, that really does lead to outside performance in terms of the compounding of positive cash flow growth for the companies and that's one of the key benefits, that we think the fund can bring.

[00:03:38] So when we're talking about a diversified portfolio, these kind of companies also have lower correlation to global equities, so bring in diversification benefits. They have that compounding effect of continual cashflow growth. They have things like inflation protection and they also embed downside protection into the portfolio because they tend to fall less than the broader market when broader markets falls in any given month.

[00:04:05] Nick Peters: You mentioned earlier inflation and maybe let's just probe that one a little more about why infrastructure benefits from rising inflation, but also if inflation was to fall, what impact that would have on the asset class?

[00:04:19] Tim Humphreys: Yeah and it's varied across different stocks and different sectors. You really have to look at each individual company in order to understand the mechanisms of which inflation is protected from.

[00:04:30] So we spend a lot of time looking through the companies, whether it's a toll road, for example, or whether it's a regulated utility or whether it's a mobile phone tower, an airport, for example. And we look through all of the companies in order to understand what the effect of inflation is going to have on the companies.

[00:04:49] And we're particularly looking for companies whereby they can have an explicit means through which to pass on inflation. So if you think about a toll road, in a lot of the toll road concessions around the world, they're allowed to increase the tolls in line with the previous year's inflation.

[00:05:06] It's a very clear mechanism, it's written into the contract, and that's the kind of inflation protection we like, and we look for similar kind of protection across all of the companies.

[00:05:17] But you make a good point in terms of if inflation goes negative and we get deflation, what impact does that have? And we particularly look for, for companies and contracts whereby there's a floor at 0% inflation.

[00:05:31] So it's a ratchet up each year, depending on inflation and if inflation drops into negative, then the tolls don't drop accordingly, they stay flat. So that kind of ratchet up of inflation is particularly attractive for what we're looking for.

[00:05:45] Nick Peters: One of the key differentiators is the essential nature of the assets that you invest in, perhaps just elaborate on what you mean by essential?

[00:05:55] Tim Humphreys: Yeah, it's an important point because we think that's one of our key differentiators in terms of our definition of infrastructure, and there are lots of different definitions of infrastructure out there.

[00:06:05] Whether it's sort of a broader thematic or whether it's just looking at the, the assets and deciding whether those are infrastructure assets or not.

[00:06:13] But for us, it's really looking at the characteristics of companies in terms of the cash flow that they deliver. Do they have a track record of delivering cash flow? Do they have embedded inflation protection built into them? Do they have diversification benefits?

[00:06:28] So essential infrastructure is all about identifying a group of companies that best exhibit the infrastructure characteristics that we think investors are looking for.

[00:06:39] So what that means is there's only about a hundred companies worldwide that fit our definition of essential infrastructure. Things like airports, toll roads, regulated utilities.

[00:06:50] There's a few pipelines around the world that fit our definition as well, and mobile phone towers. So only about a hundred companies worldwide that fits our definition and that predominantly in the developed markets as well.[00:07:02] So you should think of us as a developed market fund focused on essential infrastructure.

[00:07:08] Nick Peters: And you sort of touched on it, but there are a lot of themes that are running in the portfolio and the team is pretty prolific in producing thought pieces or white papers, which our investors find very useful. [00:07:22] One recently was on hydrogen, and I wondered whether you might like to share some of the key points from that paper.

[00:07:29] Tim Humphreys: Absolutely. We think hydrogen is a really exciting technology because when we think about the, the energy transition and moving from fossil fuels to renewable energy, there's one big piece of the puzzle that is missing in terms of the ability to store renewable energy for the longer-term.

[00:07:48] Things like batteries can certainly play a short term role in the storage of energy. But trying to solve the puzzle of what happens if the wind doesn't blow or the sun doesn't shine for a lengthy period of time is one of the biggest puzzles and this is where we think hydrogen can really play a significant role because if you can use excess renewable energy to break down water into hydrogen and oxygen and then you can store the hydrogen and then burn it when you need to generate power.

[00:08:20] Then, that for us is a really good solution because when hydrogen burns, it doesn't create any greenhouse gases, it doesn't create any carbon dioxide, all it creates is H2O, which is, which is water. So it's a very environmental way through which we can store renewable energy and use it when the wind or sun doesn't shine. So this is sort of one of the big areas of investment.

[00:08:42] It's still pretty early days in the hydrogen story. There's hundreds of billions of dollars that are being invested into it, but we think over the longer term that this could provide a key piece in the puzzle to the energy transition.

[00:08:55] Nick Peters: And obviously it's key for sustainability and can you explain how ESG and sustainability works within your fund, having focus on that?

[00:09:05] Tim Humphreys: Yeah, we have ESG and sustainability embedded into our process, it's one of the key pillars of what we look for when we analyze a company.

[00:09:14] So when we're analyzing a company, quality is really important for us. We lead with a very detailed analysis of quality, looking at regulation, looking at the company, looking at the management, looking at the balance sheet.

[00:09:26] The second pillar is ESG and we do a very detailed analysis, not only on the company ESG, but also the sustainability of the industry in which a company operates as well.

[00:09:38] We're looking for companies that do ESG well themselves, but also operate in an industry which has attractive sustainability characteristics, such as renewable energy, for example.

[00:09:49] The final pillar of our analysis is a very long-term cash flow valuation tool. We're looking at cash flows for, for the next 30 years. So that's very different to the broader market who typically use the next year's earnings or profit to value companies.

[00:10:05] So ESG is certainly one of the big pillars that we, we use in our analysis and the way we use it for a valuation creation tool is really to find those companies that are improving their ESG credentials over time, similar to how we use quality.

[00:10:21] So, if we can find a company whereby the quality is improving over time, the ESG and sustainability characteristics are improving over time, and there is good valuation support, well that for us is the holy grail of what we're looking for in a company.

[00:10:37] Nick Peters: I'm going to catch up with Paul later and talk about a couple of stocks and I imagine the process will come out when we're discussing those stocks, but again, stepping back, what do you see as the differentiators of your fund compared to other funds that are out there in the marketplace?

[00:10:54] Tim Humphreys: I think one of the key differentiators is our definition of essential infrastructure.

[00:10:59] We think this progresses the definition of infrastructure because we're distilling it down into those core characteristics of infrastructure that we think investors are looking for.

[00:11:10] And when we look at our peer group out there, they tend to invest in more cyclical industries such as rail or ports.

[00:11:18] They also tend to have more commodity sensitivity, particularly through some of the, the midstream oil and gas characteristics and we leave those out because they introduce volatility, sensitivity to the cycle and reduce the stability of cash flows and also reduce the diversification benefits that, that you get.

[00:11:38] So the essential infrastructure definition is certainly one of the key differentiators. for us.

[00:11:45] The second one would be our view on quality. We think quality is just as important as valuation in ESG, and that's why we do a very detailed quality assessment right up front before we start valuing the company in order to understand not only where the quality is today, but where's the quality going in the future. Very similar to how we use ESG.

[00:12:08] I think the final point would be the very long term view we have as investors. So we're looking at valuation for the next 30 years, and we're analysing companies and predicting companies cash flows for the next 30 years. And that gives us a very, very long term perspective that not only captures the valuation of these companies, but also talks a very similar language to the management.

[00:12:33] We spend a lot of time talking to management about what are their plans for the next 5, 10 or 15 years, and that leads to a very good vision of what the company's progression is going to look like. That tends to be very, very different from the vast majority of investors out there who are typically looking for the next quarter's earnings or the next year's cashflow.

[00:12:54] Nick Peters: Excellent. Tim Humphries, thank you very much for joining us, fund manager of the Marlborough Global Essential Infrastructure Fund. Thank you.

[00:13:02] Tim Humphreys: Pleasure. Thank you.

[00:13:04] Nick Peters: So Paul, thank you very much for joining us. The seat's still warm after Tim's been talking us through the fund and the process.

[00:13:11] He mentioned energy transition and I wonder whether you'd be able to give us a bit more colour on that and perhaps talk about one of the stocks that excites the team.

[00:13:20] Paul Johnston: Yeah, the energy transition is a really exciting sort of thematic that's running through the fund. When we look at the asset class, historically, It actually didn't have a lot of growth. And so what the energy transition sort of does for the fund is actually introduce a really long term growth opportunity.

[00:13:39] And so when we look at the fund at the moment, there's a number of stocks that are exposed to this energy transition and the sort of two main ways, if you like, that we're reflecting that.

[00:13:50] Firstly is through the electricity grids, and a company I want to particularly mention is Ilia, that owns the Belgium transmission grid and also part of the German transmission grid.

[00:14:02] That company, why we're quite excited about that company, is, it really is at the heart of the transition because it's building all the transmission needed to connect the renewable energy, be it the offshore wind that's being built or has been built, and also the renewable energy that's being built onshore in those countries.

[00:14:21] And so, in respect of Ilia, we're seeing that company grow at just extraordinary rates, they're estimating that their asset base will double in the next five or six years. And so that's a company we're really excited at, but importantly, it's got all the characteristics of infrastructure that we're after. That's what we won't sacrifice. So in addition to those characteristics, we're getting this extraordinary growth profile.

[00:14:46] So that's sort of one way through those electricity grids. And then the other way is more through the owners of renewable energy and generation, and that's predominantly in the United States.

[00:14:55] One of the largest holdings we've got is Next Era and that company is the largest owner of renewable energy in the United States. But what that company's been able to do time and time again is help utilities actually retire coal in the United States, but also invest in renewable energy.

[00:15:13] In the same breath, actually manage the affordability aspects of this difficult energy transition. And so Next Era is one of the big holdings in the fund as well, and so there's sort of a number of ways we can play, but that's the main way we play it, through the grids and also through the owners of renewable energy.

[00:15:31] Nick Peters: One thing we didn't mention is actually it's quite a concentrated fund, so about 30 holdings, I imagine the whole sort of team know all the stocks pretty well.

[00:15:40] Is there another stock in the portfolio that the team's currently very excited about?

[00:15:45] Paul Johnston: Yeah, we have about 30 stocks in the portfolio, so you're right, it is a concentrated fund. But we're all experienced fund managers, and so we spend a lot of time understanding all the holdings, and, and the one I would identify is Transurban, and that's a, one of the top holdings in the fund at the moment.

[00:16:00] And that's really sort of bread and butter for what we're trying to achieve with the portfolio. Transurban owns a number of concessions, mostly in Australia, in the cities of Melbourne, Sydney, and Brisbane.

[00:16:14] And what we get with Transurban is, is really that inflation protection, we talked about, that they can ratchet up the tolls based on inflation, but with a lag.

[00:16:24] But also they've got underlying growth, in the concessions as a result of population growth as a result of working from home that whole thematic online shopping. We've actually seen a real shift in the traffic and they've been able to capture a lot of that benefit in addition to those inflation protection qualities that I talked about

[00:16:42] Nick Peters: Paul, that's really interesting. Thank you very much for joining us.

[00:16:46] Paul Johnston: My pleasure

[00:16:47] Nick Peters: If you'd like to find out more information about the Marlborough global essential infrastructure fund, then please visit our website. Thank you.