Emerging Markets Strategy July Commentary

Key Takeaways

• Infrastructure rose strongly in July, outperforming global equities. Signs of a long-awaited market broadening began to appear, driven by the strong prospect of a U.S. interest rate cut in September, cuts in other economies underway, and positive corporate earnings.

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

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

Market Overview

Infrastructure rose strongly in July, outperforming global equities. Signs of a long-awaited market broadening began to appear, driven by the strong prospect of a U.S. interest rate cut in September, cuts in other economies underway, and positive corporate earnings. U.S. 10-year Treasury yields declined on economic reports and growing investor optimism for rate cuts during the month, ultimately ending at 4.04%, or 36 basis points lower. Emerging markets were generally weaker than developed markets in July. China’s economic activity slowdown, the tech sell-off and geopolitical risks were the major factors for this weakness.

Among listed infrastructure sectors, communications and renewables performed well on an easing monetary environment. Oil prices declined to their lowest level in nearly two months, as faltering Chinese growth weighed on expectations for global demand. The price per barrel of WTI crude fell from $81.54 at the beginning of the month to $77.91 at the end. Energy infrastructure was among laggards in the infrastructure market.

Portfolio Performance

The ClearBridge Emerging Markets Strategy outperformed relevant infrastructure and global equities benchmarks during the month.

On a regional basis, Asia Pacific (+1.88%) was the top contributor for the month, with Indonesian toll road operator Jasa Marga (+0.47%) the lead performer in the region. Jasa Marga is Indonesia’s largest toll road operator. The majority of its roads are located in Greater Jakarta, a highly populated area that provides the basis for high traffic volume on Jasa Marga’s toll roads. Jasa Marga’s share price rose with the announcement of a partial divestment of some of the company’s toll roads at lucrative prices.

Turning to Latin America, Brazilian water utility Sabesp (+0.60%) also contributed to monthly performance.

Sabesp is the largest regulated water utility company in Latin America and caters to a client base of approximately 26.7 million customers. Unlike other regulators for water utilities in Brazil, the São Paulo government has recently provided a robust regulatory framework based on a regulated asset base. Sabesp shares outperformed in July following the completion of their privatisation process and the announcement of Equatorial Energia as their new reference shareholder. Equatorial is the most efficiently run utility in Brazil and will now bring unparalleled expertise to the operations of Sabesp.

Chinese electric utility China Power International (-0.19%) and Chinese gas utility ENN Energy (-0.26%) were the largest detractors.

China Power International is an independent power producer, operating c.30 GW of capacity in China, including 56% coal-fired, 20% hydro, and 23% wind, solar and others. Its holding company is State Power Investment Corporation, one of the top five Chinese state-owned power generator groups.

ENN Energy is a major listed gas distribution utility in China with a nationwide portfolio of last-mile city gas concessions and the longest operating track record amongst the listed players.

China Power International and ENN Energy’s share prices both pulled back with the Chinese equity market, together with concerns on industrial activity slowdown.

During the month, we initiated a position in Chinese port operator Qingdao Port International. We also exited our positions in Indian energy infrastructure company Mahanagar Gas and Malaysian airport operator Malaysia Airports.

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. The Fed and many other central banks around the world have moderated in response to the inflation data. However, economic data has surprised to the upside this year and defensive sectors such as utilities may continue to struggle in this backdrop. As a result, we have been reviewing our positioning and increasing our cyclical exposure where it makes sense.