Developed Markets Income Strategy May Commentary

Key Takeaways

• Infrastructure outperformed global equities in May, with both markets helped by strength in the utilities sector.

• A moderate decline in bond yields in recent weeks also helped defensive and yield-oriented sectors such as communication towers.

• We remain defensively positioned as impacts of tightened financial conditions are expected to impact the economy and ultimately corporate earnings.

Market Overview

Fed officials voted to keep interest rate levels unchanged for the sixth consecutive time at the Fed’s early May meeting, although inflation showed signs of stabilising in May with the Consumer Price Index easing from 3.5% year-over-year in March to 3.4% in April while the Fed’s preferred inflation gauge, core PCE, which excludes volatile food and energy costs, was unchanged versus the previous month at a 2.8% increase.

Economic data and expectations were weaker during the month. The ISM Manufacturing PMI slipped further into contractionary territory, declining from 49.2 in April to 48.7 in May, and the University of Michigan Survey of Consumers saw consumer sentiment decline from 77.2 in April to 69.1. The U.S. economy added 175k jobs in April, a significant deceleration compared to the 315k jobs added in March, and the unemployment rate edged up to 3.9%.

Amid waning inflation indicators, a moderate decline in bond yields in recent weeks helped defensive and yield-oriented sectors such as communication towers. Plateauing traffic recovery in Japan weighed on performance in the Asia Pacific Developed region, while concerns over possible government intervention in Brazil weighed on performance in Latin America.

Portfolio Highlights

Our global listed infrastructure strategies outperformed infrastructure benchmarks and global equities for the month.

On a regional basis, the U.S. and Canada (+4.85%) was the top contributor for month, with U.S. electric utility NextEra Energy (+0.96%) and U.S. renewables utility NextEra Energy Partners (+0.62%) the lead performers. NextEra Energy (NextEra) is an integrated utility business with a regulated utility operating in Florida and is the largest wind business in the U.S. NextEra’s regulated business, including Florida Power & Light, serves nine million people in the State of Florida.

NextEra Energy Partners (NEP) is a growth-oriented contracted renewables company formed by its sponsor and general partner NextEra to own, operate and acquire contracted renewable energy generation assets located in North America.

Share prices of both NextEra Energy and NextEra Energy Partners benefitted from a positive readthrough to power and renewables demand as a result of data centre growth from AI.

U.K. water company Pennon (-0.13%) and U.K. electric utility National Grid (-0.37%) were the largest detractors.

Pennon (PNN) is a U.K. water and waste services company comprising two wholly owned water utilities: South West Water (SWW) and Bournemouth Water. Pennon shares were lower due to its unexpected dividend cut in its FY24 result announcement, together with market concerns around an early general election in the U.K., which delayed the regulator Ofwat’s draft determination announcement from June to July. Meanwhile, Pennon is still waiting for the result from two Ofwat investigations that have dragged on longer than originally expected.

National Grid is one of the world’s largest publicly owned utilities focused on transmission and distribution activities in electricity and gas. National Grid’s share price fell as the company announced a dilutive $7 billion equity raise.

During the month we initiated a position in German airport operator Fraport.

All returns are in local currency.

Positioning and Outlook

We remain defensively positioned as impacts of tightened financial conditions are expected to impact the economy and ultimately corporate earnings. With increased confidence by market participants that we are at the end of the rate hiking cycle and now looking toward the start of the rate-cutting cycle, we believe this could be the start of the turn for many of our long-duration assets that underperformed for most of 2023, such as towers and renewables. Utilities should continue to benefit from themes of electrification, renewables growth and more recently higher electricity demand from data centres, and we remain constructive on the sector, given reduced valuations.