On February 8th, financial advisors gathered for a comprehensive one-hour webinar hosted by AltsDb co-founder Jimmy Atkinson. The event featured Jay Hatfield, founder and CEO of InfraCap, who delved into sophisticated income investing strategies tailored for the current complex macroeconomic landscape. The discussion, now available as an audio podcast with an introduction by Andy Hagans, provided actionable insights into navigating market volatility and building robust, income-generating portfolios.
The Enduring Appeal of Income Investing
Jay Hatfield underscored the fundamental importance of income investing, particularly for individuals nearing or in retirement. He shared a personal anecdote illustrating how a well-structured, diversified portfolio with a target yield of 4% to 5% can provide essential financial security and peace of mind. "It’s really the core to a high-quality portfolio," Hatfield stated, emphasizing that a consistent income stream allows investors to meet expenses without being forced to liquidate assets during market downturns. This strategy not only provides stability but also offers the opportunity to reinvest during periods of lower asset prices, potentially enhancing future yields. Hatfield stressed that this approach is not exclusive to older investors, suggesting that a degree of income focus is beneficial for all investment portfolios.
Navigating a Shifting Economic Climate
The webinar commenced with a review of the economic outlook, a crucial backdrop for income-focused strategies. 2022 presented significant challenges for traditional fixed-income and equity markets, with many investors seeking refuge in alternative assets. Hatfield attributed the market’s difficulties in 2022 primarily to the Federal Reserve’s aggressive monetary tightening. He explained that the Fed’s actions, particularly the reduction of the money supply through open market operations, had a tangible impact on both bond and stock prices.
Conversely, Hatfield expressed a more optimistic outlook for 2023, projecting a top-decile target for the S&P 500 at 4,500. This bullish stance is rooted in the belief that the most significant monetary tightening is behind us. He highlighted the Fed’s use of reverse repurchase agreements (repos) as a mechanism for withdrawing liquidity, noting that the substantial amount held in reverse repos can offset future balance sheet reductions.
Furthermore, Hatfield pointed to several post-pandemic tailwinds that are expected to mitigate a severe recession. These include ongoing shortages in housing and automobiles, coupled with a surprisingly resilient labor market – a rare phenomenon during periods of Fed rate hikes. He posited that the Fed’s anticipated pause in rate increases would serve as a significant catalyst for market growth. However, he cautioned that the rapid market rally seen early in the year could lead to short-term volatility, particularly after earnings seasons.
The Inflation Debate: A Divergent Perspective
A key point of discussion revolved around the Federal Reserve’s approach to inflation. Hatfield expressed a strong conviction that the Fed is "completely out to lunch on inflation," arguing that they are not utilizing the most relevant indicators. He presented his firm’s proprietary index, CPI-R, which he claims has shown a negative trend over the past four months, indicating deflationary forces at an annualized rate exceeding 4%.
Hatfield detailed his methodology for CPI-R, which he states is based on historical CPI calculation methods, utilizing housing prices instead of the Bureau of Labor Statistics’ (BLS) owner’s equivalent rent estimates. He asserted that housing prices predict the shelter component of CPI with a 70% correlation, with a 12-month lead time. This approach, he believes, makes CPI-R a more timely and accurate indicator of inflationary pressures.
His analysis identified two primary drivers of high inflation: loose monetary policy, which inflates the housing sector, and energy price shocks. He drew parallels to the inflationary environment of the 1970s, characterized by similar shelter inflation and significant energy price surges. In contrast, he argued that the Phillips Curve, which the Fed often relies on to link inflation to the labor market, is less relevant for understanding high inflation. He contended that the labor market, barring pandemic-related disruptions, is historically stable, while goods prices, heavily influenced by monetary policy, exhibit greater volatility.
Hatfield acknowledged that the Fed might continue its rate hikes, predicting two more increases. However, he maintained that the underlying inflationary pressures are diminishing due to falling energy prices and moderating housing costs. He noted that natural gas prices, for instance, have fallen significantly from their peaks. This deflationary environment, he argued, should eventually lead to moderating wage pressures, a dynamic he believes the Fed is overlooking.
Strategic Asset Allocation for Income Generation
The webinar then transitioned to specific asset classes and strategies for generating income within a balanced portfolio. Hatfield outlined several preferred asset classes, categorizing them by their correlation to U.S. Treasuries and the broader stock market.
Fixed Income Alternatives:
- Treasuries: Currently offering attractive yields, they provide a foundational level of security.
- Municipal Bonds: Offering tax advantages and moderate interest rate risk.
- Corporate Bonds: Yielding approximately 5.4%, they represent a step up in credit risk and potential return.
- Preferred Stocks: Hatfield highlighted preferred stocks as a particularly compelling opportunity, with average yields around 6%. He noted that by moving beyond the cap-weighted index, which is heavily dominated by financials, investors can achieve significantly higher yields, with InfraCap’s REIT preferred fund yielding over 7% and another fund nearing double digits. These instruments offer modest stock market risk, typically around half that of common equities, providing enhanced downside protection.
- High-Yield Bonds: Attractive at current yields of around 9%, they exhibit lower correlation to the stock market compared to preferred stocks.
- Senior Loans: While not directly offered by InfraCap, these are considered an attractive asset class with lower beta and decent yields, though not as compelling as some other options.
Hatfield recommended a diversified approach across these fixed-income alternatives, suggesting that even modest allocations to preferred stocks and high-yield bonds can substantially enhance overall portfolio yield.
Equity Income Strategies:
- High Dividend Yield Stocks: Hatfield’s firm, InfraCap, manages an ETF (ICAP) focused on large-cap dividend stocks. He emphasized the historical performance of dividend aristocrats, which have delivered comparable returns to the NASDAQ with significantly lower volatility and better income generation since 1991. InfraCap’s ICAP fund, utilizing modest leverage and preferred stock investments, aims for yields exceeding 7%, significantly higher than the S&P 500’s approximate 1.7% yield.
- Preferred Stocks (Equity Component): Beyond their fixed-income characteristics, preferred stocks offer equity-like return potential. Hatfield specifically recommended investing in preferred stocks trading at a discount to their par value, offering the opportunity for capital appreciation as they approach their call price. His firm’s flagship preferred stock fund, PFFA, yields well over 9% and offers substantial potential for capital gains. He stressed the importance of active management in preferred stocks to navigate risks such as callability and to avoid securities trading significantly above par.
- REITs (Real Estate Investment Trusts): While InfraCap offers a preferred REIT fund, Hatfield expressed bullishness on REITs generally, believing they are currently depressed and undervalued. He anticipates a return to more normalized cap rates for real estate assets.
- Master Limited Partnerships (MLPs): Hatfield acknowledged past investor skepticism due to the asset class’s historical structure as growth stocks with high leverage. However, he highlighted the significant improvements in MLP fundamentals, including adjusted dividends, better coverage ratios, and reduced leverage. He believes MLPs now offer attractive total returns, not just income, especially with supportive energy price outlooks. InfraCap’s MLP fund (AMZA) is structured as a corporation, avoiding the complexities of K-1 tax filings.
Building a Balanced Portfolio for Different Investor Needs
Hatfield illustrated how these asset classes can be combined to create portfolios catering to varying income needs and risk tolerances. For a conservative investor with significant income requirements, a portfolio with a higher allocation to fixed income (e.g., 70% fixed income) could yield around 7%. For younger investors with a longer time horizon, a blended portfolio (e.g., 30/70 fixed income/equities) could target a yield of 4.67%, with the potential for higher growth by incorporating higher-risk, higher-return income-generating assets.
Q&A Session Highlights
The webinar concluded with a lively question-and-answer session, addressing key concerns from the audience:
- Yield Curve Outlook: Hatfield anticipates the yield curve remaining inverted for the next two years due to the Fed’s cautious approach. He expects the 10-year and 30-year Treasury yields to settle around 3% to 3.25% driven by global pension fund demand and modest economic growth.
- Financial Sector View: He views the financial sector positively, particularly regional banks and investment banks, citing exploding net interest margins and overestimations of loan defaults. He believes the yield curve inversion is beneficial for banks’ profitability.
- Blended Growth and Income Portfolios: For investors seeking a mix of growth and income, Hatfield suggested increasing allocations to high-yield bonds and preferred stocks, while potentially reducing exposure to Treasuries. He also advised focusing on undervalued equity income assets like REITs and MLPs, while potentially avoiding overvalued sectors like utilities and telecoms.
- Yield Metrics Explained: Hatfield clarified the distinction between SEC yield (an estimate of income based on portfolio holdings and expenses) and distribution yield (actual payout to investors). He stressed the importance of SEC yield being covered by actual income to avoid return of capital and NAV erosion.
- Public vs. Private Market Valuations: He acknowledged that private market valuations may appear higher than public market valuations, suggesting potential inefficiencies in both. He highlighted opportunities in publicly traded assets like preferred stocks and certain REITs that are trading at discounts to their intrinsic values.
- Alternative to Treasuries and CDs: While acknowledging the safety of short-term Treasuries and CDs, Hatfield argued that they forgo the opportunity for higher returns and potential capital appreciation offered by assets like preferred stocks and high-yield bonds, especially when these are trading at discounts. He cautioned that short-term rates could decline, impacting future yields on these instruments.
The webinar concluded with an invitation for attendees to visit infracapfunds.com for more information and resources. The comprehensive discussion provided valuable insights for financial advisors seeking to optimize income generation strategies in the current economic climate.
