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On February 8, AltsDb co-founder Jimmy Atkinson hosted Jay Hatfield, founder and CEO at InfraCap, on a live one-hour webinar for financial advisors. The webinar detailed income investing strategies for today’s macroeconomic environment.
This podcast includes an audio version of the webinar, including a short introduction by Andy Hagans.
Watch On YouTube
- How to create a portfolio with substantial yield to create cash flow that can be reinvested during periods of market turmoil.
- How to minimize the risk of larger losses by investing in larger capitalization companies.
- Analysis of REITs, MLPs, and preferred stocks, and their benefits for income investors.
- An introduction to actively-managed ETFs, and how they can provide investors with risk diversification strategies that may be unattainable through typical passive (index-tracking) ETFs.
- An overview of InfraCap’s products that may be of interest to income investors.
- Interactive Q&A with webinar attendees.
Featured On This Episode
- Official Webinar Replay Page (AltsDb)
Today’s Guest: Jay Hatfield, InfraCap
- Infrastructure Capital Advisors (InfraCap) – Official Website
- InfraCap on LinkedIn
- Jay Hatfield on LinkedIn
About The Alternative Investment Podcast
The Alternative Investment Podcast is a leading voice in the alternatives industry, covering private equity, venture capital, and real estate. Host Andy Hagans interviews asset managers, family offices, and industry thought leaders, as they discuss the most effective strategies to grow generational wealth.
Jimmy: Welcome to today’s AltsDB webinar, “Income Investing Strategies for Volatile Markets.” Today’s webinar is sponsored by Infrastructure Capital Advisors, also known as InfraCap. And our presenter today is Jay Hatfield, founder and CEO at InfraCap. And with that, Jay, great to see you. Welcome. Thanks for joining us today. How are you doing?
Jay: Thanks, Jimmy, for having me on. We’re excited about doing really well.
Jimmy: Very good. Well, we’re talking income investing strategies today. Before we get your presentation teed up, Jay, I just had a couple of questions that I wanted to ask you about income investing, income strategies. Firstly, really, basically, why is income investing so popular? We hear from a lot of our audience of high-net-worth and ultra-high-net-worth investors and their advisors, there seems to be just a huge focus from our AltsDB audience on building a high-yielding, high-income portfolio. What’s the appeal, Jay?
Jay: Well, we think it’s really the core to a high-quality portfolio, and particularly, of course, for people who are either nearing retirement or in retirement. So, as an example, I took over and started advising one of my best friends from high school and he had just been kind of fired from his prior advisor. And I said, “Okay, well what’s your yield?” And he said, “Well, what do you mean by yield?” So he had… The fees were so high, of course, I wasn’t charging him fees and the funds he was in didn’t have substantial yield. So I said, “Okay, let’s build a diversified portfolio, 4% to 5% portfolio yield, about half bonds, half equities. And so, we did that, and then, he got an inheritance for another couple of million dollars. And he said, “Okay, great, now I’m going to retire.”
But if we hadn’t really built that portfolio, cause he knew then he had enough income to cover his expenses, so he didn’t need to work. So it’s really, I think, for more conservative investors. It’s really the only way to maintain sanity is to know, you know, like today the market’s pretty weak, to know that, okay, well, that sort of seems bad, it feels bad, but it’s kind of good to extent that I have any money to invest cause I am getting all this yield. I can reinvest at lower prices, higher yields, and even if I’m pulling the money out of my portfolio to support my expenses, you can be confident that the stock prices are way more volatile than the income stream. And usually, the income stream still grows, which it really has through this downturn. So, that’s what we do with our own portfolios. We’re the biggest holders of all our ETFs and we think those strategies make the most sense, not just for older investors but for everyone, at least to some degree.
Jimmy: Great. Well, InfraCap is one of the leaders in the ETF industry. So want to get your thoughts on the economy right now, Jay. Obviously, 2022 was a tough year for investors both in terms of the bond market and the publicly-traded stock market. It’s a pretty good year for alts in comparison actually. But coming off a year like that, what might be in store for income investors in the year ahead following these twin bear markets?
Jay: Well, we correctly were negative about the market in 2022, particularly on tech stocks and on risky trades like cryptocurrency, meme stocks, etc. But the rationale is more important than our opinion. So the rationale was very, very simple. The Fed was tightening, they were reducing the money supply dramatically. In fact, I just talked about this on Fox Business this morning. They actually reduced the money supply by almost 20% last year, mostly through open market operations, not raising rates. So that’s why we were all feeling pain is the Fed was really sucking capital out of the capital markets driving both bond and stock prices down.
So, conversely, so we were negative, we called it adult swim where we thought the Dow would outperform the S&P. We thought actually the Dow might be a little bit up. It was actually a little bit down, so we were off by slightly. But clearly, the call on the queues, crypto, etc., were exactly correct, gain, because of this liquidity reduction of taking money out of the economy. That’s what… When you reduce the money supply, you’re basically sucking money out of the capital markets.
This year we actually have a top decile target on the S&P of 4,500. And there’s also a simple reason for that. First of all, the bulk of the reduction in the money supply is behind us cause the Fed did something called, and I’m surprised that they mentioned this on television this morning, which confused most people. They do something called reverse repo. They have 2.5 trillion reverse repo. That’s how they sucked the money out. And they’re gonna use that. It’s normally zero. So they have that 2.5 trillion to offset the reduction of the balance sheet, which almost no one knows or has ever had anybody mention it to them or understands it.
We, by the way, are available for questions anytime. You can get us through our website at infracapfunds.com, but we can go through that. So, absolutely critical point that no one understands. And when I mean no one, I mean almost no one except maybe the, obviously the Fed and the New York Fed cause they do it and few other people. But so most of the monetary tightenings behind us, we think the Fed will do exactly as they’ve said. They’ll raise rates two more times. They’re not gonna cut. But, and this is important too, normally, we’d have a pretty significant recession, Feds raising rates, long ends going up, housing markets cooling off, but we have post-pandemic tailwinds, shortage of housing, shortage of autos, which normally crash, and a strong labor market, which you almost never have when the Fed’s tightening rates. So, the reason for bullishness is the Fed’s gonna halt and just think about it simply, do you wanna be long or short the market when the Fed says they’re not, they’re done hiking. Then, obviously, you wanna be long unless the markets run up to like 5,000 or well above our target.
So, but at the same time, we do not anticipate a major recession. So that’s the prescription pretty strong market rally. Next year, eventually, the Fed will cut short term rates. We think long rates will end at 3%, which is very bullish for bonds. And pretty much that’s what’s been unfolding so far this year. The only caveat is just become pretty far pretty fast. And there’s another simple rule of investing, which is the long stocks during earning season and not so long or short or hedged after earning season because then the companies are no longer controlling the dialogue. It’s more hedge funds, short thesis, macro data, open mouth operations, so the Fed talking to market down, and being hawkish about inflation.
And just one last point, well, I can get to it in more depth in our presentation, but we believe the Feds completely out to lunch on inflation. They’re not following the right indicators, so they can be ignored but I wouldn’t assume they’re gonna get religion. So they’re gonna raise two more times and stay, you know, flat for the rest of the year. We’re okay with that. It’s not the right policy, but we’re okay with that. We’ll get into that in our slideshow.
Jimmy: Yeah. Wow. The Fed is completely out to lunch on inflation. You heard it here first, I guess. Well, I’ve heard it before. We’ve heard similar types of things, but it’s always powerful to hear that again that the administration that’s supposed to be responsible for tamping down inflation may not know what they’re doing. I wanna learn more about that, Jay.
So with that, I’ll let you share your screen and take it away with your presentation. And while Jay gets his screen share going. Again, just for those who may have joined us in the last few minutes, in case you missed my earlier announcement, we are going to save some time at the end for live Q&A. So if you have any questions for, Jay, please do use the Q&A tool in your Zoom toolbar. Jay, feel free to share your screen at this time and dive into your presentation.
Jay: So, we are income investors, and we think it’s a great strategy for markets like these where there is a lot of uncertainty. We’re bullish, but that doesn’t mean everyone is. And as I mentioned, when the news flow changes from the companies to macro, political, another short type thesis, you know, can be very volatile. When you’re an income investor, that gives you tremendous abilities to continue paying your expenses, reinvest at lower rates, and also sleep at night that you own great companies that have strong dividends.
Okay. So, this outline of what we’re talking about, briefly talk about our firm economic outlook. We covered a little bit, but we’ll go through that. Benefits of balanced portfolio and then three, four ways to generate income in some asset classes that we prefer. Who we are. My background is I’m from Northern California originally, went to University of California-Davis of a degree in managerial economics, studied under monetary economist. By the way, we don’t believe that you should be either a Monetarist or Keynesian. Keynesian is associated with Democrats and liberals. Monetarism with more conservative, although conservatives have kind of abandoned that. You should be agnostic cause we’re, at least in business, just trying to make money. But we do have a strong understanding of the money supply, that’s why we focus on that reverse repo comment.
And then, in terms of the focus of our firm, I used to be… So my career, I have a managerial economics degree, CPA from Ernst and Young in San Francisco, MBA from Wharton in finance with distinction in Philadelphia, and have been in New York for the last 34 years. Half of that time about working as investment banker doing utilities and MLPs, the rest of the time as an investor. Ran a billion-dollar portfolio for Steve Cohen at SAC Capital. Formed my own firm, founded an MLP, took it public, gets traded on New York Stock Exchange, NGO Energy Partners. That was in 2011. 2012, we launched our hedge fund. 2014, we launched AMZA, which is our pipeline MLP fund. It’s an ETF. 2017, we launched PFFR. That’s a REIT preferred stock ETF. 2018, PFFAs our flagship preferred stock fund, active preferred stock fund. And last year, we launched ICAP, which is our large-cap dividend fund.
So, we talked a little bit about the economic outlook, so I’ll just add a few details that and move through this pretty quickly. We believe not only is inflation decelerating, we’re actually in a deflation. We maintain our own index of real-time CPI, so CPI-R. And that has turned negative over the last four months, strongly negative at annual rate of over 4%. And by the way, CPI-R, even though we developed that index, it’s not very exotic. It’s simply calculating CPI as it was calculated prior to 19ED2. So instead of using the BLS’s [inaudible 00:12:54] estimate of owner’s equivalent rent and delay, highly delayed estimate in rents, we use housing prices, and housing prices predict the shelter component of CPI with 70% correlation but 12 months in advance.
So, CPI-R really moves forward and makes CPI a relevant indicator. And so, based on that and the fact that if you really look at what causes inflation, and this is where the Fed is really off track, particularly high inflation is caused by two factors, lloose monetary policy, which leads to inflation in the housing center. And by the way, this is what happened in the ’70s. In the ’70s, you had similar inflation in shelter and housing that we have now double digits and then energy price shocks and commodity shocks. You had two of them in the ’70s, 150% in’74, 200% ’79. So, almost unimaginably large. We had 70% though last year ago, quarter. So those are the two key drivers, not the labor market.
The Fed follows something called the Phillips Curve. That’s labor economists believe that’s what causes inflation. It can cause low inflation or an acceleration from low to medium inflation in our opinion. But the labor market, except for the pandemic, is highly stable. Whereas the goods market, particularly when you have ultra-loose Fed policy monetary base up 70% in ’20 and ’21, down 20 last year. When you have super volatile monetary policy, you get volatile housing prices, asset prices. And then, of course, it’s not the Fed’s fault but you had a 70% energy shock. And what they don’t appreciate fully, even though their staff produced a paper that validates it, is there’s a 5% bleed through of energy price shocks to core. So both of those factors, housing’s now negative. Energy prices are negative, particularly, nobody focuses on it, but natural gas prices are down 75% from their highs and 25% from the beginning of ’22. And that’s half of energy because natural gas prices, electricity, which a lot of people don’t appreciate.
So we have these massive deflationary forces, and when goods prices, when I say goods, I include shelter and housing, when good prices are very volatile, what the Fed doesn’t take into account is when they’re rising, that puts tremendous pressure on nominal wages because workers need to maintain their standard living. If they’re in Phoenix and rent goes up 22% and they’re making minimum wage, they need to get a raise. But conversely, so that’s what happens on the way up. And we saw that, wages rose, but they trailed inflation, and now inflation’s plummeting, which means real wages are rising, which means the demand for nominal wages is going to slacken. But the Fed completely ignores these dynamics. So, they don’t need to continue raising rates, they will. We don’t think that’s gonna damage the economy. And I think we have a couple slides that’ll talk about that.
So we do have a 4,500 target on the S&P, which is looking like a good target considering we started at 3,800 and we have a rationale for that 18.5 times 2024 earnings estimates. So that gets you to the 4,500. And the 18.5, we didn’t just make it up. We’re projecting the tenure goes to 3%. And if you do a fair value of the S&P with a tenure at 3%, it gets you to an 18.5 multiple. So should never quote multiples without quoting the associated treasury. We do think the Fed is gonna be an issue. So we’re not really saying, and today’s markets validates that view, that you should just go all in and buy the riskiest stocks right now, which should outperform enough market. In other words, NASDAQ stocks, even Bitcoin, we’re not suggesting that right now because we haven’t resolved this bad Fed policy.
So we think we’ll range bound. We think 4,200 is a big barrier. Having said that, if you look at our 4,500 target, I think the risk is to the upside, not the downside. The market is coming around to our view that inflation is rapidly declining, that the Fed is incompetent and wrong about inflation. And that also are viewed that the labor market is very resilient because we have a shortage of housing, autos, and those are normally the sectors that crash.
So the Fed is right in one way, which is that, in a normal cycle, the Fed tightens, housing rolls over and then you do get unemployment. The unemployment which does have a downward effect on wages. But the key factor is the tightening and the reduction in housing prices. And unemployment is just a byproduct and not that critical to inflation. But, so we don’t think we’re gonna have a major recession and that’s really gonna set us up, we think, for a pretty big rally as the Fed overhang. We do believe in follow the Fed as a prescription, that’s why we’re negative last year. But like I said, if the Fed’s gonna halt, then that’s gonna be a big bullish sign. And in terms of, we’ll talk about stocks later. It’s on this slide. I’ll skip it.
Jimmy: So, Jay, I did wanna interrupt with a question that we got a few minutes ago cause you told me to interrupt you if we have…
Jay: That’s great. I appreciate it, Jimmy.
Jimmy: Yeah, we’ve got one in here that asks, “I’m wondering does Jay think inflation is falling significantly this year, and if so, how fast is it falling? Can you characterize how quickly we’re seeing disinflation or deflation?”
Jay: We know that’s a great question because within that question I can highlight that there is a risk. So, our real-time index is declining at a 4% annual rate, which is pretty large, that deflation which the Fed fears, but there is a 12-month lag and housing didn’t roll over ’till really July of last year. So, what’s gonna happen is that inflation is gonna be appear to be very sticky because every time it gets reported, this lagged indicator of shelter doesn’t sound like a big deal. It’s just shelter. Well, they’re… Right now, the estimate from the BLS is 0.8% per month. So, but you have to multiply…you have to annualize that, so it annualizes right around 10%. So every time we get CPI, they’re gonna say shelter’s 10 positive annualized where we’re gonna be saying, cause we know what [inaudible 00:20:20] shelter was last month was negative 0.5 or 6% annualized.
So there’s gonna be a gigantic annualized 16% difference or if you can divide that by 12, between our estimate which is really the correct estimate or, at least, the fundamental estimate and the BLS. So that’s why we’re not super bulled up about the market in the first six months is you’re gonna get these pretty high prints on CPI unless they’re offset by very volatile reductions, which they have been so far. So we could get a hot print on CPI. So that’s the bad news. And keep in mind that CPI core is 42% shelter and headlines 33. But then there is a silver lining to this, which is PCE, which the Fed followers follows is only 16% housing, so that effect of the BLS massively overestimating CPI is attenuated.
So we’re actually forecasting that even by June of this year, PCE core will go below three and that’s why we’re confident that the Fed will pause when they do the May increase, March, yeah, March and May, there’s two more increases left, because PCE will be dropping even though CPI might still print a little bit hot. At some point, the BLS number will roll over and attenuate and go down to where we’re at. And so, it’s gonna be this odd situation where we really have deflation, you know, both from energy and the housing market, which is gonna pressure wages, not pressure them but keep them moderate cause their real wages are rising, but yet the reported numbers could seem like they’re hot. So that’s kind of the risk in the market, but that should roll over in the second half where you have a full year of moderating housing, and CPI and PCE should track that and really start going towards the Fed’s 2% target. So it’s very, it’s a little bit complicated, but it’s important to appreciate so that people don’t get too bulled up and aren’t like shocked if we have a hot CPI print. We’re not gonna be changing our numbers cause the hot portion is gonna be related to shelter.
Jimmy: Yeah, that’s good to keep in mind that the estimates that the Fed uses have a built-in lag to them that they don’t properly account for according to you, Jay. So, good to keep that in mind. Good insights there. I’ll let you resume your presentation.
Jay: So, any more interruptions are welcomed because I think it’s better to have a dialogue. And I’ve touched on this already, but we think that we’ll hit 3% on the tenure, and that’s really three to three and a quarter is what we’re saying. But that’s driven by two major factors. The first is that what we just already described, we have a deflation going on. That’s important. We don’t have it on this slide, but… We actually do, 52 trillion of global pension assets, and you throw around numbers, oh, 52 trillion whatever, but 32 trillion of that is in the United States, that’s 150% of GDP. And if you track back like when I started on Wall Street at Morgan Stanley, that number was probably 1 trillion. So what gave rise to that was the aging population of the world, at least the developed world, particularly in the United States.
And so, as the population ages, there needs to be more and more money put into pension plans. And also, surprisingly, most people don’t appreciate this because you only hear about the bad ones. But almost every pension plan in the United States, public pension plan in the United States has passed reform legislation over the last 10 years that moves part of it to 401ks but also funds the gap. So if you look at New York state’s quite well funded, about 90% funded. Most states are close to being fully funded. It’s only Illinois, New Jersey, a few outliers. So we have these well-funded pension plans, many of them like CalPERS is 400 billion, 500 billion that are potential buyers of bonds that they sell off. Cause if they have a 7% bogey for total return and the 10 years at 354, they’re gonna reallocate the bonds. They’re only 28% allocated to bonds. So we think there’s a huge global demand for bonds.
And then one final bullet point on bonds is that most U.S. investors don’t appreciate this is a global capital market. When I look on the screen, my Bloomberg screen for the world bond market, they’re almost always trading exactly the same way. Almost every global bond is up a point, down a point. And if you look at it, the U.S. tenure is very attractive relative to the rest of the world. The most extreme example is we’re about 60 basis points above Canada, which is really shocking. Canada’s not that different than the United States. Canadian [00:25:54] working for CIBC, Canadians don’t necessarily like to hear that, but similar capital markets. Most of the European economies are 100, 150 basis points below the U.S. So U.S. bonds are very attractive on a global basis and bond market have been rallying pretty close to down towards our target.
This employment report kind of set that back. We don’t think people should overreact to the latest employ employment report. Just keep in mind, everybody said, “Oh my god, we added 500,000 jobs.” But it’s important to note that we actually lost 2.5 million because that’s the normal cycle after Christmas is that you have a lot of layoffs, and then, the commerce department goes in and estimates, “Oh, well, normally you lose 303 million jobs. So, we actually added 500,000.” I’m not saying that the labor market’s not strong, but I wouldn’t overreact to this seasonal adjustment. There is also some changes in the way they estimate it. So they can be both the seasonal factors can be wrong and then their first estimate can be wrong. So we think it’s strong but not like overheating exploding like 500,000 jobs would indicate.
And this is just a graph of our index CPI-R. The reason actually we published the index is if you go to and look in the 2020 year, you can see that’s really started diverging from CPI in mid-2020 and then ran up at this pretty rapid rate. Well, if you annualized these rates, they hit 10%. So in October of ’20, it hit 10%. So it’s really the smoking gun cause I’m not being pejorative with regard to the Fed, I’m just looking at the facts, and the smoking gun of Fed incompetence is that they were buying 120 billion of securities, keeping rates at 0 when a reasonable index of real-time inflation that is not a secret cause it was just simply calculating like it was by the BLS before 1982 was signaling double-digit inflation, their targets too.
So, it just massive objective incompetence. But the other point now is you can see the deflation starting, the index is actually going down and they’re telling us that they’re worried about inflation because of the labor market, but they ignore the fact that services, non-shelter services is only about 25% of CPI. And of that, about 10 is transportation, which is driven more by energy prices than wages. So even though the economy is 70% services, that’s the economy, that’s not inflation. Inflation’s primarily driven by the goods sector, and a lot of things are called services aren’t even driven by wages, like insurance services are not. The key to that is not wages, it’s actually losses on insurance.
So we think the Fed is massively off base, but therein lies the opportunity because now we’re at the, towards the end of the tightening cycle, and so, the Fed is going to win the CPI and PCE core actually go close to three, which should be their target but isn’t. They’ve gonna at least halt and wait to see how far it does go down. So this is really key to our view is we’re more bullish about inflation than most market participants, but definitely the Fed. And we think the reason the markets rallied is they’re starting, not that they’re all subscribed to CPI-R, but there’s most reasonable people can tell that we’re in either rapid disinflation or deflation.
This is a graph of housing’s…total houses for sale, not just new but existing. And you can see here that if we had this chart up and we were given the presentation in 2007, we would be highly concerned because we have 4.5 million homes for sale. The average is 2.5. W build about 1.5. So we’ve basically had three years inventory, but now we have the polar opposite situation where, and if you look on a cyclical basis, we’re close to the cyclical bottom for inventory of houses, but yet the price is coming down because of mortgage rates. What’s bullish about this is it’s unlikely we have mass layoffs in the construction industry cause keep in mind that’s pretty much a 01 type industry. You don’t keep my father as a home builder. You don’t keep all of your construction workers around when you’re not building apartment complexes or whatever building you’re building.
So, this is unlikely to be a source for mass unemployment, and it’s an important point made it to this morning is that tech unemployment is… First of all, tech is a very small component of total employment. Secondly, I know from growing up in Silicon Valley that tech workers normally do not remain laid off for long periods of time. They’re highly educated, and they can work remotely. They can move from the new economy to the old economy because even companies like Honeywell need programmers and software engineers and even managers of tech. So, we don’t think that’s significant. But if you have mass layoffs of lower-skilled workers in the Midwest, which is a less robust job market, that can be a problem cause then you have the downward spiral. Unemployment, less spending leads to, you know, declining demand for goods and bad GDP.
And then, I talked about the monetary base, huge run-up coming down. I’m gotta move through these pretty quickly so we can get to the other rest of the presentation. And I’m gonna try to wrap up in 5 or 10 minutes. But here’s actually a chart of global bond yields and you can see how low Germany is, France, Portugal. The only OECD country higher than United States is Italy, and it’s only…This is the end of the quarter, so it’s higher than normal of the rates are now, but the gap is literally what we’re looking at. So Italy was only about 30 basis points higher the United States, and it has risk, of course, of being kicked out of the EU if they’re bond, if they can’t get their fiscal situation in order. I don’t think anybody believes that, but there is a risk. So very attractive on a global basis. Canada, well below the United States. Now, we’re into more of the discussion of how do you implement a balanced portfolio.
So, there’s really obviously two major asset classes. You have fixed income. So, this is a slide of the fixed income alternatives, and it’s arranged by correlation to treasuries, highest to lowest, and then really correlation to the stock market, sort of highest…or lowest to highest. So, obviously, treasuries have a one-to-one correlation, have a decent yields now. Municipal bond’s a little bit below that, same amount of interest rate risk or correlation. Well, half the interest rate risk of a government bond. Corporate bonds are starting to look attractive at 5.4%. We’re gonna talk a lot about preferred. This is the average preferred stock as yielding six. But if you look to rather than cap weighting the preferred index and look to other sectors besides financials, financials is 65% of the cap-weighted index. You can get significantly higher yields one of our REED fund yields well over seven and our other fund yields nearly double digits cause we’re not just focused on the financials. So you can get attractive yields with about modest stock market risk. We usually use 50% that says 45. So about half the risk of the stock, your [inaudible 00:34:46] better protection. High yield is attractive now at 9%. This is showing a lower correlation stock market than preferreds, which I guess might be true cause they’re not listed like preferreds are.
And when we’re talking about preferred, you’re talking about $25-listed preferred. So you can buy, easily buy individual securities on stock exchange, which is what we like. And then senior loans, we don’t have any funds in high yield or senior loans, but attractive asset class, lower beta to the stock market. Lower interest rate risk and decent yields but not super attractive. So, we recommend actually if you’re building a bond portfolio, you’d have exposure to all these asset classes. So a lot of people forget about preferreds, but when I built my… I don’t manage a lot of individual portfolios, but when I helped my friend build his, we added preferred stock. We added high yield. He already had the Vanguard total bond funds, so he had some of these other things. But by adding, you know, 5% to 10% preferred, 5% to 10% high yield, you get much higher yields. So we suggest being in all these asset classes. We think they’re all attractive, particularly after treasuries have run up so much and weren’t attractive at the beginning of last year.
And then on the equity side, this is also arranged by correlation to government bonds with the highest correlation being at the top. And then, stock market’s a little bit different than that, but generally, the risk goes higher. So we have utilities which we think are pretty overvalued. You can tell that by the yield. And I used to be utility banker, so these companies are way more highly valued than when I was a banker doing utilities. REEDs we think are goodbye depressed last year. Too much pessimism about cap rates and the value of long-term real estate. Telecom’s attractive. That’s really AT&T, Verizon, the stocks have come off, so have good yields. MLPs, we really like a lot here. They’re become much better asset class, better capitalized, we’ll talk about that more. High dividend yield stocks. We have ICAP, the trades, and these 4.4 average. Our fund, we use low leverage and some preferreds to get a higher yield than that. And the S&P is only yielding 1.7%. So pretty fully valued. It doesn’t really get you to that kind of 4% to 5% nut that we’re seeking.
And then, just in terms of value building these portfolios as I mentioned, we think even younger investors should have some fixed income component, if for no other reason to rebalance if the stock market didn’t work last year. But normally, when the stock market goes way down, the bond market actually rallies so you can reallocate so you’re able to buy at the bottom. So in this hypothetical portfolio, we’re saying the yield of a 30/70, by the way, these yields are way higher than they used to be, would be 4.67. If you put in more fixed income, you can get to six. And then if you’re 70% fixed income, so be a pretty conservative investor with real big income needs, 7%. So, we think there should be a component of fixed income and equity income, cause you’re never gonna get to these yields unless you have pretty good income, not just 1.7, but better income coming from your equity portfolio.
And now we’re just gonna cover some of these asset classes pretty quickly. I’m just gonna check the time. So, go through these in the next three to five minutes. So high dividend, large-cap stocks. We like large-cap stocks, they’re lower risk in general than small-cap stocks have lower betas, better credit ratings, been around longer. All times, they’re dividend aristocrats. And you can see over the long run since 1991, you’ve actually got nearly the same return as the NASDAQ for which way lower volatility, better sharp ratio, and of course, better income, which is critical, particularly for conservative investors, conservative value investors like us. And then, just gonna talk a little bit about the fund we have in this sector. So, it’s been… These stocks do have lower beta as I mentioned. So they easily outperformed the S&P last year. They’re also doing well this year, so pretty resilient in a lot of markets.
We do think the market is, you know, probably range bound. So if you’re gonna add stocks, it’s probably good to do these more conservative stocks. The fund is well diversified by sector and also by companies. So we have 80 companies, and our company’s significantly more than 3%. And then we do add a little bit of active style management, and then, we run low leverage about 20% and we buy preferred stock with that. And that’s why you’ll see the yield on ICAP is well above 7% versus the index we track is about 4.5%. So we have a little bit of bias towards higher-yielding stocks. We also have that preferred portfolio which has attractive yields, particularly now cause preferreds are undervalued in our opinion and have come off very well below trading level at par.
So we have, as I mentioned, diversified, well, good diversification. We are constantly monitoring the portfolio, looking at the valuation, and can see the SEC yield is very high, 9.54%. Sometimes that’s a little bit higher than our distribution yield. So it’s well-covered dividend and most of the dividends are going to be qualified dividends. So, it has good tax characteristics. And then, preferreds, we’re strongly recommending, particularly for clients that don’t have exposure to preferreds, to add them now. And the reason for that is pretty simple. They’re callable at par. These are all… We’re recommending listed preferreds. So they’re callable at par, so they’re pretty attractive when they’re trading around par, but they’re super attractive when they’re trading where they are now, which is our fund, our flagship fund. PFFA is roughly trading about 21. That’s indicative of the underlying preferreds. So you’re getting $4 discount to the call price. So you have the potential for equity-like returns, which would be going from 21 to 25.
So back to par, which normally happens when you get out of a major cycle. It happened in ’09, happened during the pandemic, we think it’ll happen again. So you get at least that potential but while you wait, you get good dividends. PFFA almost yield yields well over nine. And then you get enhanced safety at least relative to common, not relative to bonds but relative to common because a lot of times companies will shut down or virtually eliminate their common equity dividend and maintain their preferred dividends. And you might say, “Well, why do they do that?” It’s because they’re trying to target. Most of the companies we invest in are investment-grade bonds and double B preferreds. So, they need to defend their investment grade credit and they’ll do whatever it takes. And the last thing they wanna do, including selling assets, selling bonds, reducing dividends, common dividends. Last thing they wanna do is go into the rating agency and say, “Oh, yeah, we have a great credit. Look at what we’re forecasting. So you should maintain our investment grade rating. Oh, but by the way, we’re not paying our cumulative dividends on our preferred stock.”
And so, 90% of our fund is cumulative. So there’s really no incentive to not pay it cause you’re gonna owe it back anyway unless you think you are gonna go into bankruptcy. And of course, we pick credits that we think have a very, very low probability going into bankruptcy. And if it seems like we made a mistake, we would sell them hopefully at relatively high prices because that is the disadvantage of preferred is they don’t do well in bankruptcy. So you want solid credits, you don’t wanna do distressed investing in preferreds.
And the only thing that’s really critical about preferred is that the 30-year default rate, these are listed preferreds, again $25 preferreds, the default rate is very similar to an investment-grade bonds, about 0.33% over 30 years, that’s a Moody’s figure, versus 0.1 for investor-grade bonds and high-yield bonds are well over 3. So you can get attractive yields with modest defaults if you have active management, hopefully, de minimis defaults even below this number. No guarantees, but that’s why we’re monitoring all the credits. So quite an attractive asset class should be added to most clients’ portfolios. Even if you don’t use our ETFs, you can pick individual stocks, you can find other ETFs. But of course, we do like our own ETF. We’re also the largest holder of PFFA and have 600,000. Our firm owns 600,000 shares. So we eat our own cooking.
So I’m gonna wrap this up pretty quickly now. It’s not relevant right now. The other risk with preferreds that argue for active management is if they do trade above par, you wanna sell them. But index funds don’t do that. So you can end up owning securities through the ETF that are trading above par, callable par, which is really arguably even a violation of fiduciary duty cause you can lose money at any moment when it gets called. I won’t get into this a lot, but ETFs, we do use modest leverage in our ETF but well below closed-in funds, and we also dynamically manage that. So we keep it capped well below 30%. And so that does help us enhance returns over time. This is a risk to preferred, you know, the key risk, interest rate risk.
We manage that through having higher coupon securities, default risk, I mentioned, and then call risk are three of the major risks. They also just have mark to market risk. And they’ve talked a little bit about PFFA, reasonable fees, attractive returns relative to other funds. SEC yield has estimated 11.54, that’s well above the distribution, so covered dividends. Performance has been superior to other ETFs since we launched it. REITs, we have a preferred stock fund PFFR that invests in the preferred REITs. We don’t have a REIT fund. We do think REITs are attractive. Even office REITs. We do think that market will come back. It doesn’t really matter if employees go in four days or five days, there’s still a demand for office space. We have more office space and roughly the same number of employees cause employees need more space because of potential for COVID and that’s just a demand. If you’re gonna come in the office better the nice office. So we’re bullish on REITs but I won’t spend a lot of time on that. We just have a REIT preferred stock fund, which is REITs are good credits, they have low leverage.
And then, we’re gonna talk about master limited partnerships for just a couple minutes. The most important thing to note cause some of you on the webinar might have PTSD from holding MLPs in the past, but what happened is they were structured as growth stocks. So they had relatively high leverage, low dividend coverage, no retained earnings, no sheer repurchases. And the notion was they’re gonna issue equity to grow. Well, they got attacked by hedge funds and of course, energy prices came way off. So that model blew up. So in response, all the large-cap companies have now adjusted dividends to be well covered. Usually, about two to one covered with free cash flow.
So they’re retaining earnings, which they’re buying assets, growing earnings. So they’re able to raise a dividend, they’re buying back shares. So hedge funds aren’t attacking them anymore. Their leverage is down. Some of them EPD-ing. One of the leaders enterprise has a three…is only three times levered, which is very modest for a pipeline company. So these companies have repaired themselves, but yet a lot of people are shunning them because of the fact that they haven’t performed well. They also shunned them because you get something called K-1, which is partnership return. It’s very awkward unless you have like a very expensive CPA to file it. Our fund is a corporation so you don’t get the K-1s, you get capital gains treatment instead of recapture if you sell it. We do think that energy prices are gonna be relatively strong this year, 80 to 100. So that’s a good support for MLPs, and we have fund risks. It’s correlated to the energy sectors. Been pretty volatile, we think the volatility’s calmed down, but no guarantees on that side.
And so with that, Jimmy, I would turn it back to you to see if we have any questions or maybe you can manufacture a few questions if we don’t.
Jimmy: Yeah, that’s great, Jay. I don’t know if I’m gonna need to manufacture any, we’ve got plenty of questions from the audience. We’ve got eight minutes left until the top of the hour. We might go a few minutes over but we won’t hold it against you if you have to bug out at 1:00 PM Eastern time. Let’s start with Ian had a couple of questions for you, Jay. His first question is, “What will the yield curve look like?” And he didn’t indicate over what time period, but I don’t know if you have any thoughts on yield curve.
Jay: Well, yeah, so the situation we described where the market is ahead of the Fed is why we have an inverted yield curve and we think it probably will remain inverted for the next two years because we do have this Fed that likes to look in the rear-view mirror to drive the bus. Fortunately, we don’t think they’re gonna drive the bus off the cliff because of post-pandemic tailwinds, but so we think it’ll be inverted for the next couple of years. Eventually, the Fed will drop it probably back to its long-term equilibrium, which is probably about 2.5% slightly above their long-term target for inflation. We do think the long bond, the 10-year and the 30-year will settle into this three to three and a quarter because of the retirement boom that we have. And also, we’re gonna have modest growth in the U.S., Europe and China. So that’ll should keep lids on long-term rates.
Jimmy: Good. Ian’s second question was, “What is your view on financials, the financial sector, financial stocks?”
Jay: You know, we like the financials. We think that people became too fearful of mass write-offs of loans. And so, we particularly liked regional banks that don’t have exposure to being an investment banker like I used to be. Good, boy, do I know, in downturns, you do not want to be an investment banker. And so, Morgan Stanley’s been pretty resilient cause they have a gigantic wealth business. Goldman Sachs has underperformed, JP Morgan, Bank of America to a lesser degree. Now, having said that, so we do think that yield curve is very positive for banks. Keep in mind, they don’t really care about the tenure. They borrow short-term and lend short-term. So it’s really the spread between deposits and what they can charge corporations mostly, but anything with floating rate. So their net interest margins are exploding. We don’t think credit’s gonna be a big problem.
But if you do subscribe to our bullish thesis about the market, later this year, at some point, people will realize the Fed’s gonna pause. And so, you probably wanna be in the riskier investment banks because you’ll see more offerings and there’s actually a fair amount of fixed-income offerings going on right now. So, there’s a little bit improvement investment banks, so you can figure out that rotation but generally, we’d like financials and can think people have overestimated default because you’re assuming there’s gonna be mass unemployment which the data don’t support particularly on housing and autos.
Jimmy: Next question coming in asks, “Jay, what do you believe are the best asset classes for a blended growth and income portfolio versus pure income?” So, maybe this question was thinking of that moderate portfolio that you presented earlier. Now, I know you already mentioned four different asset classes that you like, dividend stocks, the dividend aristocrats you mentioned as well in that category, preferred stocks, REITs and MLPs. I don’t know if you had any other commentary on…
Jay: Well, certainly, this gets…
Jimmy:… other asset classes like.
Jay: That’s really a great question because you don’t have to go into the ultra-conservative like a lot of the portfolios from that I have for like my IRA probably yields 8.5%. But yeah, you can take those asset classes and say well actually I’ve got a younger investor that’s willing to take more market risk cause they have a longer-term horizon would actually argue for not really having any treasuries. Maybe some muni bonds depending on their tax situation. But having a bigger slug of high-yield bonds and preferreds cause there you get closer to equity-like returns like 7, 8, 9, and then, a lower allocation to fixed income like 30 is a reasonable number. And then, on the equity income side, yeah, maybe you do have a pretty big tech allocation but you could still have set of 5% MLPs.You could still have one or two cuz we do think that there’s good total return there, not just income.
REITs, we think are not just an income investment right now, but really a return to normal cap rates for the underlying assets. So, you could have some of that, that’s a riskier asset class, but maybe right now avoid utilities, void telecoms cause they’re not that undervalued. So sort of take the same approach but add a little bit of risk and we have those parameters there, you know, risk being correlation to the stock market or higher betas and less correlation to the bond market because if you have a longer-term horizon, you don’t need to necessarily have….treasuries should not last year but should actually go up when the bond…when the stock market’s down. But if you’re not as concerned about short-term volatility, you don’t need the treasuries, you don’t need investment grade, you can have the lower credits, maybe some munis cause of taxes. So you can take that slide and build a higher beta portfolio that’s gonna have better growth in the long run.
Jimmy: Next question’s a bit technical but hoping you can clarify this for this person, “Can you explain the difference between the various yield metrics for instance the SEC yield versus the distribution yield versus any other yield metrics that you like to use? What are the technical distinctions between those different metrics?”
Jay: Well, so the SEC yield is an estimate that the SEC requires and so that’s beneficial because you can’t use your own judgment. And what it attempts to do is take the portfolio exactly as at the end of the month or quarter and then look at what the income that’s should come from the portfolio based on their dividend yields and then subtracts us off expenses like borrowing. It’s not a 100% accurate like I’ve actually the distribution. So distribution yield is just simply what we’re paying out to our investors. And so, most advisors like to have a SEC yield that’s either above or similar to the distribution yield because they don’t want their clients to get what’s called 19as or return of capital notices. And they don’t want their NAV of what they hold to just slowly go down as they book all this income.
So, we structure our funds so they’re close to being covered by cash so that the SEC’s an estimate of a cash. It’s not perfect like I said. Sometimes it looks a little bit high to me, but it’s a good estimate, it’s objective and it’ll allow you to eliminate certain funds. We’re aware of many, many funds we won’t pick on anybody where they pay out seven or eight, but they’re SEC yield is two or three. So you’re really just getting back your capital and they’re calling it yield, which doesn’t really do what you wanna do, which is you should be able to take your income and spend it confidently and not assume all of your investor’s investments are just gonna decline, you know, rateably with the amount that’s not cash covered.
Jimmy: Regarding some of these income asset classes, preferred REITs, etc., are the publicly-traded funds valued at a discount compared to private funds right now, broadly speaking?
Jay: Yeah, so, and not to pick on your…the other, your other clients and funds that you focus on, but generally speaking, the stock market is far more volatile than the private market. And so, there’s no doubt, you know, [inaudible 00:56:35] being the sort of poster child that the marks in the private market are much higher than the marks in the public market. Now, you could argue, well, that’s fraudulent cause you’re not properly marketing your private portfolio. But I would also argue it’s also just a market inefficiency. Like preferred stocks shouldn’t be trading at 21. So, I mean we don’t have private funds, but to me, it wouldn’t be completely irrational to say, look, these preferreds are all great, they’re all paying their dividends, they’re all extremely well covered so we’re just gonna mark them at 25. I don’t care that these retail investors have dumped them and they’re trading at 21.
So it’s unclear whose, you know, marks are better but therein lies the opportunity. You can buy discounted securities like you can buy portfolios of office REITs, retail REITs, these ones that have been really out of favor that discounts to what arguably could be sold today now the private market’s a little bit slow now cause it’s hard to get financing, but where they arguably could be sold. So, we think that right now sometimes they’re actually traded premiums. You have to be careful, but right now you’re getting these assets that are like alternatives, in fact, have private funds. There are alternatives in the public market and you can access them through ETFs close-in funds. So our ETFs all are arbitraged by market makers. So, they trade close to the public market value but close-in funds will trade in premiums or discounts.
So you have to look at that, makes it more complicated to own because you have to kind of play that. Whereas with our funds and all ETFs, you can be confident when you’re buying and selling, you’re trading at NAV close to at least. So you don’t have to manage as closely. Like I know some, even some preferred stock funds, one that we track as a competitor is trading at a slight premium. So you don’t have to worry about that though and you don’t get kind of double hit on the downside. Like, if you buy a slight premium market crash, cracks, and then the premium goes to negative 10, you kind of have losses on top of losses. Whereas ETFs is gonna track the public market valuation of the securities even if the public, you know, the public may be discounted, but at least you get what it’s actually trading on in the market are close to it.
Jimmy: Good. Well, we’ve got I think we have got just one more question. We’re a couple of minutes over but we’ll get you out of here quickly. Last question, is why not buy one and two-year treasuries in 5% CDs if you’re seeking yield?
Jay: You can. What you’re missing there is just the opportunity to get higher returns and buy these securities at a discount. But if that hits your bogey and you want to completely sleep at night, then that’s a perfectly reasonable strategy. It’s just, for most investors, that’s not enough. So they would like to get more. And keep in mind also that when you roll those securities, they could very well be lower, you know, if I’m right about the short end coming down, you’re gonna be getting five and then three years from now you’re being two. Where if you buy preferreds and you can pick, and by the way, if you wanna pick individual preferred, you can look in our portfolio holdings, but…and we’re happy to help people do that.
It’s reasonable to buy our fund and some of the underliers, but you can get seven, eight, nine, and if you believe the company’s good, then you’re gonna continue to get seven, eight, nine. So, it’s gonna both higher than what you can get in short-term treasuries and then likely to be sustained. Whereas, I would argue because of those charts I showed that that’s gonna trend down over the next three or four years and then you’re gonna be, if that doesn’t hit your not, then you’re gonna be running down your principle to pay your expenses, particularly in retirement, That’s not that fun. So that’s the trade-off is risk-return, kinda obviously.
Jimmy: Excellent. well Jay, it’s, it’s been a pleasure hosting this webinar with you today. Great insights. Our audience of high-net-worth investors and advisors can head to infracapfunds.com to learn more and, and get in touch with you, I believe. Is that right?
Jay: That’s correct. And also, there’s a question, would you please share the deck in addition to the recording? And I think you folks are gonna do that and you can contact us through our website, www.infracapfunds.com and we can send you the deck if you’d like to receive that.
Jimmy: Perfect. Thank you, Jay. Yes, we will get this recording out by tomorrow and we’ll also have a link to the deck on our website. We’ll email everybody who registered for this webinar with that information. So sit tight, we’ll get that out to everybody by tomorrow, Jay. And Jay, thanks so much for joining us today, and everybody who attended, thank you for your participation and for attending today. Thanks so much.
Jay: Thanks, Jimmy. Great hosting. Thank you. Bye-bye.