UK-based Darwin Investment Managers has built up its exposure to railways in its portfolio, and explains the rationale behind such an approach in the latest “Perspectives” report.

The first and second largest equity positions in Darwin’s portfolio are US railway company Kansas City Southern and West Japan Railway, respectively. The remaining exposure is through Japan’s largest rail operator, East Japan Railway, and manager and operator of the Channel Tunnel, Eurotunnel, bringing total exposure in the portfolio to just under 5 per cent.

Such railway investments have been structured so as to minimise risk and maximise exposure, said the firm. That they have high capital costs but low energy costs, relative to other transport stocks, suggests these investments would benefit from a world where energy costs will move higher in the long term, which the firm sees as a probable scenario.  

Similarly, Darwin stresses the investments’ common characteristics which are particularly favourable, such as high fixed asset bases with long-term funding structures, captive and growing customer bases, and revenue lines sensitive to inflation and economic growth. These are particularly appealing features considering moves by central banks to pump money into the system to create inflation and economic growth in a world of low funding costs, said the firm.

But how the investments differ is their individual contributions to total portfolio risk. Eurotunnel is the largest contributor to risk, which is mainly a reflection of its high volatility profile and this drives the decision to keep the weighting small. Likewise Kansas City Southern contributes meaningfully to risk, although this is a function of its higher weighting as well as a medium to high volatility profile.

In contrast, the two Japanese positions behave as diversifiers of risk in that they detract from the contribution to total portfolio risk. Their correlation with the rest of the portfolio is therefore limited and their volatility profiles are low.

Such differing stock-specific characteristics between each investment is what allows Darwin to build a larger position in the portfolio, without distorting risk, concluded the firm.