On February 8, AltsDb co-founder Jimmy Atkinson hosted Jay Hatfield, founder and CEO at InfraCap, for a comprehensive one-hour webinar aimed at financial advisors. The session delved into nuanced income investing strategies tailored for the current challenging macroeconomic landscape. The discussion, which has since been made available as an audio recording with an introduction by Andy Hagans, provided a detailed look at how investors can navigate market volatility while seeking consistent returns.
Context of the Webinar
The webinar, held against a backdrop of significant economic uncertainty, including the lingering effects of a turbulent 2022 for both bond and equity markets, aimed to equip financial advisors with actionable insights. As traditional fixed-income yields remained historically low for an extended period, and the stock market experienced considerable swings, the demand for robust income-generating strategies has intensified among high-net-worth and ultra-high-net-worth individuals and their advisors. AltsDb, a platform focused on alternative investments, recognized the critical need for such guidance, leading to the collaboration with InfraCap, a firm specializing in income-focused investment solutions.
The Appeal of Income Investing in Volatile Markets
Jay Hatfield, in conversation with Jimmy Atkinson, underscored the fundamental importance of income investing, particularly for individuals nearing or in retirement. He shared a personal anecdote illustrating how a carefully constructed, diversified portfolio yielding 4% to 5% can provide financial security and the confidence to retire. This income stream, he emphasized, acts as a crucial buffer against market downturns, allowing investors to reinvest at lower prices and higher yields, even when drawing on their portfolios for living expenses. The stability of income streams, even amidst stock market volatility, offers a critical psychological advantage, enabling investors to maintain discipline and avoid making rash decisions based on short-term market fluctuations. This strategy, according to Hatfield, is not exclusively for older investors but offers a degree of portfolio resilience for all investors.
Economic Outlook and Inflationary Dynamics
Hatfield presented a contrarian view on the prevailing inflation narrative, asserting that the Federal Reserve is "completely out to lunch" on the issue. He detailed InfraCap’s proprietary index, CPI-R, which monitors inflation using a methodology that predates 1982. This index, he explained, has shown a significant decline, turning negative over the past four months and indicating a deflationary trend at an annualized rate exceeding 4%. The methodology behind CPI-R, which incorporates housing prices with a 12-month lead over the Bureau of Labor Statistics’ owner’s equivalent rent estimates, provides a more forward-looking inflation indicator.
Hatfield attributed high inflation in the 1970s to loose monetary policy driving housing inflation and energy price shocks. He argued that the current focus on the labor market via the Phillips Curve is misplaced, as the labor market, aside from pandemic-related anomalies, is historically stable. Instead, he pointed to the dramatic swings in the monetary base – a nearly 70% increase in 2020-2021 followed by a 20% reduction in 2022 – as the primary driver of volatile asset prices.
The Fed’s current tightening cycle, while reducing the money supply, is nearing its end, according to Hatfield. He projected that the Fed would likely raise rates two more times but not cut them. However, he anticipates that post-pandemic tailwinds, such as shortages in housing and automobiles, coupled with a resilient labor market, will prevent a severe recession. This combination of factors supports InfraCap’s top-decile target of 4,500 for the S&P 500, predicated on an 18.5 times 2024 earnings estimate and a projected 3% yield on the 10-year Treasury.
The Role of Bonds and Interest Rates
A significant portion of the discussion focused on the bond market and the trajectory of interest rates. Hatfield forecasted that the 10-year Treasury yield would settle around 3% to 3.25%. This outlook is underpinned by several factors, including the aging global population and the resulting substantial demand for bonds from well-funded pension plans. With approximately $52 trillion in global pension assets, a significant portion of which is in the U.S., these plans are increasingly reallocating towards fixed income to meet their long-term return objectives. Furthermore, U.S. bonds are seen as attractive on a global scale, offering higher yields compared to many developed economies, a fact that has driven significant capital inflows.
Despite a recent uptick in the employment report, which temporarily impacted bond yields, Hatfield advised against overreaction, noting the inherent seasonality and potential estimation errors in such data. He reiterated his belief in a strong but not overheating labor market, supported by persistent shortages in key sectors like housing and automobiles.
Implementing a Balanced Income Portfolio
Hatfield outlined strategies for constructing a balanced portfolio designed to generate income, differentiating between pure income-focused portfolios and those blending growth and income.
For pure income, he highlighted several fixed-income alternatives:
- Treasuries: Currently offering decent yields, they provide a foundational level of safety and correlation to fixed-income markets.
- Municipal Bonds: Suitable for tax-sensitive investors, offering yields comparable to Treasuries with some interest rate risk.
- Corporate Bonds: With yields around 5.4%, they present an attractive option, albeit with higher credit risk than government bonds.
- Preferred Stocks: Yielding around 6% on average, with specialized funds potentially offering yields exceeding 7% or even approaching double digits by focusing beyond the heavily weighted financial sector. These offer modest stock market risk, typically half that of common equities.
- High-Yield Bonds: Currently yielding approximately 9%, these offer lower correlation to the stock market than preferreds and can be accessed through listed securities.
- Senior Loans: While not a focus for InfraCap’s funds, they are noted for their lower beta to the stock market and decent yields, though not considered super attractive at present.
On the equity side, for a balanced growth and income portfolio, Hatfield suggested:
- High Dividend Yield Stocks: Companies like dividend aristocrats have historically delivered comparable returns to the NASDAQ with significantly lower volatility and superior income generation. InfraCap’s ICAP fund, for instance, aims for yields well above 7% by employing modest leverage and investing in preferred stocks.
- REITs (Real Estate Investment Trusts): Despite recent pessimism, REITs are considered undervalued, offering potential for both income and capital appreciation as market valuations normalize.
- Telecom Stocks: Companies like AT&T and Verizon offer good yields due to recent stock price declines.
- MLPs (Master Limited Partnerships): Modern MLPs have evolved from high-leverage growth plays to more stable income generators with well-covered dividends and reduced leverage, supported by a favorable energy price outlook.
Hatfield emphasized the importance of diversification across these asset classes, noting that even younger investors can benefit from a fixed-income component for rebalancing purposes. A 30/70 stock/bond portfolio could yield around 4.67%, with higher allocations to fixed income potentially reaching 6% to 7%.
Deep Dive into Preferred Stocks and MLPs
A particular focus was placed on preferred stocks, which Hatfield strongly recommends adding to portfolios. He highlighted that listed preferreds, trading around par, offer attractive yields and potential for equity-like returns when they revert to their call price. His flagship fund, PFFA, currently yields well over 9%, with the underlying securities trading at a discount to their call price, presenting an opportunity for capital appreciation. He stressed the importance of active management in preferred stock investing to avoid securities trading above par and to monitor credit quality, as the default rate for listed preferreds is comparable to investment-grade bonds.
Regarding Master Limited Partnerships (MLPs), Hatfield addressed the past negative perceptions associated with the sector. He explained that the industry has undergone significant reform, with companies now focusing on well-covered dividends, retained earnings for growth, and reduced leverage. This transformation, coupled with a projected strong energy price environment ($80-$100 per barrel), makes MLPs an attractive income and total return opportunity, particularly for investors seeking an alternative to traditional K-1 reporting through corporate structures.
Responding to Audience Questions
The webinar concluded with a robust Q&A session. Key questions addressed included the future of the yield curve, the outlook for the financial sector, and the distinction between various yield metrics. Hatfield reiterated his expectation for an inverted yield curve for the next couple of years, with the 10-year Treasury settling around 3-3.25%. He expressed a positive view on financials, particularly regional banks and investment banks, citing exploding net interest margins and a likely overestimation of default risks by the market.
On yield metrics, he explained the SEC yield as an SEC-mandated estimate based on portfolio income and expenses, designed for objectivity, and contrasted it with the distribution yield, which reflects actual payouts. He cautioned against funds that pay out high distribution yields not fully covered by their SEC yield, as this could indicate a return of capital rather than income.
Addressing the valuation of publicly traded versus private alternative assets, Hatfield acknowledged that private market valuations can appear higher, but emphasized that public markets often present opportunities through discounted securities, such as preferred stocks trading below par. He concluded by recommending diversified income strategies over solely relying on short-term Treasuries and CDs, arguing that these alternatives offer superior risk-adjusted returns and greater potential for sustained income generation.
The webinar provided a comprehensive overview of income investing strategies, emphasizing the importance of a well-diversified portfolio, a nuanced understanding of macroeconomic trends, and the identification of undervalued asset classes. Financial advisors were encouraged to explore these avenues to enhance their clients’ income generation capabilities and portfolio resilience.
