On February 8th, financial advisors were provided with a comprehensive deep dive into income investing strategies tailored for the current complex macroeconomic landscape. The exclusive one-hour webinar, hosted by AltsDb co-founder Jimmy Atkinson, featured Jay Hatfield, founder and CEO of InfraCap, a prominent firm in the alternative investment sector. The session, which also included an audio version as a podcast with a brief introduction by Andy Hagans, aimed to equip advisors with actionable insights for navigating market volatility and constructing robust income-generating portfolios.
The webinar, sponsored by InfraCap, a firm specializing in alternative investment solutions, underscored the growing importance of income-focused strategies, particularly for investors nearing or in retirement. Jay Hatfield, drawing on his extensive experience in asset management, including a significant tenure at SAC Capital under Steve Cohen and founding an MLP that went public, articulated the appeal of income investing as a cornerstone of a resilient portfolio. He emphasized that a consistent income stream provides a crucial buffer against market fluctuations, enabling investors to meet expenses and reinvest at potentially lower prices, thereby enhancing long-term returns.
The Enduring Appeal of Income Investing
Hatfield elaborated on why income investing has become a focal point for many high-net-worth and ultra-high-net-worth individuals and their advisors. He shared an anecdote about assisting a friend who had transitioned to retirement. By strategically building a diversified portfolio yielding 4% to 5%, comprising both bonds and equities, the friend gained the financial confidence to retire, knowing his expenses were covered. This personal example highlighted how a reliable income stream can offer not only financial security but also psychological comfort during periods of market uncertainty.
"It’s really the core to a high-quality portfolio, and particularly, of course, for people who are either nearing retirement or in retirement," Hatfield stated during the webinar. He further explained that in volatile markets, the ability to generate income allows investors to "reinvest at lower prices, higher yields," even when drawing from their portfolios for living expenses. He also noted that the income stream itself often demonstrates resilience and can even grow through economic downturns, a phenomenon he has observed in his own investment strategies.
Economic Outlook and the Fed’s Role
The discussion then shifted to the prevailing economic environment. Hatfield acknowledged that 2022 was a challenging year for traditional asset classes, with both bond and publicly traded stock markets experiencing significant downturns. He contrasted this with the performance of alternative investments, which often demonstrate less correlation to traditional markets.
Hatfield’s analysis of the macroeconomic outlook was particularly pointed regarding the Federal Reserve’s monetary policy. He attributed the market pain experienced in 2022 directly to the Fed’s aggressive tightening measures, which involved a substantial reduction in the money supply. "The Fed was tightening, they were reducing the money supply dramatically," he explained. He noted that the Fed’s actions, particularly through open market operations rather than solely relying on interest rate hikes, effectively "sucked capital out of the capital markets driving both bond and stock prices down."
For 2023, InfraCap projected a more optimistic outlook for the S&P 500, setting a target of 4,500. This bullish stance was predicated on the expectation that the most aggressive phase of monetary tightening was behind them. Hatfield highlighted a key, often overlooked, mechanism the Fed employed: reverse repo operations, which effectively absorbed liquidity from the financial system. He argued that with this liquidity withdrawal largely complete, and with the Fed expected to implement only two more rate hikes, the market conditions were set to improve.
Furthermore, Hatfield pointed to several post-pandemic tailwinds that he believes will mitigate the risk of a severe recession. These include persistent shortages in housing and automobiles, coupled with a remarkably strong labor market, which is an atypical condition during periods of Fed tightening. This combination of factors, he suggested, would support a more robust economic performance than typically observed in similar monetary policy cycles.
Addressing Inflationary Concerns
A significant portion of the webinar was dedicated to dissecting the complexities of inflation. Hatfield expressed a strong divergence from the Fed’s current approach, asserting that the central bank was "completely out to lunch on inflation" and not utilizing the most accurate indicators. He presented InfraCap’s proprietary real-time CPI index, CPI-R, which he claimed had turned negative over the preceding four months, indicating a deflationary trend at an annualized rate exceeding 4%.
He critiqued the Bureau of Labor Statistics’ (BLS) methodology, particularly its reliance on owner’s equivalent rent and delayed rent estimates, arguing that using housing prices provides a more forward-looking and accurate reflection of shelter costs. "CPI-R really moves forward and makes CPI a relevant indicator," he stated.
Hatfield identified two primary drivers of high inflation: loose monetary policy, which inflates housing costs, and energy price shocks. He drew parallels to the 1970s, a period marked by significant inflation, and contrasted it with the Fed’s current focus on the labor market via the Phillips Curve. He contended that while the labor market can influence low to medium inflation, it is not the primary driver of high inflation, especially when contrasted with the volatility of goods and energy prices.
The webinar addressed audience questions regarding the pace of disinflation and deflation. Hatfield acknowledged the lag in official CPI reporting due to the delayed impact of shelter costs. He explained that while his firm’s real-time index shows deflation, the reported CPI figures might appear "sticky" due to these lags. However, he projected that core PCE, a metric closely watched by the Fed, would fall below 3% by June, even if CPI prints appear hotter. This divergence, he argued, would likely prompt the Fed to pause its rate hikes.
Strategies for Diversified Income Portfolios
InfraCap’s approach to income investing emphasizes a balanced portfolio, incorporating both fixed income and equity income strategies. Hatfield outlined several asset classes that he believes are particularly attractive in the current environment:
-
Fixed Income Alternatives:
- Treasuries: While yields have improved, Hatfield suggested that longer-term bonds are becoming more attractive as the Fed nears the end of its tightening cycle.
- Corporate Bonds: Yields are beginning to offer compelling returns, making them a viable option.
- Preferred Stocks: Hatfield strongly advocated for preferred stocks, citing their current undervaluation and the potential for equity-like returns. He highlighted that many preferred stocks are trading at a discount to their par value, offering a dual benefit of attractive dividends and potential capital appreciation. He noted that InfraCap’s flagship preferred stock fund, PFFA, yields well over 9%.
- High-Yield Bonds: Currently offering attractive yields of around 9%, these bonds present an opportunity for higher income generation.
- Senior Loans: While not a focus for InfraCap’s funds, senior loans offer lower beta to the stock market and decent yields.
-
Equity Income Strategies:
- High Dividend Yield Stocks: Hatfield expressed a preference for large-cap dividend-paying stocks, citing their lower volatility, historical outperformance relative to the NASDAQ with better risk-adjusted returns, and crucial income generation. InfraCap’s large-cap dividend fund, ICAP, offers a yield significantly above the S&P 500’s 1.7%.
- REITs (Real Estate Investment Trusts): Despite pessimism surrounding the real estate market, Hatfield believes REITs are currently depressed and offer attractive opportunities, particularly preferred REITs.
- MLPs (Master Limited Partnerships): Hatfield acknowledged past investor concerns with MLPs but argued that the sector has undergone significant reform. Modern MLPs are better capitalized, have reduced leverage, and offer well-covered dividends, making them a more stable income-generating asset class. He also noted that InfraCap’s corporate structure for its MLP fund avoids the complexity of K-1 tax forms.
Portfolio Construction and Yield Metrics
When discussing portfolio construction, Hatfield suggested that even younger investors benefit from a fixed-income component for rebalancing purposes. For a balanced 30/70 portfolio (30% fixed income, 70% equity), he estimated a yield of 4.67%, which can increase to 6% or 7% with a higher allocation to fixed income. He emphasized the need for income generation from the equity portion of the portfolio to achieve overall yield targets.
Regarding yield metrics, Hatfield clarified the distinction between SEC yield and distribution yield. SEC yield, a standardized calculation mandated by the SEC, aims to provide an estimate of income based on current portfolio holdings and expenses, excluding capital gains. Distribution yield, on the other hand, represents the actual payout to investors. He stressed the importance of ensuring that the SEC yield is at least similar to, if not higher than, the distribution yield to avoid "return of capital" notices and ensure that dividends are sustainably covered by income, not by eroding the principal.
Public vs. Private Market Valuations
In response to a question about valuations, Hatfield posited that publicly traded assets, particularly in income-focused sectors like preferred stocks, are often trading at discounts compared to their private market counterparts. He cited preferred stocks trading at 21 when their call price is 25 as an example of this market inefficiency. He argued that while private market valuations might appear higher, the public market offers immediate liquidity and transparency, albeit with potentially greater short-term volatility. ETFs, in particular, he noted, trade close to Net Asset Value (NAV), offering a more straightforward way to access these assets compared to closed-end funds that can trade at premiums or discounts.
Conclusion and Future Outlook
The webinar concluded with a forward-looking perspective. Hatfield reiterated his conviction that the Fed’s current policy is misaligned with the unfolding disinflationary trend. He predicted that the yield curve would likely remain inverted for the next couple of years due to the Fed’s cautious approach, but long-term rates, such as the 10-year Treasury, are expected to settle around 3% to 3.25% driven by global pension asset demand and modest economic growth.
For investors seeking yield, Hatfield suggested that while short-term Treasuries and CDs offer a safe haven, they might not provide sufficient returns to meet long-term financial goals, especially in retirement. He advocated for exploring asset classes like preferred stocks, high-yield bonds, and dividend-paying equities, which offer higher yields and the potential for capital appreciation, albeit with a commensurate increase in risk. The key, he emphasized, is to construct a diversified portfolio that aligns with an investor’s specific risk tolerance and income needs.
The session underscored the critical role of informed decision-making in income investing, particularly in an environment characterized by evolving macroeconomic conditions and monetary policy shifts. Financial advisors were equipped with a framework for evaluating asset classes and understanding the nuances of income generation to better serve their clients’ long-term financial well-being.
