On February 8th, financial advisors had the opportunity to delve into the intricacies of income investing strategies tailored for the current macroeconomic landscape during a live, one-hour webinar hosted by AltsDb co-founder Jimmy Atkinson. The featured guest, Jay Hatfield, founder and CEO of InfraCap, provided expert insights into navigating volatile markets and constructing robust income-generating portfolios. An audio version of this insightful discussion, including an introduction by Andy Hagans, is now available, alongside a YouTube recording of the event.
The webinar, sponsored by Infrastructure Capital Advisors (InfraCap), addressed the growing demand among high-net-worth and ultra-high-net-worth investors for portfolios that not only preserve capital but also generate substantial, reliable income streams. Atkinson initiated the discussion by probing the fundamental appeal of income investing, particularly for individuals nearing or in retirement. Hatfield emphasized that income investing forms the bedrock of a high-quality portfolio, providing a crucial buffer against market volatility and enabling financial independence. He illustrated this point with a personal anecdote about restructuring a friend’s portfolio to achieve a 4-5% yield, which ultimately provided the confidence needed to retire. This income stream, Hatfield argued, offers psychological comfort during market downturns, allowing investors to reinvest at lower prices and potentially higher yields, even while drawing on funds for living expenses.
Hatfield’s perspective on the broader economic outlook for 2023 was a central theme. Reflecting on the challenging performance of both bond and publicly traded stock markets in 2022, he noted that alternative investments generally fared better in comparison. However, he cautioned that 2022 was characterized by significant monetary tightening by the Federal Reserve, which dramatically reduced the money supply. This liquidity drain, Hatfield explained, was the primary driver behind the decline in both bond and stock prices. The Fed’s actions, particularly through open market operations and balance sheet reduction, effectively "sucked capital out of the capital markets."
Looking ahead, Hatfield presented a more optimistic outlook for 2023, projecting a top-decile target for the S&P 500 at 4,500. His rationale centers on the belief that the bulk of the monetary tightening is behind us. He highlighted a key, often overlooked, mechanism the Fed used: reverse repo operations, which effectively absorbed substantial liquidity from the financial system. While the Fed is expected to raise rates two more times, Hatfield does not anticipate a severe recession. This projection is bolstered by post-pandemic tailwinds, including shortages in housing and automobiles, and a remarkably resilient labor market—a combination rarely seen during periods of monetary tightening. The imminent halt in rate hikes, he suggested, will likely serve as a significant tailwind for the market.
A significant portion of the discussion focused on inflation, with Hatfield asserting that the Fed is "completely out to lunch on inflation." He presented his firm’s proprietary index, CPI-R, which he claims shows a negative inflation rate, or deflation, over the past four months, exceeding a 4% annual rate. This index, he explained, differs from the Bureau of Labor Statistics (BLS) calculation by using housing prices instead of owner’s equivalent rent, a measure with a significant lag. Hatfield argued that high inflation is primarily driven by loose monetary policy leading to housing inflation and energy price shocks, rather than the labor market, as suggested by the Phillips Curve favored by the Fed. He pointed to the dramatic decrease in natural gas prices and the impact of energy price shocks on core inflation. The Fed’s reliance on lagging indicators, particularly in the shelter component of CPI, leads to a misinterpretation of the current inflationary environment. He foresees PCE core inflation dropping below three percent by June, prompting the Fed to pause its rate hikes.
The Case for Income Investing
Hatfield underscored the strategic advantages of income investing in an uncertain market. For those who are income investors, the ability to continue paying expenses, reinvest at potentially lower rates, and maintain peace of mind through consistent dividend payments from strong companies is paramount. He elaborated on his firm’s approach, emphasizing that they are significant holders of their own ETFs, aligning their interests with those of their investors.
Economic Outlook and Market Implications
Hatfield’s economic outlook for 2023 is characterized by a belief that the Fed’s tightening cycle is nearing its end. He projects the 10-year Treasury yield to settle around 3%, a level he considers bullish for bonds. This outlook is supported by several factors: the aging global population driving demand for fixed-income assets, the substantial size of pension assets seeking yield, and the attractiveness of U.S. bonds on a global scale. He noted that many European economies offer significantly lower yields compared to the U.S.
Despite his bullishness on the eventual market direction, Hatfield cautioned against immediate aggressive positioning in the riskiest stocks. He suggested a range-bound market in the near term, with 4,200 serving as a significant barrier for the S&P 500. However, he maintained that the risk lies to the upside, as the market increasingly recognizes the declining inflation and the Fed’s policy missteps. The resilience of the labor market, coupled with shortages in housing and autos, further supports his view against a major recession.
Building a Balanced Portfolio
The webinar then transitioned to practical portfolio construction. Hatfield advocated for a balanced approach, integrating both fixed income and equity income strategies. For fixed-income alternatives, he highlighted treasuries, municipal bonds, corporate bonds, preferred stocks, high-yield bonds, and senior loans. He specifically noted the attractiveness of preferred stocks, which offer yields well over six percent, and even approaching double digits in certain sectors not dominated by financials. His firm’s flagship preferred stock fund, PFFFA, currently yields over nine percent, offering the potential for equity-like returns as preferreds trade below their par value.
On the equity side, Hatfield expressed a preference for high-dividend, large-cap stocks, citing their lower volatility and consistent returns compared to growth-oriented sectors like technology. His firm’s large-cap dividend fund, ICAP, utilizes modest leverage and preferred stock to achieve a yield well above seven percent. He also discussed the appeal of Master Limited Partnerships (MLPs), emphasizing their improved financial health and dividend coverage compared to historical performance, and their potential for strong total returns beyond just income.
Asset Class Deep Dive
Preferred Stocks: Hatfield strongly recommended adding preferred stocks to portfolios, especially given their current undervaluation. He explained that these securities are callable at par and are currently trading significantly below this level, offering potential upside appreciation alongside attractive dividends. He highlighted that preferred dividends are often cumulative, providing a layer of safety even during challenging corporate environments, and that their default rates are comparable to investment-grade bonds.
REITs: While his firm offers a preferred REIT stock fund, Hatfield also expressed a positive outlook for REITs in general, including office and retail sectors. He believes the market has been overly pessimistic about cap rates and the long-term value of real estate.
Master Limited Partnerships (MLPs): Hatfield addressed potential negative sentiment surrounding MLPs by explaining the significant structural changes and financial improvements made by these companies. He noted that they have adjusted dividends for better coverage, are retaining earnings for growth, and have reduced leverage. The K-1 tax reporting, which has deterred some investors, is mitigated by his firm’s corporate structure for its MLP fund, offering capital gains treatment instead of recapture. He anticipates strong energy prices to support MLPs throughout the year.
Yield Metrics and Market Valuation
During the Q&A session, Hatfield clarified the distinction between various yield metrics, such as SEC yield and distribution yield. He emphasized that SEC yield, an estimate mandated by the SEC, aims to reflect the income generated from a portfolio’s holdings after expenses, providing an objective measure for comparison. He advised investors to be wary of funds that pay high distribution yields but have significantly lower SEC yields, as this may indicate a return of capital rather than genuine income generation.
Regarding market valuation, Hatfield acknowledged that publicly traded markets are generally more volatile than private markets, leading to discrepancies in valuations. He pointed to preferred stocks trading at a discount as an example of market inefficiency. However, he also cautioned that closed-end funds can trade at premiums or discounts, adding complexity for investors. ETFs, he noted, generally trade closer to Net Asset Value (NAV) due to market maker arbitrage, offering greater transparency and predictability.
Strategic Yield-Seeking
In response to a question about opting for short-term Treasuries or CDs for yield, Hatfield acknowledged their safety but argued that they miss out on opportunities for higher returns and potential capital appreciation offered by assets like preferred stocks and high-yield bonds. He suggested that for most investors, the yields offered by these instruments are insufficient, especially when considering the potential for declining short-term rates as the Fed pivots. He advocated for a diversified approach that balances risk and return to meet income needs without eroding principal.
The webinar concluded with an open invitation for further engagement via the InfraCap website, infracapfunds.com, where attendees can access the presentation deck and learn more about the firm’s income-focused investment strategies. The discussion provided valuable insights for financial advisors seeking to navigate the complexities of the current economic climate and construct portfolios that deliver both income and long-term growth potential.
