- Yves Siegel
Market Commentary: Introduction to SAM’s ESG Infrastructure Strategy
Siegel Asset Management (SAM) Partners recently launched its ESG Infrastructure Strategy, which seeks to provide sustainable income and growth from infrastructure companies that are well-positioned to participate in the energy transition to a net zero carbon future and have a favorable environmental, social and governance (ESG) profile. This is accomplished by investing in a concentrated portfolio of high-quality clean energy companies (including YieldCos), midstream energy companies [both c-corps and master limited partnerships (MLPs)] and utilities. A diversified approach to investments across these sectors should optimize risk-adjusted returns, in our view.
The portfolio targets an attractive yield of 3% plus potential for appreciable growth from clean energy.
ESG Investing: Leveraged to the Energy Transition to a Net Zero Carbon Future
Global ESG assets under management (AUM) is projected to reach $53 trillion (T) by 2025 (or one-third of the global total of $140.5T), according to Bloomberg Intelligence. This AUM projection is more than double the total of $22.8T, reported in 2016 (stellar growth forecasted over a period of less than 10 years).
Source: Bloomberg Intelligence
The market is increasingly focused on ESG-related issues and the impact on investment decisions – particularly, environmental risks. As noted in the World Economic Forum’s Global Risks Report 2021, environmental risks dominated survey responses, accounting for four of the top five risks by likelihood (i.e., extreme weather, climate action failure, human environmental damage, biodiversity loss) and three out of five by impact (i.e., climate action failure, biodiversity loss, natural resource crises). SAM’s ESG Infrastructure Strategy focuses on companies with favorable ESG metrics that are directly involved in addressing such risks and/or participating in the energy transition.
We believe that the train to net zero carbon emissions has left the station and the view we’re seeing along the way is attractive energy-related infrastructure opportunities.
ESG Infrastructure Strategy: Income Plus Growth Potential – A Three-Pronged Approach:
Clean energy, midstream companies (both c-corps and MLPs) and utilities are well-positioned for the energy transition to a net zero carbon emissions world. Trillions of dollars of investment in new technologies and infrastructure, government support, international cooperation and changes in human behavior will all be required to meet aggressive net zero carbon emission goals.
• Clean Energy and Decarbonization are megatrends with a long runway. Renewable energy
sources (predominantly wind and solar) are growing rapidly and capturing market share from
fossil fuels. YieldCos are an attractive vehicle to participate in this trend and provide compelling total return potential — yield plus growth. Hydrogen may be the next big disruptor in the coming decade; other notable energy sources and sustainable technologies include renewable natural gas (RNG), electric vehicles (EV), batteries and energy storage and carbon capture, utilization and storage (CCUS).
• Midstream Energy companies are in a good position to provide the requisite infrastructure in a net zero carbon world. The sector has the potential to re-rate higher as investors recognize that the sector is part of the energy transition to a decarbonized future. Today’s pipeline
infrastructure may be utilized to transport renewable diesel and eventually repurposed to
transport hydrogen. Midstream companies are becoming ESG friendly: directing capital
investments to clean energy, issuing Sustainability Reports and focusing on reducing carbon
• Utilities with renewable and natural gas exposure offer superior growth potential in the form of higher relative earnings and dividend growth. Utilities are beneficiaries of the electrification of the economy, new investments in grid modernization to improve reliability, and the privatization of water infrastructure. Utilities provide portfolio diversification and mitigate risk as defensive stocks. Additionally, they offer attractive relative yields in a low interest rate environment.
Portfolio Construction is based on the following:
1. Rigorous bottom-up fundamental review of each company.
2. Selection of sustainable businesses with strong balance sheets, high barriers to entry, stable cash flows, management track record of success and favorable ESG metrics. At least
90% of the portfolio companies have an acceptable ESG score by a third-party rating
company (MSCI, Refinitiv, Sustainalytics, Wells Fargo Securities Midstream ESG score card).
3. Mitigation of downside risk through insightful industry experience, proprietary research, active monitoring of portfolio, and direct engagement with senior company management and sell-side analysts.
4. Disciplined sell policy is based on an active monitoring of company fundamentals, tax
considerations and valuation.
August — Another Tough Month for the Energy Sector
On a year-to-date basis, the energy sector was the best performing of the 11 S&P sectors through July. However, energy fell to just the fourth best performing sector by the end of August. While the S&P 500 continues to post new highs and appreciated 2.9% in August, the energy sector declined 2.9% and was the only S&P sector that fell for the month. This was the second consecutive monthly loss for the energy sector; it posted an 8.4% loss in July and was down approximately 14% from its June 15th peak. WTI crude oil prices dipped below $70 per barrel (Bbl) and closed at $68.43 per Bbl at the end of August vs $73.93 at the end of July. The ten-year Treasury yield has traded in a tight band and ended the month at 1.3%
versus 1.2% in July.
S&P Global noted in its monthly commentary that there is an inverse relationship between Growth and Value factors and Information Technology and Energy. Since March, Growth has outperformed Value, a reversal of the prior six months when Value stocks performed better. Despite this, the S&P 500 energy sector is still up 26.6% this year through August 30 relative to a 20.4% gain in the S&P 500. The S&P Utility sector did well in August (up 3.5%) but is up just 8.7% year-to-date and is the second worst performing sector just ahead of consumer staples.
In August, SAM’s Infrastructure Portfolio underperformed the overall market with a 0.42% total return vs. the S&P 500’s return of 3.2% but outperformed relative to its benchmark (i.e., -0.48%). We continue to overweight Midstream, which produced a total return of 0.3% in August versus -1.6% for the Alerian Midstream Energy Index (AMNA). Our YieldCo holdings generated a total return of 2.9% in August, in line with the S&P Global Clean Energy Index (SPGTCED)). Utilities posted a 1.3% return, which was below a 4.2% return for the PHLX Utilities Index. On a year-to-date basis, SAM’s total return of 23.6% compares
favorably with the 21.6% and 18.3% return for the S&P 500 and its benchmark, respectively.
IN OUR VIEW: SIGNIFICANT UPSIDE FOR ENERGY AHEAD
We are surprised by energy’s relative underperformance over the past two months, albeit, the absolute year-to-date performance is still quite good. We believe that there is still significant upside potential, both on an absolute and relative basis, for several reasons:
1. Sector Correction Overdone. The energy sector is approximately 22% below its pre-pandemic level of January 2020 despite no deterioration in fundamentals.
2. Financial Discipline Has Been Restored. Balance sheets have improved, and companies are
generating free cash flow. The focus is on returning cash to shareholders via stock buybacks and dividends.
3. ESG is In Focus. Companies have begun to set emissions reduction targets as highlighted in their sustainability reports.
4. Valuations Are Attractive. In a market starved for income (yield), investors need to look no
further than the energy sector that sports a yield of 4.7%. The sector trades at an estimated P/E multiple of ~14.8x versus ~21.9x for the S&P 500.
A Word on the Strength in Natural Gas Prices
Natural gas prices have surged to multi-year highs, driven by higher global demand and supply disruptions at the end of August, courtesy of Hurricane Ida. U.S. Henry Hub prices closed the month of August at $4.33 per MMBtu, up approximately 10% from July month end and up about 83% year-to-date. There are both seasonal and secular factors at play. Seasonally, extremely warm weather (e.g., this was the hottest summer on record in the U.S.) drives demand higher, while global demand for natural gas is also growing on a secular basis, especially from emerging Asian economies. According to the Shell LNG Outlook 2021,
global LNG (liquefied natural gas) demand is expected to nearly double from 360 million tonnes in 2020 to 700 million tonnes in 2040.
Natural gas is a wonderful complement to renewable energy because it can be easily stored. It’s also reliable, affordable and the cleanest burning of the fossil fuels. We are very bullish on the long-term potential for U.S. exports to help satisfy the anticipated growth in global LNG demand. Cheniere Inc. (LNG-NYSE) is our preferred way to invest in LNG and weighs largely in both SAM’s Infrastructure Income and ESG Infrastructure Strategies.
Sam Partners’ Infrastructure and ESG Infrastructure Strategies seek to provide sustainable income and growth with capital preservation. This is accomplished by investing in a concentrated portfolio of high quality clean energy companies, midstream energy companies and utilities that are well positioned to participate in the energy transition to a net zero carbon future. A diversified approach to investments across these sectors should optimize risk-adjusted returns, in our view. Our Infrastructure Income Strategy offers investors a current yield of ~5.5% (as of 8.31.21) and growth potential of 3% to 4%; while the ESG Infrastructure Strategy that is more heavily weighted with clean energy stocks and adheres to strict ESG criteria, offers investors a current yield of ~ 3.5% (as of 8.31.21). In a world starved for yield, we
believe these Strategies offer a compelling value proposition.