On February 8th, financial advisors convened for a comprehensive one-hour webinar, hosted by Jimmy Atkinson, co-founder of AltsDb, featuring Jay Hatfield, founder and CEO of InfraCap. The session delved into sophisticated income investing strategies tailored for the current, often turbulent, macroeconomic landscape. This detailed discussion, now available as an audio podcast with an introduction by Andy Hagans, provided valuable insights for professionals seeking to navigate evolving market dynamics and enhance portfolio yields for their clients.
The webinar, sponsored by Infrastructure Capital Advisors (InfraCap), aimed to equip financial advisors with actionable strategies for building resilient income-generating portfolios. Jay Hatfield, a seasoned executive with extensive experience in investment banking and asset management, shared his firm’s perspective on economic outlook, portfolio construction, and specific asset classes poised to deliver attractive income.
The Enduring Appeal of Income Investing
Jay Hatfield opened the discussion by addressing the persistent popularity of income investing, particularly among high-net-worth and ultra-high-net-worth investors and their advisors. He emphasized that income generation is not merely an ancillary strategy but forms the bedrock of a high-quality portfolio, especially for individuals nearing or in retirement. Hatfield recounted a personal anecdote illustrating this point: advising a high school friend who had recently parted ways with a previous advisor. The friend’s portfolio lacked substantial yield, and high fees eroded potential gains. By constructing a diversified portfolio with a target yield of 4% to 5%, comprising roughly equal parts bonds and equities, the friend gained the financial confidence to retire. This underscores the psychological and practical benefits of a reliable income stream, providing a buffer against market volatility and a tangible means to cover expenses.
Hatfield elaborated that for more conservative investors, a focus on income is crucial for maintaining financial sanity. In periods of market downturns, knowing that one’s portfolio continues to generate yield—even at lower prices, potentially leading to reinvestment at higher yields—offers significant reassurance. This income stream can be vital for covering living expenses, and its relative stability, often growing over time, contrasts sharply with the volatility of stock prices. InfraCap itself, as significant holders of their own Exchange Traded Funds (ETFs), demonstrates a strong conviction in these income-focused strategies, believing they are beneficial not just for older investors but for a broader spectrum of the investment community.
Navigating Economic Headwinds and Tailwinds
The discussion then shifted to the prevailing economic environment. Hatfield acknowledged that 2022 was a challenging year for traditional markets, with both bond and publicly traded stock markets experiencing significant declines. Alternative investments, in contrast, demonstrated relative resilience. Looking ahead, Hatfield offered a nuanced outlook for income investors following the twin bear markets of the previous year.
He noted that InfraCap had correctly anticipated the downturn in 2022, particularly for tech stocks and speculative assets like cryptocurrencies and meme stocks. The rationale was rooted in the Federal Reserve’s aggressive monetary tightening. Hatfield pointed out that the Fed significantly reduced the money supply in 2022, primarily through open market operations rather than solely relying on interest rate hikes. This withdrawal of liquidity from capital markets directly contributed to the decline in 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 predicated on the belief that the bulk of the monetary tightening is behind us. He highlighted a critical, often overlooked, mechanism the Fed employed: reverse repos, which effectively absorbed trillions of dollars from the financial system. As this process concludes, the Fed can offset further balance sheet reductions. While acknowledging that the Fed might implement two more rate hikes, Hatfield stressed that the crucial factor is the impending halt to tightening.
Furthermore, Hatfield identified several post-pandemic tailwinds that could mitigate a severe recession. These include shortages in housing and automobiles, coupled with a remarkably strong labor market—a rarity during periods of Fed tightening. This combination of factors suggests a potential for a strong market rally as the Fed’s restrictive policies abate. He anticipated that long-term interest rates would eventually settle around 3%, which would be a significant tailwind for the bond market.
However, Hatfield cautioned against unbridled optimism, noting that the market’s rapid ascent could present its own set of challenges. He advised investors to be mindful of the period following earnings season, when market dialogue can shift from company performance to macro-economic data and speculative narratives.
Inflation Dynamics and the Fed’s Role
A key point of contention in Hatfield’s analysis was his strong assertion that the Federal Reserve’s approach to inflation is "completely out to lunch." He argued that the Fed is not utilizing the most effective indicators and that their policy responses are misaligned with the underlying inflationary pressures. Hatfield presented his firm’s proprietary index, CPI-R (Consumer Price Index – Real-time), which he claims has turned negative over the past four months, indicating deflationary forces at an annualized rate exceeding 4%. This index is constructed by calculating CPI as it was prior to 1982, substituting housing prices for the Bureau of Labor Statistics’ (BLS) owner’s equivalent rent estimate. This methodology, he contends, provides a more forward-looking and relevant indicator of inflation, as housing prices historically correlate strongly with the shelter component of CPI with a 12-month lead.
Hatfield identified two primary drivers of high inflation: loose monetary policy, which inflates the housing sector, and energy price shocks. He drew parallels to the 1970s, a period characterized by similar shelter inflation and significant energy price spikes. In contrast, he argued that the labor market, while important, is not the primary driver of high inflation, contrary to the Federal Reserve’s reliance on the Phillips Curve.
He pointed to the dramatic reduction in the monetary base in 2022 (down 20% after a 70% surge in 2020-2021) and the significant decline in energy prices, particularly natural gas (down 75% from its peak), as strong deflationary forces. This deflationary environment, he argued, should lead to moderating nominal wage growth as real wages rise, a dynamic the Fed is overlooking.
Implementing Income-Focused Strategies
Hatfield then transitioned to practical strategies for implementing income-focused portfolios, emphasizing the benefits of a balanced approach. He discussed various asset classes within fixed income and equity, detailing their characteristics, correlations, and yields.
Fixed Income Alternatives:
- Treasuries: Offering decent yields, they provide a direct hedge against market downturns.
- Municipal Bonds: Presenting slightly lower correlation to Treasuries and half the interest rate risk of government bonds.
- Corporate Bonds: Becoming increasingly attractive with yields around 5.4%.
- Preferred Stocks: Hatfield highlighted preferred stocks as a particularly compelling opportunity, with average yields around 6%. He noted that by diversifying beyond the heavily weighted financial sector in cap-weighted indices, investors could achieve significantly higher yields, with InfraCap’s REIT preferred fund yielding over 7% and another fund approaching double digits. These offer modest stock market risk, approximately half that of common equities, providing enhanced protection.
- High-Yield Bonds: Currently offering attractive yields of around 9%, with lower correlation to the stock market than preferreds.
- Senior Loans: While not a focus for InfraCap’s funds, they offer lower beta to the stock market, reduced interest rate risk, and decent yields.
Hatfield recommended a diversified exposure across these asset classes for a robust bond portfolio, especially given the recent rally in Treasuries.
Equity Income:
- Utilities: While historically a stable income source, Hatfield suggested they are currently overvalued.
- REITs (Real Estate Investment Trusts): He believes REITs are depressed and undervalued, presenting a buying opportunity despite concerns about cap rates and long-term real estate values.
- Telecom: Stocks like AT&T and Verizon offer good yields due to recent price declines.
- MLPs (Master Limited Partnerships): InfraCap views MLPs as a significantly improved asset class, better capitalized, and more disciplined in their dividend policies and retained earnings.
- High Dividend Yield Stocks: InfraCap’s ICAP fund, a large-cap dividend fund, aims for yields well above the S&P 500’s 1.7% average, employing modest leverage and preferred stock investments to achieve yields exceeding 7%.
Hatfield presented a hypothetical portfolio illustrating the impact of income-generating assets. A 30/70 (fixed income/equity) portfolio could yield approximately 4.67%, while a more conservative 70/30 split could achieve around 7%. This highlights the necessity of incorporating equity income to reach the desired yield targets.
Deeper Dives into Key Asset Classes
Hatfield then provided more detailed insights into specific asset classes:
- High Dividend, Large-Cap Stocks: He emphasized their lower risk, lower beta, better credit ratings, and long-term track record of near NASDAQ-level returns with significantly lower volatility and superior income generation. InfraCap’s ICAP fund, with its diversified sector exposure, modest leverage, and inclusion of preferred stocks, aims to enhance yield beyond the index.
- Preferred Stocks: Hatfield strongly recommended preferred stocks, particularly as they are currently trading at a discount to par value. He highlighted the potential for equity-like returns as they revert to par, coupled with attractive dividend yields. He noted that 90% of their fund is cumulative, meaning dividends must be paid if the company is to maintain its credit rating, making them a relatively safe income source for financially sound companies. The default rate for listed preferreds, he noted, is comparable to investment-grade bonds.
- Master Limited Partnerships (MLPs): Hatfield addressed past investor concerns by explaining that MLPs have transformed from growth-oriented, highly leveraged entities to more stable income generators with well-covered dividends and retained earnings for growth and share buybacks. He believes energy prices supporting 80-100 dollar a barrel will provide a stable foundation for MLP performance.
Addressing Investor Questions
The webinar concluded with a robust Q&A session, where Hatfield addressed several pertinent questions:
- Yield Curve: Hatfield expects the yield curve to remain inverted for the next two years due to the Fed’s rear-view mirror approach. However, he anticipates long-term rates (10-year and 30-year) settling around 3-3.25% due to global retirement asset growth and modest economic expansion.
- Financial Sector: He views the financial sector favorably, particularly regional banks, citing exploding net interest margins due to the yield curve’s shape. He believes fears of mass loan write-offs are overstated, given the resilience of the housing and auto markets.
- Blended Growth and Income Portfolios: For younger investors with longer horizons, Hatfield suggested reducing or eliminating Treasury exposure and increasing allocations to high-yield bonds and preferred stocks for higher potential returns. He also recommended focusing on less-overvalued equity income sectors.
- Yield Metrics: Hatfield clarified the distinction between SEC yield (a standardized, expense-adjusted estimate) and distribution yield (actual payout), stressing the importance of the SEC yield being sufficiently above the distribution yield to avoid return of capital.
- Public vs. Private Market Valuations: He acknowledged that private market valuations can appear higher than public market valuations, suggesting inefficiencies and potential opportunities in publicly traded assets that are trading at discounts, such as preferred stocks and certain REITs.
- Short-Term Treasuries and CDs vs. Alternatives: While acknowledging the safety of short-term Treasuries and CDs, Hatfield argued that they forgo the opportunity for higher, potentially more sustainable returns offered by preferred stocks and other income-generating alternatives, especially considering the potential for declining short-term rates.
The webinar provided a comprehensive overview of income investing strategies, emphasizing the importance of a well-diversified portfolio, a deep understanding of macroeconomic trends, and a critical evaluation of the Federal Reserve’s policy actions. Jay Hatfield’s insights offer a valuable framework for financial advisors seeking to optimize income generation and capital preservation for their clients in the current market environment.
