Lead-Lag Live

Navigating Volatile Markets Through Income with Jay Hatfield

• Michael A. Gayed, CFA

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Amid rising market turbulence, finding stable income sources has become increasingly crucial for investors seeking portfolio resilience. In this compelling discussion, Jay Hatfield draws on his 35 years of Wall Street experience to illuminate the path forward for income-focused investing strategies that can weather economic uncertainty.

Hatfield challenges conventional wisdom with his razor-sharp macroeconomic analysis, demonstrating why tariffs are actually deflationary rather than inflationary and how this misunderstanding creates opportunities for well-positioned investors. His forecast that the 10-year Treasury will drop to 3.75% as the Federal Reserve finally acknowledges economic slowdown provides a framework for strategic positioning across asset classes.

The discussion reveals why traditional S&P 500 portfolios yielding just 1.3% simply can't generate meaningful income in today's environment. Instead, Hatfield outlines a comprehensive approach using preferred stocks (PFFA yielding ~9%), high-yield bonds (BNDS yielding ~8%), dividend-paying stocks, and reformed MLPs to create substantial income streams while managing risk. His insights on small caps are particularly compelling – currently trading at significant discounts to large caps, they offer both attractive income and growth potential as rates decline and M&A activity accelerates.

What sets this conversation apart is Hatfield's practical approach to portfolio construction. Most investors unknowingly carry excessive technology exposure through their index funds and individual holdings, leaving them vulnerable to tech sector volatility. By strategically incorporating income-producing assets, investors can create more balanced portfolios that generate consistent returns regardless of market conditions. As Hatfield notes, "staying out of trouble is about 90% of the battle" when it comes to long-term investment success.


DISCLAIMER – PLEASE READ: This is a sponsored episode for which Lead-Lag Publishing, LLC has been paid a fee. Lead-Lag Publishing, LLC does not guarantee the accuracy or completeness of the information provided in the episode or make any representation as to its quality. All statements and expressions provided in this episode are the sole opinion of Infrastructure Capital and Lead-Lag Publishing, LLC expressly disclaims any responsibility for action taken in connection with the information provided in the discussion. The content in this program is for informational purposes only. You should not construe any information or other material as investment, financial, tax, or other advice. The views expressed by the participants are solely their own. A participant may have taken or recommended any investment position discussed, but may close such position or alter its recommendation at any time without notice. Nothing contained in this program constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in any jurisdiction. Please consult your own investment or financial advisor for advice related to all investment decisions.

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Speaker 1:

For those that are starting to come in here into the webinar. Give us just a second to make sure everybody comes in. I think this is going to be actually quite informative from a lot of perspectives. Jay, candidly, has been spot on a lot of his macro calls and his funds is quite strong. I think this will be very eye-opening from the perspective of how to think about generating income in an environment which is increasingly getting more volatile, which personally I enjoy. I will be popping in and out. This is Jay's show. If you don't know Jay Halffield, you unequivocally should know Jay Halffield. I've been doing more of these with him and I've very much gotten to enjoy his view on markets. So, Jay, this is all you. As you can tell, he's not exactly in his office right now, nor is on a virtual background but you're getting the full, unfiltered J-Half right there.

Speaker 2:

Thank you, michael. Thanks everybody for joining. So we're going to go through an overview of our fund, spend a fair amount of time on macro because I know everybody's pretty concerned about macro right now I think maybe a little bit over-concerned and then just talk a little bit about some of our funds that are relevant. And then just talk a little bit about some of our funds that are relevant. So, just in terms of our fund, we believe in investing in super high quality companies, a lot of time in old economy industries with a lot of assets, particularly on the credit side. We also believe in super high quality large and small cap stocks, but specifically they're profitable, trading at reasonable multiples, have low leverage and typically pay dividends. And we think if you stick to that philosophy either by buying the funds or doing it yourself you will stay out of trouble. Either by buying no funds or doing it yourself, you will stay out of trouble, and staying out of trouble is about probably 90% of the battle. If you look at your returns on some of your portfolios and if you have some wipeouts or some huge decliners, you can wipe out a lot of solid income, as I've been on Wall Street for 35 years. I have a CPA from Ernst Young, undergrad degree in monetary economics from UC Davis, mba in finance with distinction from Wharton. 15 years as an investment banker, mostly at Morgan Stanley. I've worked for two hedge funds and then launched my own money management company in 2018, founded an MLP and then launched our six ETFs, the first being AMZA in 2014.

Speaker 2:

So we have the best way to think about our funds. We have three that are in fixed income. The best way to think about our funds we have three that are in fixed income. So the biggest is PFFA. That's a preferred stock fund. Bnds is a bond fund. That's similar to PFFA but it's senior. It's a lower risk, less volatility. Scap is our small cap dividend income fund. We do write some index calls there. Icaps are um large cap dividend strategy. Uh, we do write a lot of short term individual calls. You can do that with large cap, not small cap. The AMCA is our um is our MLP fund and we do also have PFFR. If some of you own that. That's an index read preferred fund. And we did recently launch our hedge fund.

Speaker 2:

In case anybody's interested and is an accredited investor and looking at those materials, but we don't usually talk about that in the general audience very much. So in terms of the market, I'm not going to go through so we don't usually talk about that in the general audience very much. So in terms of the market, I'm not going to go through every one of these slides, but where we've been 100% differentiated is that, instead of following the political talking points that the Trump administration's policies are inflationary, we actually do what's called economic analysis on those policies. So, specifically, the most important is tariffs. Tariffs do not cause inflation, they're actually deflationary and, most importantly, they're recessionary. So they're sales taxes, the equivalent of a sales tax. So if you think about a sales tax, like an extreme sales tax, say 50%, what would the economic impact of that be? Well, it'd be highly deflationary. You're taking money away from the consumer paying down government debt. That's very deflationary. The demand would drop significantly and the people, like the Fed, would look through the one-time price increase because it's never going to be repeated at 50%. So, whether it's 50% or 5% or 10%, that's the way they analyze tariffs. So that's at the margin.

Speaker 2:

Policy of deporting criminals and or recent immigrants who aren't working is mildly deflation, irrelevantly deflationary. But the whole notion that it's inflationary was ridiculous. Inflationary, it was ridiculous. Also, if you listen to the Trump administration which a lot of people don't prefer to do, but if you do you'll hear that they're trying to admit more wealthy investors they talked about that yesterday and also H-1B immigrants. Those all are highly trained, are deflationary, do increase economic growth. So it's important to try to leave your politics behind and just analyze what the actual policies are.

Speaker 2:

And then the other element about tariffs that's critical to us is it does raise revenue. It could raise up to $2 trillion of revenue that could be used to fund tax I'm sorry, corporate tax decreases and those are the taxes that matter. So I wouldn't focus too much on the individual taxes or the tariffs. What matters is corporate taxes. If you're a stock investor, so if there's a cut in the corporate tax rate to 18, our target goes up by 400 S&P points because earnings estimates goes up. So this is not like a political subjective argument. Simply, the companies earn more. Plus, say, multiple stock prices go way higher and we saw that in 2017. There was a lot of deniers back then. President Trump then was highly unpopular versus now just sort of 50-50 unpopular. So you know we do have the other tailwinds. So even if we don't get quite to 18% deregulating the antitrust side of it, other deregulation is all positive for multiples and stock prices. So we're comfortable for multiples and stock prices. So we're comfortable.

Speaker 2:

It's unclear exactly where the tax bill is going, but I think there will be some significant corporate tax relief and we think that we're bullish on the market. Short term we're neutral because it's not earning season. That's a simple way to trade the market. It could long when it's not earning season. That's a simple way to trade the market. You get long when it's earning season and you get less long or not short, but less long when it's not earning season. So it's not earning season at nvidia yesterday, but that's not earning season. That's one data point. Wasn't fabulous, so salesforce wasn't was negative, so you're saying it took off today.

Speaker 2:

But we're really in a news vacuum. We are bullish about PCE core being in line with expectations at 0.3. That means it rolls down to 2.6. We think that clears the way for the Fed to cut rates, because we do think the economy is very slow. We have ultra tight Fed policy, as evidenced by not only the fact that the yield curve is inverted but also by the fact money supply is growing a negative 5%, which is deflationary. Inflation mark-to-market on a real-time basis is below the Fed's 2%, both on CPI and PC Corp percent, both on CPI and PC Corp. And so the combination of tight monetary policy and then these deflationary slash, recessionary policies of the Trump administration, tariffs, but also Doge job cuts up to 300,000, that's negative for economic growth.

Speaker 2:

We're hopeful and expect the Fed to figure this out. It seems like they're slowly figuring out Still to get three rate cuts. That's getting price in the market. So everybody's coming around to our view. We're about like 56 base points, so not that far from three rate cuts. So we get to three grade cuts. We don't think we'll have a recession. And then the last kind of macro point is that the best cure for higher rates is lower rates. So we had this non-consensus view and rates are 480. Now they're at 430. Well, that's a lot better for the economy, it's better for the housing sector, it's better for the auto sector. So if the market just anticipates Fed cuts, then that's good enough to keep us in the 2% growth area. The market doesn't anticipate maybe one to two. We don't see a recession because of tech spending being very strong.

Speaker 2:

We do think M&A volume is going to accelerate throughout the year. It takes a long time to get M&A deals announced. It sounds easy but it's not. It takes six to nine months. So we're bullish on investment banks and also on small caps because they tend to get bought out more than large caps, just for obvious reasons. It's easier, it's more creative, easier to get the deal done, easier to finance. So we're bullish on small caps.

Speaker 2:

Talked about this already Fed's way too tight Administration policies are recessionary. Adds up to slower growth. That's becoming consensus over the last couple weeks. We're talking about it a month and a month and a half ago. So these are the rate cuts. This is just like a few days out of date. So it says 37 base point cut in the US, but that's up to 53. So it's been tracking rapidly higher. But you can see we're going to have global rate cuts.

Speaker 2:

Global monetary policy matters because rates are global. So we think it's a bullish time to invest, notwithstanding today's tech wreck. This is on our website. So we've been among the most accurate forecasters after the last four years, over the last four years. But we don't have some secret model. Our key advantage we're giving you the keys to the kingdom. Our key advantage we're giving you the keys to the kingdom. Our key advantage is, we think the money supply matters for both inflation and also economic growth. And so if you just follow like this monetary base, you can see it peaked in late 21.

Speaker 2:

When global central banks are tightening, you want to be out of the market. Right now they're loosening, our Fed's going too slowly but still bullish time. And then you have deregulation, us lower tax rates, so pretty easy to stay long and pretty normal to have these pullbacks when we're not entering season, so we're not concerned about it. Uh, six thousand targets. So that means right now, in the short run. So market goes over six thousand. I mean sell it sell, and then you know, if it goes to 5,900, 5,800, 5,700, it becomes more attractive. Then be cautious, though, because the next catalyst, well, tomorrow's PC, but after that it's really earnings season, which is really April. So we've got a fairly long period of time before we get an obvious catalyst or rally. So it's okay to be cautious.

Speaker 2:

Now the Eurozone's a different story. They're definitely cutting their disaster inflations down there. They blew up their economy with the poor energy transition. Ukraine war, um over regulation under savings. So you're. The reason we put this here is that europe and the rest of the world has to cut. The US can get away with not cutting, probably so that's bullish for global equities and actually European stock's been doing well. We don't necessarily recommend that, but they got super cheap so they're rallying.

Speaker 2:

We talked about this. I'll give it just a little bit more detail. On bonds, we are forecasting 10-year. It's now at 430, goes to 375. We estimate the terminal Fed funds rates 275. That's normal, that's inflation plus about 50 to 75 base point premium, and then the normal premium between the Fed funds and the 10-year is 100 base points. So 275 gives you 375. That call looked a lot worse when the 10-year was at 480. I do think to get below four we're going to have to get the Fed to finally figure out the economy's weakening. The Fed acts as if its third mandate is to be behind the curve, so they may take them a little while, but that's going to be the catalyst probably that takes us down below this 430 level.

Speaker 2:

Everybody thinks and always obsesses about the US budget deficit and other problems in the US, but they don't recognize it's a global bond market and all of those negative things are already reflected in our bond yields and so we think particularly if the Trump administration is more fiscally prudent which they're making noises about that that our rates could drop down to like Canada, which is obviously a similar economy, and they're 10 years at three, so that would be a lot lower than even our forecast. But it's important to keep in mind it's a global bond market and US rates are extremely competitive. Just another chart of how terrible Europe was. The other thing that's slowing the real economy is just high mortgage rates. Anything over seven is going to choke off.

Speaker 2:

Housing Housing is already in a recession and this chart says 1.8 or 1.79 times more expensive to buy a home than rent. So if you're a new couple and thinking, oh, it's a great time to buy an apartment, and then you go look at the apartment and say, oh, maybe it's not a great time because it costs 1.8 times our rent to service a similar apartment. So that's why the old economy is slowing. Commercial construction is slowing, offset by tech spending, but we are definitely slowing. This is a good chart because if you listen to television which I recommend um, everybody will obsess about the consumer and say, oh, the consumer is two-thirds, so that's what drives recessions, and so we're either predicting recession or not because of the consumer.

Speaker 2:

But what they're missing is all recessions are caused not by the consumer. The average drop in consumption during recession is zero, so it's very resilient, but the average drop in investment is 13%, so that smaller investment is about 20% of the US economy. So that smaller component, being so much more volatile, creates recessions. It comes from Fed policy. They hammered the housing and and construction markets just like they are now. That produces layoffs, which then produces less consumer spending, and that creates recession. So that's a normal pattern which very few people seem to appreciate, but that's why we're obsessed with investment. It was was down last quarter. That's negative, continues to be negative on the old economy side, so we think it's pretty clear growth slowing rates will go lower. We still don't think there's going to be recession, though, mostly because of tech spending and also, hopefully, the Fed cuts rates and also, like I said, the markets cut rates for the Fed by 50 base points, so that should help stabilize the housing market.

Speaker 2:

And this is just our index that I mentioned. You get this on the website and, if you look at it closely, cpi-r, so that's real-time rents tracked from below market rates or, I'm sorry, below the CPI shelter calculation, which is about two years behind what the market's doing. It's important to look at real-time inflation and, by the way, it's important to look at it both on the upside and downside. Right now we're on the downside. You can see from the chart that the Fed had followed CPI-R on the way up, they would have raised rates way sooner. So they really get damaged and we've been recommending the Fed reform their policy framework because they focus on this index is two years behind, so they miss the inflation increasing and they also miss it decreasing, so they're always behind the curve.

Speaker 2:

So then getting into our funds and how to build an income portfolio. So obviously, to build an income portfolio, you can see the yields here on the S&P is only 1.3%. So if you buy S&P equivalents, your portfolio yield is going to be about 1.3%, and that's clearly, unless you're a billionaire, your portfolio yield is going to be about 1.3. And that's clearly, unless you're a billionaire, not enough to move the needle from an income perspective. And so if you want more income, you have to layer in some of these other securities that are equities to get equity upside, but more income, but the other thing to pay attention to is and this is done in order of risk so utilities have the least market risk, down to the S&P 500, which has a normal market risk.

Speaker 2:

And so if you look at the utility sector, it's highly correlated, though, to bonds. So you're basically taking interest rate risk with very low about 50% correlation to the market. Reits are similar 81% correlated to bonds, 57% to the market. Same with telecom. That's really AT&T and those type MLPs. We have an MLP fund, amca. That's an interesting asset class because right now it has very low beta the s&p 0.3 and no interest rate risk in today's market at least large cap dividend stocks. So that's like icap or large cap dividend fund.

Speaker 2:

So negative correlation to bonds, you're not taking industry risk and lower than the market at 0.82 and higher yield. If you just buy the index at four, our funds is closer to eight, and then you can see how that obviously compares to the S&P right now a lot of times is negative, but because of 2022, has just a 25% correlation to the market. Same thing. So you can be in all equities and build pretty decent income from just using equities, but a lot of more conservative investors want to use some bonds as well, and this, like the prior chart, is in order of risk, market risk lowest market risk being on the top. But also the inverse is true, because typically the ones at the top have the highest correlation to bonds. So treasuries obviously have a high correlation to themselves. So that's one, and a low correlation to the market at 0.2.

Speaker 2:

Municipals similar but not quite as high 0.58, 1.0, 0.19. Corporate bonds a lot of industry risk and more beta to the stock market. Preferred stocks PFFAs are flagship funds. The current yield is 6.6 for the index, but our fund's 9. Correlation of government bonds 0.79. So those have well, particularly the index, more than PFFA as interest rate risk and modest risk to the S&P at 0.6.

Speaker 2:

High-yield bonds BNGS is our fund. There we have a higher yield at eight. Similar risk characteristics. Low sensitivity to bonds because they're getting higher yields, that's less sensitive to bonds. Lower sensitivity to the S&P lower sensitivity to the S&P and also, just on an absolute basis, high yield bonds have quite low volatility at 9%. So you know, below the S&P, well below the S&P, like a quarter of the S&P and senior loans we don't have fund there, but they were a good asset class to be when rates are going up, have low interest rate sensitivity because they're floating and pretty low sensitivity to the S&P. So that's definitely worth considering as an asset class.

Speaker 2:

Convertible bonds aren't really that attractive from a risk reward. You get a little bit extra yield at four but you really get a beta. The market is pretty close Well, it's 0.8, so it's pretty high. So you can consider convertible bonds but it doesn't give you that much more income for the risk you're taking. So now we're getting into our funds a little bit Small cap value stocks.

Speaker 2:

So when S-Cap is our fund there, we focus on companies that are profitable. 40% of the Russell 2000 are unprofitable companies, a lot of biotechs, pretty risky companies. We also require that every company has a substantial dividend, as I mentioned earlier, has low leverage, reasonable leverage, strong credit metrics, um and um has good dividend coverage. And then finally, probably most importantly, trades that are reasonable, multiple growth. We also look at yield, but for small caps yield is not that important, so you don't want to. You know it's fine. It's exciting to buy Palantir at 110. It's trading at about 150 times earnings, so you can do that, but you're basically gambling, so we don't do that. We buy companies that are cheap to their. The growth rate of Palantir is like 25%, so maybe you could justify a 50-60 multiple, but not 120. So once you get above those valuations you're basically gambling, so we avoid those kind of stocks.

Speaker 2:

We do think that it's an attractive time to add small caps. When rates come down, typically small caps outperform or when you come out of a cycle they outperform. They benefit from M&A. They're inefficient. We have detailed research cover on every company in our portfolio so we have analysts with quarterly estimates coming up with targets and valuation so we can add more value with small caps because there's no sell side coverage there. And also nice thing about small caps is domestic exposure, so less exposure to tariffs or new tariffs, whether it be in us or retaliatory tariffs. We do think small cap values a better approach Get rid of the money-losing companies, get rid of the biotechs with new drugs Not established biotechs, but biotechs that are losing money with established drugs.

Speaker 2:

So long-term, notwithstanding recent last two or three years, small caps have had very good long-term returns, typically depending on the period and excess of the market. As I mentioned already, we curate away the money-losing company and all its companies and also these super high PE companies. So you know we're much less likely to have blow-ups. And then when companies report, typically they report decent earnings, as they normally do. You get pretty good price appreciation um and you can look it up on our website. But s cap has dramatically outperformed the index. But do your own research on that. In terms of returns you can see that um the current p multiple um, normally it of the markets sort of in line with small caps. Right now it's trading at like nine times multiples higher. It's also I think we might have a chart in here. But it's important to look by sector too, because a lot of that overvaluation from large cap stocks. So this is just the overview of the sector, so pretty well diversified by sector, and here you can see the performance of Beacon Index. But quite a bit, it's pretty straightforward, as I mentioned, you just curate these companies that are profitable, trading at reasonable multiples and high quality, and it works pretty well.

Speaker 2:

The next fund I'm going to cover real quickly is high cap. That's our large cap um high dividend stock fund um. You know these companies in the sector have good shock ratios. That means you get less volatility than S&P but over long periods of time, more return and, of course, more income, which we like, which can reduce your risk as well, particularly if you need money right away.

Speaker 2:

Most important feature of ICAP is that we write individual calls on these large cap stocks using HI, so human intelligence. So we do it at levels where we have profits and where the companies are fully valued, based on our models, and we do them very short term, like one or two weeks out, maybe three, and we constantly monitor exposure to the market. So we're not like JEPI and some other funds that write almost their whole portfolio but if you look at the returns, they underperform dramatically if the market runs hard and we our objective is to not have that happening by monitoring what's called like our delta to the market. So and if it gets too low, then we make adjustments and you can see we've had solid returns on this fund and the good thing is that writing these calls is just a very consistent way to add alpha and it's a lot of work and takes a lot of expertise, but reliable way to add alpha and it's a lot of work and takes a lot of expertise, but reliable way to add alpha because you're not just riding in the whole portfolio, which can lead to capture churns.

Speaker 2:

Mlps is an asset class. It's a little bit controversial. It shouldn't be now, and the reason it shouldn't be is that really what happened is. Five years ago these companies were trying to be growth. Companies said low coverage of dividends, high leverage, needed to issue equity all the time. When the big downturn in oil occurred, they reformed themselves. They reduced leverage, increased the coverage of the dividends, increased retained earnings buying back shares, coverage of the dividends, increased retained earnings, buying back shares, low leverage. So if you've been burned by MLPs in the past, that's no longer relevant On the commodity side.

Speaker 2:

It's an argument for buying MLPs and not pure energy. We actually think that the one policy that Trump administration is going to be able to implement that will affect inflation is we think they're going to try to keep oil prices capped, not so much from drill, baby drill, but because our US companies are in a pretty tight box in terms of how much more they're willing to spend. But the Saudis have three million barrels of extra capacity. The Trump administration is very close to the Saudis, so we think the prices start to run significantly above 70. The Saudis will increase production and you might say, okay. Well, I don't want to be anything energy related. But MLPs do the best where energy prices are contained and they're also benefiting from dramatic increases in natural gas consumption, which is disconnected from price, because natural gas prices in the US are always below the rest of the world the green charts the rest of the world. That's because natural gas is produced with oil production, so we produce way too much. We have to export it. It also is available, of course, to expand electricity production. So there's a big growth story of natural gas through US pipeline companies. So those companies have been doing well but likely to continue to do well. So this is just like historical returns.

Speaker 2:

There was a big drawdown on MLPs during the pandemic which was 100% irrational. So I think AMCA is up. Don't have that data here, but like 600% or something from the pandemic. It was way down before that but there was a huge buying opportunity. People tend to overreact and, to be fair, of course, these companies were already in the process of becoming way higher quality but continued to do that after the pandemic. So lower risk than we've seen in the past. We talked about both things already. The companies no longer consistently issue equity. Hedge funds don't short them anymore, have really good coverage, growing dividends about five. Current yield on AMCA is about seven, so you get about 12% total return. So good addition to most portfolios looking for income. And then, in terms of fixed income, our two funds here we focus on are PFFA and BMDS. As a bond fund, obviously Good ticker.

Speaker 2:

The big benefits of the asset class, particularly preferreds, is you have low default rates. Preferred stocks are almost always issued by public companies. They care about their credit, they can issue more equity, they can cut their dividends. So that's what we've seen. We never had a default in PFFA over six years. The default rate's only 0.3. For preferred, it's about three percent for high yield bonds and 0.1 for investment grade bonds. So attractive default rates means that you should be able to close to realize your coupon is a long-term return. I mean, we're always optimizing our portfolio so we're trying to beat the coupon, but no guarantees, of course.

Speaker 2:

So the good thing about preferreds, if you can look at this chart over on the right, is and a lot of people appreciate this you're senior to common, so you can continue to be paid even if the common stock dividend is suspended. A lot of times they'll take it to one cent, but even it's suspended you continue to be paid, and particularly on cumulative dividends. The companies are so you in other words, they don't pay you, they owe it to you later reluctant to suspend the dividend because it doesn't really do them any good in the long run. And that's what we've seen is very few suspensions of preferred dividends, even during the pandemic. Tons, tons of common cuts, but very, very few preferred cuts, and a lot of times they suspend them and then catch up right away. So you can see that the market cap of the company's issue preferred is very large.

Speaker 2:

So good credits, high yield also. And the good thing about preferreds, only 10% are private. You do in high yield general bonds, you get a fair amount of private companies. We don't let private companies run by private equity firms typically trying to take money out of the company. So with our BNDES fund, we are almost exclusively public issuers that care about their credit ratings, will issue equity, not try to take dividends like private high-yield issuers. Here's the default rates I was talking about just under 0.6 for preferreds and about 3% for high-yields, and they were only a little bit worse during the financial crisis. So in terms of comparing the two funds, you can see that we have large market cap issuers and attractive yields and so pretty similar in terms of number of issues. So somewhat similar funds, but high yield bonds tend to be less volatile. Preferred stock a little bit more volatile, but higher longer term returns.

Speaker 2:

So the key advantages the reason really we have to have active management for bonds and fixed income securities is these three risks interest rate risk, call risk, credit risk. None of those exist with equities, so it's okay to be an index fund for equities because they're not. These are characteristics of fixed income. So we manage the interest rate risk by both adjusting the coupon and looking for floating rate. We're actually selling our floating rate now because we think rates will come down. Call risk when they go above par, which is $25, you really need to sell them because they become unattractive above par. And then the most obvious, credit risk. We're constantly monitoring to make sure we don't have any defaults. But it's good to outsource that too, because you should have a diversified portfolio. So you have 120 credits challenging for an individual to monitor 120 credits.

Speaker 2:

Bmds is a high yield bond fund that yields 8. It's reasonable expenses at 0.8. We look for very strong companies, usually very old economy, asset intensive, like weights, utilities pipelines, but with attractive yields. We're looking for, you know, attractive spreads, and this is the key point about high yield is that in terms of getting a good amount of yield relative to volatility, really high yield bonds are the best. So high yield bonds are half the volatility of preferreds and about a third of volatility of the S&P the volatility of the S&P. So you know, if you're looking for lower risk or lower volatility way to add income, high yield and BNDS is very attractive from that perspective. It's true about total return and yield. So it's a little bit less. It's not at the opposite top when it comes to yield to volatility. So the other I mentioned this already but to extend, you have higher coupons, you have less duration and less correlation to interest rates, and so that's what we typically look for. So even if we're wrong about the 10, you're going to 375,. Bnds should continue to do well, get your eight coupon. Even if it doesn't appreciate in price that much, you still get eight, and so it's not as sensitive to interest rate risk as most bonds are.

Speaker 2:

Call risk Just need. If something's trading above par, you've got to sell it. It's pretty easy to manage that, but it's time intensive. If you are an individual Credit risk. We have our own credit ratings. Rating HEs a lot of times are too negative on dividend paying stocks, so like utilities, reits. So we have a lot of those pipelines. So it's easy really to come up with better ratings than rating HEs. They also tend to be a little bit too positive about financials. We saw that over the last couple of years where First Republic was rated double A single A rather two weeks before they went bankrupt. So that's our prepared remarks.

Speaker 1:

So if there's any questions, michael, maybe we can answer those, or if you have any questions, yeah, and so I always go back to this broader point that typically income isn't demand when volatility is rising, right, I think, of the total return spectrum in terms of there are times everybody wants capital appreciation, times everybody wants income, and typically the pendulum swings back to income when capital appreciation is at risk, right from a volatile environment. Now, great that this is kind of a very short-term movement, but it does look like markets are getting more volatile. You see a lot of that actually intraday look like a strong comeback and then a heavy sell-off in tech. At the end Do you get a sense that that pendulum is going to really swing hard now towards the income side of the equation?

Speaker 2:

Well, I think so, because not just because we're having this kind of seasonal volatility, but we're becoming more and more confident that our call on slowing growth is going to unfold. So in a declining interest rate environment, obviously that's really good for fixed income, but it's also good for the non-tech sector. But when tech's not doing well, the overall market is flat to down, like it was today, like actually there's a lot of stocks up today, so in that environment you could vary In terms of opening the S&P versus fixed income funds. You're probably going to be doing quite well on a risk-adjusted basis. We do think it's a good time to be in small caps on these interest rate sensitive stocks that do better when tech's rolling over to that, to get both price appreciation in the fixed income side and rotation into old economy and small caps.

Speaker 1:

From experience and you have these very abrupt momentum breakdowns like we're starting to see in tech. Are these short-lived or did it tend to be maybe suggestive of more broader cycle shift of money rotating?

Speaker 2:

well it does. It depends on the economic outlook. So during 22, everybody kept saying that, oh, tech stocks are down because rates are rising, because they're longer term duration. Well, that sounds perfectly reasonable, but it just doesn't happen to be the case. So tech stocks have the same duration. All stocks have very long the case. So tech stocks have the same duration, all stocks have very long durations and they're basically all the same. They have to be profitable, which most of them are.

Speaker 2:

So in the case of 22, you didn't want to catch those falling nines because you had the Fed constantly raising interest rates, slowing economy, rising interest rates. So you really have to get to get that answer. You need to get the macro right. We think that the macro is good because of growth in the tech. Even if the stock prices are dead, there's still a lot of spending going on and a lot of startups are going to go public, which helps employment, helps CapEx.

Speaker 2:

So our assessment is the economy's fine, so that this is just a minor pullback, and it's also entirely normal late February through March to have pullbacks. So that's our call. We have the 6,000 target on the S&P, so that implies it's you know, don't rush, but at some point you should catch, you know, or not catch a flying knife, hopefully. But when things go down, start stabilizing and we're getting close to the end of March where we're going to get an earnings season, we think it's going to be totally fine, but it does. It's a good time to demonstrate that. Maybe it seems blind on PFFA to yields nine, but it basically does nothing whether the market's way up or way down. So on days like today, I feel pretty good about it. I mean, it's flat, basically, and tech stocks are down well over one, the S&P is down one, so good place to be during drawdowns of the regular stock market yeah, it does look like.

Speaker 1:

Um yeah, this is another point you and I've talked about on the podcast before um I, it does look like. Again, I go back to this kind of flight to safety dynamic with treasuries. It's maybe coming back, which is more like the way the market used to work prior to the past. I say about history as we think through valuations now, granted, this is a sweeping question, but, generally speaking, is it fair to say that fixed income as an asset class is considerably cheaper than equities as an asset class?

Speaker 2:

Well, equities are about 22 times earnings and we're using that for 7 000 target as well. I mean, you roll forward to get there right, because we have about 10 percent growth built in and I'd say real quickly that earnings growth is more or less automatic, that just retained earnings being invested in reasonable returns like 15 so%. So when you hear, oh, the S&P is going to grow at 10%, a lot of pundits will say, oh, my God, that's too high. Well, that's like it normally grows at 10. But 22 is high relative to where the bond yields are.

Speaker 2:

We kind of need my 375 to take hold to make equities attractive where they are now. So they arguably are overvalued by you know, the two. That's two like almost two multiple. So that's a lot, or we think they're fine, but that's theoretically. You can easily make that argument. And then I think maybe, um, high yield bonds are a little bit similar to that because spreads are pretty tight. Now we buy ones where the spread's wider. So I don't think ours are overvalued. But if you just go buy the index funds, they're at least somewhat tight. So I'm not sure they're that much more cheap. But if we do have a situation where rates are dropping, people continue being nervous about tech stocks. They're going to dramatically outperform.

Speaker 1:

I don't think we've talked about this before, but I am generally curious about this. If somebody on small caps, if you look at small cap equities versus the equivalent small cap equity bond issuances by these companies, how do those look? Are there dislocations in the small-cap bond side of things relative to the?

Speaker 2:

equity side. Well, you know that's. One advantage of not being small-cap is that there's some diseconomies of scale to issuing bonds. So all the bond investors want to have really big issues of like $300 million, $400 million, $500 million at every, every maturity. So when you do that math you have to have like three billion dollars of bonds to really make it economic.

Speaker 2:

And the rating agencies hate small companies, I think too much. So they tend to get single b, double b ratings. So most of the time, um, small caps have lines of credit and term loans. They can swap them out. So they're like the notion that they're taking tons of credit risk I'm sorry, interest rate risk is not really true because I can swap those but so typically their portfolios are more dominated by those type of securities and then only when they're getting closer to the mid-cap is it economic tissue a ton of bonds. So if you look at our portfolios, would they tend to be? You know the issuers are more of the large cap issuers and they are safer. They're more equity. You know, easier to issue equity and bail out the bonds and fail from.

Speaker 1:

How closely do you consider liquidity in in BNDS of some of the underlying bond positions?

Speaker 2:

I mean we're definitely looking for more liquidity. We do have some positions in the portfolio that are just meant for liquidity. So we have a small amount of ETFs so that we can, if we need to sell something quickly, we can just do that. But all the bonds are, you know, well-traded. They're not all listed. Some of them are. A good portion of them actually are listed on stock exchange, which is unusual. So we do have a favor there. So I think about, off the top of my head, like 30 to 35% are actually listed Very unusual. But the rest is or have good over-the-counter markets. So liquidity is definitely a consideration, yeah.

Speaker 1:

Yeah, as you look across the various funds that you have out there, if you were to blend them into one all-encompassing portfolio, what would be, in your view, sort of the overweights of the different six funds?

Speaker 2:

Well, I mean it's always important to bifurcate between fixed income and equity income because you're like taking three times as much risk. So I would just say, within fixed income, I do think it's important to have a good allocation to preferreds and high yields because in the long run you're going to get better returns and lower interest rate risk and only a little bit more equity risk. And in particular now, where it's more neutral now, but before, earlier in the year, our interest rate call was much more controversial than our equity call and so if we were wrong about the interest rate side but right about equities, you definitely want to be in high yield and preferred and not in investment grade bonds, aggregate bonds, mortgages and treasuries, so they're pretty all weather. So I'd recommend, like, if you have 40%, it's fine to have even half of that 40% bonds, half of that, or 10% or 25% of your fixed income and high yield and another 25% in preferreds. You're going to get much better long-term returns and better risk characteristics. And then on the equity income side, so say you're 60-40, so that'd be 60% of your portfolio.

Speaker 2:

I do think that having 5% or 10% small caps makes sense. Having dividend stocks 5% to 10% makes sense, because when I go I don't do it a lot, but go analyze individuals' portfolios, they basically all have the S&P portfolios. They basically all have the S&P Like they're called different things, but you know it's large cap this, mad and some other maybe active funds and so you just end up with 40, 45% tech. You know whether you like it or not, but when you mix in these dividend stocks you get close to zero tech. So they're more defensive, more income. So if you have a slug of MLPs, small cap dividend, large cap dividend and then the normal.

Speaker 2:

However, some people like pure tech stocks, which you don't really need if you have S&P funds. But a lot of people have those and also their individual names tend to be tech stocks as well because they like Apple or whatever, and also they get locked into it. I launched with a friend yesterday. He said well, I've owned apple for like 25 years because if he sells it pays a million dollars on it. So most investors are over, slightly by accident, over allocated tech. So, putting a big slug of dividend stocks in, like you know, our three funds, if you want diversification and to do like our funds are roughly flat today, even though the market was getting annihilated. Yeah, a little bit more of a sleep, well at night.

Speaker 1:

type of Right.

Speaker 2:

No, you shouldn't have tech stuff. I mean, we're bullish on tech and they'll, you know, think tech stuff will do fine. But I prefer lower volatility returns, like today, where our funds are boring. They're not skyrocketing anything, but they're boring. And if you're in a tech fund like if you're in a pure tech fund, it would be down like whatever. The one and a half 2%. I didn't see how to work it close, exactly.

Speaker 1:

For those on the webinar, Jay, who want to see more in terms of fact sheets or read the actual prospectus, it's imprecatfundscom.

Speaker 2:

Yes, yes, yes, and you can also ask questions on the website. You can register for a monthly you have a regular monthly webinar and send direct questions to me, or?

Speaker 1:

marketing people, everybody that's here again those that are attending for the CFP CE credit. I will email you shortly, either later today or early tomorrow morning. We'll get that done with the request information. Appreciate those that did attend. Hopefully you found this insightful. We'll be doing more of these webinars with all kinds of interesting content with Jay and his team in the coming months. Everybody enjoy the rest of your evening. Thank you, jay, I appreciate it.

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Michael A. Gayed, CFA

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