CEF Insights: EMO - Opportunity in Structural Growth of North American Energy

Transcript

CEFA:
Welcome to CEF Insights, your source for closed-end fund information and education, brought to you by the Closed-End Fund Association. Today we are joined by Peter Vanderlee, Portfolio Manager with ClearBridge Investments. ClearBridge is an affiliate of Franklin Templeton and sub-advisor for ClearBridge Energy Midstream Opportunity Fund, symbol EMO. We are happy to have you with us today, Peter.

Peter Vanderlee:
Wonderful to be here. Thanks for having me.

CEFA:
Peter, I mentioned the ClearBridge Energy Midstream Opportunity Fund. Can you discuss the investment strategy of the fund?

Peter Vanderlee:
The ClearBridge Energy Midstream Opportunity Fund focuses on investing primarily in North American midstream energy companies, businesses that transport, store, and process oil, natural gas, and natural gas liquids. These are typically fee-based models, which means they generate stable cash flows with limited direct exposure to commodity price volatility. Our strategy emphasizes high-quality companies with strong balance sheets, durable asset footprints, and disciplined capital allocation. We're particularly focused on businesses that can generate sustainable free cash flow, and return capital to shareholders through dividends and share buybacks. Importantly, the fund seeks to deliver a combination of attractive income and long-term capital appreciation, while also benefiting from structural growth trends in the U.S. energy production and export, especially in LNG.

CEFA:
How do you determine the specific security selections as you build your portfolio?

Peter Vanderlee:
Security selection is grounded in a bottom-up fundamental process. We focus on five key pillars that can be summarized as follows. Number one, balance sheet strength and leverage discipline. In practice, this means low to moderate leverage ratios for the companies we invest in. Our companies also typically have a rating of investment grade. Number two, quality and strategic value of assets, such as pipelines, processing infrastructure assets, storage facilities, and export capabilities. We look for assets that are strategically located, servicing attractive basins, and that are difficult to replace. Number three, cash flow stability and growth potential. We favor companies with strong, stable, and recurring free cash flow, which also have the ability to exhibit growth. The cash flow stability stems from contractual terms that favor take-or-pay provisions, minimum volume commitments, and long-term duration of contracts with financially sound counterparties. The growth potential stems from built-in contractual inflation escalators, as well as the ability to process more hydrocarbons, translating into higher fees collected. We tend to shy away from companies that exhibit a large dependence on commodity prices, as those prices tend to be volatile, compromising cash flow stability and complicating the stable dividend policy. Number four, strong and attractive dividend profiles. In terms of the dividend, we look for a company's ability to sustain the dividend at a minimum, which typically translates into a conservative payout ratio or generous coverage ratios. We also look for a company's ability to grow the dividend over time, providing a measure of inflation protection. We abhor distribution or dividend cuts and carefully scrutinize the ability of the company to, at a minimum, sustain the dividend and better yet, the ability of that dividend to grow over time. Number five, management quality and capital allocation track record. We prefer seasoned management teams that have a proven track record of creating shareholder value over time. We assess management's capital allocation policy and scrutinize its track record in terms of its ability to navigate through different economic cycles and market environments. The goal is to own businesses that can navigate short-term volatility while compounding value over the long term. Outside of these fundamental factors, we look for opportunities where the stocks are trading at attractive prices, on an absolute basis and relative to their growth and income potential.

CEFA:
What factors or events would lead you to make significant changes to your portfolio?

Peter Vanderlee:
Portfolio changes are typically driven by a few factors. One is fundamental shifts in a company's outlook, such as a deteriorating balance sheet or weaker than expected cash flows. Another one is valuation dislocations, where stock either reaches or surpasses our estimate of fair value, or where more compelling opportunities exist elsewhere. A third one is changes in industry dynamics, including regulatory developments, M&A activity, or mutations in supply-demand, where the competitive dynamics will be shifting. And a fourth one is macro developments, such as changes in energy policy, interest rates, or global demand trends, especially as they relate to long-term competitive dynamics. We also continuously reassess relative opportunities within the midstream sector, reallocating capital towards companies that we believe, and in our view and analysis, have and exhibit the best risk-reward profiles.

CEFA:
Peter, the Federal Reserve has held rates steady. Markets have seen some volatility with shifts in U.S. trade policy, as well as geopolitical tensions. Where do you see the investment markets currently, and what is your outlook for the rest of 2026?

Peter Vanderlee:
Markets have been navigating a mix of crosscurrents, such as moderating inflation, stable interest rates, and ongoing geopolitical uncertainty. Within that environment, energy, and particularly midstream, has remained relatively resilient. Looking ahead, we're constructive, U.S. energy production continues to grow, and demand, especially for natural gas, is supported by increases in LNG exports and structural drivers, such as AI-driven power consumption. Midstream companies are well-positioned to benefit from this backdrop, with strong free cash flow generation, improving balance sheets, and growing shareholder returns.

CEFA:
What are the most significant risks you consider in the current environment?

Peter Vanderlee:
Key risks include commodity price volatility, which can impact sentiment even if midstream cash flows are more insulated, regulatory and political uncertainty, particularly around pipeline permitting and energy exports, geopolitical risks, which can influence global supply-demand dynamics, and microeconomic slowdowns, which could dampen energy demand. Now, that said, the sector today is much more resilient than in prior cycles due to the improved capital discipline and stronger financial positioning. More broadly, however, it's important to consider market risks. Midstream energy companies fit squarely within the "Halo", hard asset, low obsolescence framework. And in the current environment, represents a particularly attractive place to be if the AI-driven tech trade continues to unwind. At the core of the Halo thesis is asset durability. Midstream businesses own physical infrastructure assets such as pipelines, storage facilities, and processing plants, which have extremely long, useful lives. and have limited technological obsolescence risk. According to our analysis, one major point of differentiation of Halo stocks from technology stocks is the long, useful lives of the products they provide in contrast to assets like PCs, servers, or GPUs, that face rapid replacement cycles and uncertain competitive positioning over a five to six-year time horizon. This is in stark contrast to energy pipelines, for example, which have useful lives over 35 years. Now, this distinction is critical. Long-lived infrastructure assets are supportive of long-term contracts. which in turn underpins highly predictable cash flows. That predictability is exactly what becomes scarce and valuable during a tech unwind. If the AI party fades under the weight of stretched valuations, heavy CapEx, and uncertain returns, investors tend to rotate towards businesses with stable earnings, tangible assets, and more reasonable valuations. We are witnessing that this shift is now on the way, with leadership broadening out and away from mega-cap AI-dominated tech companies towards sectors like energy and utilities that exhibit predictable earnings, strong free cash flow underpinned by tangible assets. Midstream stands out even within the Halo framework because it combines this defensiveness with structural growth. Natural gas demand, driven in part by AI-related power needs and LNG exports, provides A multi-year volume tailwind. These dynamics support sustained volume growth for high-quality midstream operators tied to both domestic demand and global energy security. In other words, midstream is not just hiding from tech risk. It is indirectly benefiting from the physical build-out required by AI. Finally, from a portfolio construction standpoint, midstream stocks offer diversification precisely when it's most needed. Halo-heavy groups like midstream exhibit low correlations to high-growth AI equities and provide free cash flow cushions and income stability in an AI-driven correction scenario. That combination of low correlation plus durable cash generation makes midstream a hedge against the derating of long-duration tech assets. In short, midstream companies embody the Halo playbook, long-lived hard-to-replace assets, contract-backed cash flows, and exposure to real physical assets with corresponding demand that exhibits low cyclicality. In a market increasingly questioning the level of AI-driven returns, that's not just the defensive positioning. It's also strategically advantaged and well-positioned to play offense.

(Read more on HALO: The Rotation to Resilience)

CEFA:
How is the EMO portfolio currently positioned?

Peter Vanderlee:
The portfolio is positioned towards high-quality, large-cap, midstream operators, with strong balance sheets, attractive assets such as pipelines, storage facilities, processing plants, and export capabilities in the energy midstream space. Towards stable, recurring, and growing cash flows, with attractive dividend profiles, meaning an attractive upfront yield and the ability to demonstrate income growth over time. We emphasize companies that can generate copious amounts of free cash flow and return those to shareholders in the form of an attractive dividend, while also benefiting from long-term volume growth tied to U.S. production and exports.

CEFA:
How did the portfolio perform with the volatility we have experienced over the past several months?

Peter Vanderlee:
Despite broader market volatility, in part due to the ongoing Iranian conflict, our midstream portfolio has held up well. The midstream energy sector is well insulated from geopolitical uncertainty and actually, is a beneficiary. First, the conflict underscores the importance of U.S. energy independence. Second, as energy infrastructure is attacked or damaged in the Middle East, it will induce higher production volumes in the U.S. which the midstream sector benefits from. Third, as we're seeing from the Ukrainian conflict, international natural gas flows are being rerouted, especially around Europe, which is looking to reduce its gas dependence on Russia. This benefits the U.S. natural gas value chain, including many midstream companies, as they can be a provider of LNG to Europe, increasing US-based natural gas production. Further, the midstream sector has benefited from its defensive characteristics, including stable fee-based revenues and strong cash flow generation, as well as its ability to play offense by exhibiting cash flow and distribution growth. Performance has also been supported by continued cash flow strength, attractive yields, especially relative to other asset classes, and investor recognition of improved long-term fundamentals across the sector. While there has been some volatility tied to commodity price movements, underlying business performance has remained solid, as would be expected of midstream assets, which are removed from direct commodity exposure.

CEFA:
Where are you seeing the best opportunities to put new capital to work?

Peter Vanderlee:
We believe that in the long term, midstream companies and MLPs represent an attractive investment opportunity as the U.S. continues to cement its status as an energy superpower and exhibit sustained hydrocarbon production increases, which can bode well for high-quality energy midstream and MLP companies, as volumes to be processed are poised to increase over time. We have a healthy exposure to natural gas-oriented midstream companies, and indeed, we anticipate healthy growth in US natural gas production as a result of, one, the AI data center build up requiring significant and reliable power sources well suited to be provisioned by natural gas. Number two, the increased demand for natural gas in Europe for US provisioned LNG as Europe is looking to further reduce its reliance on Russian supplied gas. And number three, is still growing US economy, lifting demand for power sources in general. The recent events in the Middle East where critical energy infrastructure assets, including LNG facilities, for example, in Qatar, have been damaged, further provide a tailwind for US-based companies engaged in the LNG value chain. Given this backdrop, we continue to see compelling opportunities in natural gas infrastructure, particularly companies leveraged to the LNG transporting, processing, storing, and exports. We see opportunities in large-scale integrated midstream players with irreplaceable assets, and we see opportunities in companies that are trading at attractive valuations relative to their cash flow, growth, and yield. More broadly, the sector still offers a rare combination of income, growth, and reasonable valuations, which is increasingly difficult to find in today's market. In our assessment, midstream stocks continue to be attractively valued. Despite stable and long-lived asset bases, midstream valuations have not significantly re-rated to reflect their improved outlook and continue to trade at a discount to technology and the broader market where valuations are very rich. In fact, with midstream, investors can get exposure to more predictable cash flows at lower multiples.

CEFA:
Peter, how do you see an allocation to a midstream energy strategy like EMO best positioned in an investor's diversified portfolio, and likewise for an investor that is more income-oriented?

Peter Vanderlee:
Midstream energy can play a valuable role in a diversified portfolio for several reasons. low correlations to traditional asset classes like equities and bonds, attractive income, often higher than both equities and many fixed income sectors, and inflation resilience as revenues are often tied to volumes and long-term contracts, oftentimes containing built-in inflation escalators. For income-oriented investors, EMO is also compelling. The sector in which EMO invests in offers high and growing distributions supported by strong free cash flow and disciplined capital allocation. In short, midstream can serve as both an income generator and a diversifier, helping improve overall portfolio efficiency.

CEFA:
Peter, thank you so much for taking the time to join us today.

Peter Vanderlee:
Thanks for having me.

CEFA:
We want to thank you for tuning into another CEF Insights podcast. For more educational content, please visit our website at www.CEFA.com.

Podcast recorded April 2026.

Disclosure
This material is not and is not intended as investment advice, an indication of trading intent or holdings or the prediction of investment performance. All fund-specific information is the latest publicly available information. All other information is current as of the date of this presentation. All opinions and forward-looking statements are subject to change at any time.
Franklin Templeton and ClearBridge Investments disclaim any responsibility to update such views and/or information. This information is deemed to be from reliable sources; however, Franklin Templeton and ClearBridge do not warrant its completeness or accuracy. This presentation is not intended to, and does not constitute an offer or solicitation to sell or a solicitation of an offer to buy any security, product, investment advice or service (nor shall any security, product, investment advice or service be offered or sold) in any jurisdiction in which Franklin Templeton and ClearBridge are not licensed to conduct business, and/or an offer, solicitation, purchase or a sale would be unavailable or unlawful.