Infrastructure PLUS Strategy: Q2 2010 Commentary

The Infrastructure PLUS Strategy

We hope your last few months have you feeling happy, healthy, and terrific. This is our inaugural review of our first quarter running our Infrastructure PLUS strategy. For those new to our PLUS strategy, we have found in our research that many available public equity infrastructure strategies (both ETFs and mutual funds) have not performed as desired. The premise behind many of these strategies is that, in exchange for giving up performance on the upside during bull markets, infrastructure investments should perform better on the downside during bear markets. Instead, what we found is that over the long term listed infrastructure strategies simply lagged broader markets, even during certain downturns. This finding was born out during the onset of the recent COVID-19 global pandemic.

We set out to expand the definition of infrastructure to fit with what we believe actually drives a modern economy – that is, certain assets and technologies have become fundamental to the function of the economy which did not exist a couple of decades ago, or in some cases even five years ago. Thus, modern infrastructure goes beyond a traditional “bridges and tunnels” mentality. Bridges and tunnels remain essential of course, but in the digital- and data-driven world of today, we believe services and technologies such as payment processing, cellular towers, data centers, computer operating systems, and renewable energy are just as vital as railroads, utilities, telecom, environmental services, and pipelines. In addition, we believe that many of these essential assets and technologies are growing faster than traditional infrastructure and the broader economy while generating positive current cashflow. Thus, we set out to create a portfolio that would enable investors to achieve the stability and lower volatility they desire from traditional infrastructure investing without sacrificing the growth necessary to achieve superior long-term total returns.

2Q Macro Backdrop

The Coronavirus was exploding onto the world as 1Q closed and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law. The CARES Act, along with the Paycheck Protection Program and Health Care Enhancement Act provided $2.2 trillion in fiscal support. Congress followed with the Heroes Act on May 15 which provided another $1+ trillion in state and local funding and included another round of stimulus checks. In addition, the Federal Reserve added ~$3 trillion to its balance sheet. After roughly 20 million continuing claims for unemployment through June 20, the result of the multiple stimulus packages as well as support from the Fed resulted in 4.8mm jobs recovered in June which followed 2.5mm jobs recovered in May. US GDP fell 5.0% in Q1 and for 2Q the GDP consensus forecast now stands at -33.4% Estimates for a 2021-2022 recovery have continued to improve and now stand at 4.5% for 2021 and 2.8% for 2022. Unemployment stood at 14.7% in April but has fallen to 11.1% for June.

Infrastructure PLUS Performance

Against the Covid19 negatives offset by the stimulus packages, we launched the Infrastructure PLUS strategy on April 24. Markets were already in the process of recovering with the S&P 500 having recovered ~27% from the March 23 bottom. For May and June, the S&P 500 delivered a total cumulative return of 6.8%. On a composite basis, our Infrastructure PLUS strategy did even better, returning 7.4%, beating the S&P 500 by ~60 bps and the DJ Brookfield US Infrastructure Composite by ~550 bps. PLUS had its best relative week during the first week of May, beating the S&P 500 by 198 bps. The worst relative week was the last week of May/first week of June when PLUS trailed the S&P500 by 246 bps. The PLUS strategy had an extraordinary full month of May beating the S&P 500 by 450 bps. Compared to other infrastructure equity products, PLUS beat US-focused strategies as measured by the DJ Brookfield Infrastructure ETF by 400 bps. During June, PLUS performance was a mixed bag as PLUS fell 1.8% along with all other infrastructure ETFs/Funds. Still PLUS beat the DJ Brookfield US Infrastructure composite by 140 bps. Since inception, through July 10, PLUS is ahead of all the relevant benchmarks with 60 bps of outperformance versus the S&P 500 to 560 bps versus the DJ Brookfield US Infrastructure composite, which we consider to be the most comparable benchmark given its focus on US listed infrastructure.

Top performers for Q2 were Paypal Holdings (PYPL +55.3%), SolarEdge Technologies (SEDG, +48.2%), and Enphase Energy (ENPH, +21.9%). Bottom performers were TC Energy Corporation (TRP, -4.5%), Ameren Corporation (AEE, -3.9%), and CMS Energy Corporation (CMS, -3.9%). We note that the top performers not only have outperformed with technology in general during the Coronavirus rally but also continue to benefit from broad trends in renewable energy (in the case of SEDG and ENPH) and an acceleration in online commerce (PYPL). On the trailing side, while utilities continue to be an important component of infrastructure, the sector in general experienced a sharp pullback as Coronavirus cases surged and economic lockdown measures were implemented late in 1Q and early 2Q and utility stocks have thus far recovered less than broader market averages. Much of the lag, we believe, is due to concerns over customer delinquencies associated with the sharp rise in unemployment during the lockdown as well as impacts to load on utility systems from the economic slowdown. As a result, utilities are not trading at the premiums usually seen during periods of low interest rates. We will continue to monitor our positions and allocation to this sector. While pipelines are expected to be a vital sector for decades to come and carry attractive yields, this sector has also been a laggard during the coronavirus rally. We are broadly underweight pipelines with select positions in what we believe are the highest quality names with the lowest commodity price exposure and acknowledge that the sector faces significant ongoing negative sentiment. None- the-less, we will continue to monitor the portfolio and news flow to determine if changes are warranted. We continue to believe we are well positioned to capitalize on trends from the accelerating demand for data (cell tower companies and data centers), shifts to a lower carbon footprint (renewable energy), acceleration in 5-G deployments (telecom, cell towers), and digital transactions (infrastructure technology) as well as broad economic recovery (rail).

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This commentary is provided for informational purposes only and contains no investment advice or recommendations to buy or sell any specific securities. The statements contained herein are based upon the opinions of the Portfolio Management team and the data available at the time of publication of this report. Any sectors or securities mentioned are based on newsworthiness and may or may not reflect holdings in any Principal Street portfolio. The reader should not infer that any securities discussed were or will be profitable. Information was obtained from third party source s believed to be reliable, are not necessarily all inclusive, and are not guaranteed as to accuracy. Past performance is no guarantee of future results and there is no assurance that any predicted results will actually occur.