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Audience

Downside protection while capturing upside

17/01/2019

For many investors, 2018 was a year to forget. Positive returns were scarce across financial markets, particularly in equities, where the FTSE All-Share Index fell almost 10%. Losses in global equities were less pronounced, but the MSCI ACWI Index declined more than 3% in sterling. Europe recorded the biggest slump, closely followed by emerging markets and Asia. The US provided the only consolation as the S&P 500 Index generated a positive return in sterling.

Looking back on 2018

The year was characterised by increased volatility and changes in market leadership. In the first quarter, defensive stocks led equities lower as investors became increasingly concerned about the pace of interest rate hikes in the US. Bond proxies were sold off indiscriminately, while technology stocks proved most resilient after gathering momentum in January. In the second and third quarters, equity markets enjoyed a broad rally as corporate earnings continued to deliver. Healthcare, energy and technology were the best-performing sectors.

The fourth quarter saw another turn in sentiment. Equity markets experienced a sharp drop, amid concerns about slowing economic growth, trade wars and political uncertainty. Defensive stocks, which were so unloved during the first quarter, were suddenly back in favour as investors sought the comfort of safety. Utilities was the only sector to end the fourth quarter higher in sterling.

Defensiveness of listed infrastructure

Listed infrastructure as an asset class demonstrates characteristics of higher yield and lower volatility relative to global equities. These defensive qualities were given a mixed reception throughout the course of the year, but came to the fore in the fourth quarter, when investors had little appetite for risk.

However, the attraction of listed infrastructure is not limited to high yield and low volatility. The asset class offers a wide array of growth opportunities to drive attractive returns over the long term.
Infrastructure has also changed with the times, providing new avenues for investors to pursue. Consequently, the M&G Global Listed Infrastructure Fund invests beyond the traditional sphere of economic infrastructure (utilities, energy, transport), diversifying into the social (education, health, civic) and evolving (communications, transactions, royalty) categories of the asset class.

By combining the benefits of defensiveness and growth, the M&G Global Listed Infrastructure Fund generated a positive return in 2018 and was in the top decile in the IA Global peer group.

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Past performance is not a guide to future performance.

Please note that the value of investments and the income from them will fluctuate. This will cause the fund price, as well as any income paid by the fund, to fall as well as rise. There is no guarantee the fund will achieve its objective, and you may not get back the amount you originally invested.

First phase of the market downturn

Rising bond yields provided a challenging environment for equities in the first quarter. Bond proxies and, by association, many infrastructure stocks were targeted by sellers. Economic infrastructure, which covers utilities, energy and transport, was the hardest hit, alongside companies structured as real estate investment trusts (REITs).

The M&G Global Listed Infrastructure Fund provided downside protection against this difficult backdrop by applying its modern and diversified approach to the asset class. M&G’s interpretation of infrastructure extends beyond the traditional realm of economic infrastructure, to better reflect an increasingly digital society and capture the long-term growth opportunities arising from this structural trend.

During the first quarter, top contributors included MasterCard and Visa, the world leaders in payment networks, as well as INWIT and American Tower, the owners of communication towers that feed society’s seemingly insatiable appetite for data. All four stocks belong to the evolving infrastructure category, which exhibits the fund’s strongest growth characteristics.

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Past performance is not a guide to future performance.

That said, many of the fund’s holdings in economic infrastructure came under pressure, which created some uniquely compelling valuation opportunities. We acted on the opportunity and bought aggressively into weakness because of our conviction in company fundamentals.

We were motivated by our strong belief that our holdings – all of which we expect to pay growing dividends, reflecting the growth in the underlying businesses – should not be treated as bond proxies, which, by definition, offer a high yield with no growth. The actions we took during this time made a positive contribution to performance in the following six months, highlighting the importance of applying a valuation discipline.

The recovery

Equity markets staged a strong comeback in the second and third quarters, as investors’ focus shifted to company fundamentals. Corporate earnings were making progress around the world, most notably in the US, where tax reform provided a meaningful boost. The MSCI ACWI Index posted a double-digit return and recouped the losses from the first quarter. Each sector generated a positive return during this six-month recovery phase.

Infrastructure stocks tend to lag in an environment of improving economic growth as investors typically favour cyclical exposure over defensives.

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The M&G Global Listed Infrastructure Fund overcame this headwind and performed strongly during the market rally, capturing the upside when there were gains to be made.

The biggest contributors during this period were, perhaps surprisingly, companies in economic infrastructure, with utilities and energy infrastructure featuring prominently. We added meaningfully to holdings such as Edison International and Enbridge during the first quarter, and we were subsequently rewarded for our actions when the negative sentiment towards interest-rate sensitives was lifted.

Social and evolving infrastructure businesses also made their mark. John Laing Infrastructure Fund was a beneficiary of a takeover approach in the social segment, while CoreSite, a data centre structured as a REIT, made a positive contribution in the evolving category.

Second phase of the market downturn

In the fourth quarter, equity markets were dragged down again, this time by escalating fears about slowing economic growth, unresolved trade talks between the US and China, and the ongoing uncertainty over Brexit. Rising interest rates in the US did not help the cause. The Federal Reserve’s fourth rate increase of the year, announced in December, was widely anticipated. However, the Fed’s guidance for two more hikes in 2019 was met with disappointment.

The M&G Global Listed Infrastructure Fund demonstrated resilience once again, albeit in different circumstances and with different contributors.

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Past performance is not a guide to future performance.

Enel, the Italian utility, made the biggest contribution after a double-digit return during the period, followed by Franco-Nevada, a Canadian royalty company in the ‘evolving’segment, and CCR, the Brazilian operator of toll roads. Ventas, the US healthcare REIT in the social category, also added value and generated a positive return.

The fund also benefited from its low volatility characteristics, which have improved as market turbulence has increased. The fund’s beta, which currently stands at 0.7, has been steadily falling during the year.

Dividend growth

As we mentioned earlier, the attraction of infrastructure is not limited to low volatility. The asset class offers a wide array of growth opportunities and there is no better signal of a company’s confidence and capital discipline than rising dividends. It has been encouraging, therefore, to see dividend growth – and in many cases significant dividend growth – across the spectrum of infrastructure industries and from a number of countries.

It may be surprising to hear that a utility was responsible for the portfolio’s highest dividend growth in 2018. But not all utilities are the same. Orsted, the Danish offshore wind company, reported a 51% dividend hike, reflecting its position as market leader in the fastest growing area of renewable energy. More conventional utilities such as American Water and Atmos Energy delivered perfectly respectable dividend growth of 10% and 8% respectively, helped by the regulatory climate in the US, which is far less punitive compared to the restrictive regime in the UK. US tax reform provided a tailwind for companies such as Union Pacific (railroads) and ONEOK (energy pipelines), which raised their dividends on more than one occasion during the year.

The evolving part of the portfolio delivered on its high growth expectations with INWIT, the Italian communication towers company, and Unite Group, the UK’s leading provider of student accommodation, delivering dividend growth of more than 20%.

We are encouraged by the dividend growth we see in the portfolio and expect continued steady progress in 2019.

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Past performance is not a guide to future performance.

Outlook

The abrupt reversal in equity markets towards the end of 2018 has caught many investors by surprise, and the pickup in volatility has led to increasing discomfort among those who identify themselves as risk averse. However, volatility is not synonymous with risk, and it is our strong belief that short-term swings in sentiment can present excellent opportunities for long-term investors.

What has surprised us in recent months is not so much the return of volatility, but the fact that the market downturn has occurred at a time when little has changed on a fundamental basis. We see excellent opportunities across a wide range of infrastructure industries for companies with robust cashflows and solid growth prospects. Growth is available at attractive prices, and in many cases at bargain prices, which gives us great confidence for the fund’s performance in the years ahead. We look forward to the future with optimism.

M&G
January 2019

Please note that the fund invests mainly in company shares and is therefore likely to experience larger price fluctuations than funds that invest in bonds and/or cash.

Further risks associated with this fund can be found in the fund’s Key Investor Information Document.

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The value of the fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested.
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