Lead-Lag Live

Fixed Income in Uncertain Times

• Michael A. Gayed, CFA

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Speaker 1:

Said this repeatedly, I'm a big fan of Jay Hatfield's way of thinking about markets, obviously a very successful entrepreneur, business owner and somebody that I think you'll enjoy hearing from when it comes to thinking about fixed income investing, especially in an environment where nobody knows what's going to happen next. I just did a Ask Me Anything type of live interview with XM Serious Business Radio and one of the questions was is it safe to be in the stock market now? And of course, my response was safe is a loaded word, and maybe the better question is is it better to be in bonds? So we can touch on that a little bit. So I'll let Jay get right into it Again. My name is Michael Guy. Thank you everybody for joining this webinar hosted by Infrastructure Capital. Jay Hatfield, the man of the hour. Go ahead, jay. Great Thanks, michael.

Speaker 2:

So you know, Michael pretty much already covered this we're focused on long-term investing and income securities, and often in what we call infrastructure. So long-lived assets tends to produce more stable outcomes and also can be used by investors who have a lot of S&P exposure to diversify away from tech and what we do to. Well, actually, one of the things we're going to do is we don't have any slides on this right now, but just talk a little bit about the environment, because you referenced that, michael. We're maybe way more constructive on not just fixed income investing, but equity and fixed income at the capital markets than most people. We think there's been a massive overreaction to the tariffs. We call it a tariff tantrum. It's certainly disconcerting for consumers, but it doesn't really impact the overall economy. So consumers might be upset that they have to pay more for a toy, but that's not the key driver of the US economy. In fact, what's driving the market today is the key driver of the US economy right now, which is the fact that we are the tech leader in the world, notwithstanding all the commentary to the contrary that we've lost our leaderships and that the US economy is growing steadily and rates are likely to come down when the Fed finally figures out that they need to cut. So to answer the question you raised, we said this about three weeks ago on our webinar that we are constructive on the market, that all the bad news on tariffs seems to be out, or most of it at least. So we think it's a good time to put money to work.

Speaker 2:

Only caveat is it is normally we're in earnings season, the peak of it right now. That's normally bullish. We've got a 5,000, 6,000 target on the S&P for this quarter. We need to get tariff resolution, fed resolution and tax bill resolution behind us, probably before we break out above 6,000. So there's going to be probably, or almost certainly, some pullback in the market after earnings season's over, before we get into the next quarter. But that doesn't mean you shouldn't put money to work, because we could run up the 5,900 and then have a pullback. So it's unclear what that pattern is, but we're bullish on the second half. I think we're going to have a 6,600 year end on the S&P. So it's always better to put context on these things.

Speaker 2:

So we think it's a good time to invest and what we do that's difficult for a lot of individual investors to do is we do have models on every company that is included in our portfolios company that is included in our portfolios and we talk to the company to vet our models and then constantly update them for new information and then come up with price targets. And if you really watch, listen to television and people touting stocks, they rarely have targets and they rarely talk about whether their estimates are above consensus or not. So it doesn't seem like they're really doing enough work to analyze companies. And when running your own portfolios, if you don't have time to do that work, then it's okay to own some like Dow type stocks Microsoft would be good today, but you know Microsoft McDonald's because you're sort of going to be fine 10 years no matter what. But when it comes to riskier stocks like Palantir and Tesla et cetera, we would counsel against doing that kind of gambling Again, unless you want to develop your own model and really closely follow the companies. So ETFs are good for alternative. You can have a few stocks that you kind of know really well and are, for instance, conservative, and then you know, have a lot of other hopefully some income as well from your other securities.

Speaker 2:

So our fixed income strategies, which is the topic of the day, bnds is our high yield bond fund. High yield bonds, we think, are a very attractive asset class. They have low volatility relative to the stock market about 0.3, and also low correlation to interest rates because they have much higher spread. So the correlation is about 0.2 to the bond market. So you get a nice mix between those two risks and the key driver of all returns are those two risks stock market risks, interest rate risks and yet you get high yields. So the NDS yields over 8%. So even if there's some market volatility, as long as we don't have defaults which is what we're working on 24-7, then you get the steady, attractive income which produces good total returns in the long run.

Speaker 2:

That's also true for PFFA. That's our active preferred stock fund and it also invests in you know, the same sort of old economy asset-rich companies that are most of our investments and those are great from a credit perspective. The rating agencies don't like them, so they have pretty good yields but they're actually great credits. Rating agencies don't like companies that pay dividends, have the higher payout ratios on dividends because in theory they don't deliver quickly over time, but in practice if there is a problem they can eliminate their common dividend and still pay the preferred single bonds, so big opportunity in those type of securities. And PFFA you're checking our website is one of the top performing funds in the preferred stock sector.

Speaker 2:

Since it was launched over six years ago, focused on real estate companies, which are great credits. They're very low leverage, high quality real estate, higher quality than buildings, diverse by a lot of times, no leverage on the buildings directly and so great credits. It has smart data such that if something trades above par, it can be sold by the index and has no leverage. The index and has no leverage. The NDS has no leverage. A PFFA runs 20% leverage, which is about the lowest you can find of anything that has any leverage. And we do that on equity, not assets. So we have $100 equity, $20 of borrowing. So then we do have the topic of the day three equity income strategies.

Speaker 2:

Small cap income index calls to an ENC income on some preferred stocks so that fund yields over six. I-cap is a large cap dividend stocks. So that fund yields over six ICAP is large cap dividend stocks. You're going to get much better yields with large cap dividend stocks. You get Verizon, chevron, some of these companies that yield four, five, sixadvantaged, in the sense that usually not always, but usually you get something from the tax perspective return on capital but the cash covers our dividend. We pay that come in from the companies. But from a tax perspective it's attractive because usually you can defer paying tax, because it's treated as return on capital and these it is important to look at SEC yields because that's really the cash coming in sustainable cash flow coming in to support the dividend. You can see all of our funds have high SEC yields. You will find a lot of competing funds that might have a high distribution yield, so they're paying out a lot but they're not getting a lot of cash. We think it's fine to add a little bit of income from options, but you try to do the whole portfolio. A lot of times you don't participate in big rallies, so we've had a lot of big declines of big rallies this year. That makes it challenging to run those funds that have 100% written.

Speaker 2:

We talked a little bit about Macro. Some of these slides are not fully updated because PC came out yesterday. The real key here is that the feds behind the curve. They follow an index, cpi, its shelter component of which is delayed by about two years. So real inflation, real-time inflation, is below their 2% target. Tariffs are going to have a one-month blip. But at the same time energy is bringing down inflation. So we actually don't think there'll be a big spike in reported inflation and then the Fed will be forced. Also, the labor market's weakening we saw a weak ADP report. Rising unemployment claims, we think, decelerating growth because of these high interest rates.

Speaker 2:

A little bit of drag from tariffs maybe. So we're forecasting 1% to 2% growth. But actually that might be conservative consumers buying inventory and and wholesalers for that matter, buying inventory ahead of the tariffs. Then gdp actually grew at three percent, which is well above our one two um. We'll have to keep monitoring that. But gdp now from the atlanta fed was um is tracking like 2.3, 2.4.

Speaker 2:

So if we're wrong about our GDP forecast, it may be on the low side. So it is essentially impossible to hurt the US economy through tariffs. It's only imports are only 13% of the US economy. The total tariff burden on the high side, if everything gets implemented in 90 days that was announced, is $157 billion, which is about half percent of GDP. But that's being offset by a 20% drop in energy, which is almost a full 1% of GDP. So nobody cares about the energy, everybody cares about tariffs, but that's just not the way the numbers unfold in our, based on our models. So keep those numbers in mind when you're thinking about tariffs. Like any individual product, yeah, it could be big, particularly for these low priced items like tweezers that were up 300%, but in terms of affecting the overall economy, not that critical. Annoying if you're paying it, of course, but the revenue does come in and pays down debt or, more likely, funds, tax cuts. It's just not a complete loss number.

Speaker 2:

So we do think that when the Fed cuts rates they're going to end up the year at 350 to 4% and so that's going to be bullish for all these fixed income strategies. But it's also important, particularly for our funds, that the stock market stabilizes or rises like it is now, because that now is a spread. But the interest rates do play a role. It's a big tailwind if interest rates are going down. We've had this view since 480 on the 10-year, so we've been correct and it seems like every day people are coming around to our view and the 10 years dropping close to at least the top end of our target.

Speaker 2:

We are negative on oil, although here is probably getting close to go by. We have a 60 to 80 dollar target for the year. We lowered that because the Trump administration is putting tremendous pressure on the Saudis to produce more, and so we think that'll keep a lid on oil prices. Drill baby drill's not really working because when oil prices come down, energy companies tend to drill less. So if Trump administration's successful in bringing down oil, you're probably not going to see a big surge in US production, and the oil companies are in much more cashflow producing mode, so they're less growth oriented like they used to be.

Speaker 2:

If you do wonder why the economy might be slowing, of course everybody's going to blame tariffs. But the real issue is the Fed is way too tight. They're shrinking the money supply when they normally grow it at 5%. That's keeping long rates elevated. We have some of the highest rates in the world. That's pinching the bond market and the mortgage market, and so you did see mortgages go above 7. Housing continued to slow. The good news is the market has cut rates for the Fed. So by having the market anticipate these cuts they're anticipating four cuts, we're forecasting three. That's brought the 10-year down to 415. And 30-year mortgages are more like 660, which is sustainable. So this is the other key, so the two factors or three really that are supporting the economy, that again nobody wants to talk about because a lot of the conversation is more sort of clickbait driven. But you have lower energy prices, very stimulative to demand, and then you have these lower interest rates, which are stable, not causing the housing market to boom but stabilize. And then continue tech spending. Everybody again momentum analysis and forecasting oh, tech spending is dropping, that's why tech stocks are down. But no, actually it was just panic and Microsoft blew out their numbers on very strong cloud numbers, so that thesis was not correct.

Speaker 2:

I would urge you to focus on the money supply. Everybody should have their own macro view. You can get some of our data that helps you have your own macro view. Have a view where interest rates are going, at least in a broad base. You don't have to be as precise as we are. Have a view on the stock market.

Speaker 2:

Usually the stock market, by the way, is positive because earnings are growing. When companies retain earnings, they then invest the money, usually about 15%. They retain 70%, invest it at 15%. That's 10.5% earnings growth. If you look historically, it's been a little bit lower than that. But taxes used to be higher, corporate taxes and so, all things being equal, stocks will go up roughly 10%. There'll be these ups and downs. If you close your eyes, you're going to be one of the top investors because most balanced portfolios beat most hedge funds. So keep that in mind when you're tempted to sell all of your securities.

Speaker 2:

That stock market goes up over time but nevertheless it's good to avoid like, if you look at this chart here, where it's most attractive to be long the market is when the money supply this is a global money supply, monetary base is M0, so the easiest to analyze, analyze and you can see this huge spike up was in late 20 and into 21. That's when everything was exploding. So central banks are injecting liquidity. To keep rates low tends to cause the capital markets to surge, and then you had this big decline in 22. That was horrible to be long anything, and now it's kind of stabilized for a while. It's still trending down and it's starting to trend up, not in the US still negative but the rest of the world's cut rates before us because they have better central banks than we do, and so, in fact, european growth is picking up now because they've got rates well ahead of the US, and so you should see this gradual increase in global money supply, and one of that really matters is it affects global interest rates. So you know, everybody just looks at the US, but you need to look at for interest rates and bonds. You have to look at the whole world so you can get this on our website, only place in the world where I know you can get the global monetary base. We love it. Nobody else seems to care. But if you follow this, you'll be better forecast than almost anyone, forecaster than anyone.

Speaker 2:

And then, just diving a little bit more into the topic of the day, these are this is kind of what I call the money chart, and so you have all of the alternatives of what you can use to build your fixed income portfolio. So everyone should have probably 20 to 30 percent minimum and up to 70, even if you're older and retired, depending on your income. But so to stabilize your portfolio and give it more yield. So you're going to get more yield from fixed income than equity income in general, and so that's why it's critical to have fixed income. And then the great thing about fixed income is that, if it covers a significant percentage of your required cash flow, if you're retired, you do have to take the money out of your IRA, so it's good to take out the free cash flow and not have to sell your securities. So you want to build this substantial income flow from the fixed income side. So you want to build this substantial income flow from the fixed income side, and so let's just pick 50%. Let's say 50% fixed income.

Speaker 2:

Then it would be prudent to not necessarily have all these asset classes but at least consider all these asset classes. Certainly don't want to just be a birds or just be an ideal. We saw that in this downturn. Although there was no place to hide, you know, treasuries got dislocated during the tariff tantrum. Unis did. Corporate bonds are pretty stable. It's a little more institutional. The birds traded off irrationally. It was a great buying opportunity. Ieo bonds sold off. Senior loans are more stable. And then convertible bonds really got smacked because they have high equity exposure.

Speaker 2:

So the two columns to really focus on here are the columns the second column from the right and the third. The beta is a complicated way of saying correlation. So if you look, these securities are roughly laid out in their percentage correlation to the 10-year. So obviously treasuries are 100% correlated. Unis 50, sometimes higher, corporate bonds are just pretty much adequate treasuries, preferreds some of these, I would say preferreds, are less sensitive than this indicates, but we need to a lot of times these uh, this data comes from regressing against 22 and so bonds became much more correlated to a lot of asset class because bonds are selling off while other asset classes were selling off.

Speaker 2:

Ideal bonds, lower sensitive to interest rates, senior loans not at all because they're floating. So that's a good asset class to have. We don't have a fund in that area, but a lot of great funds that are senior loans are floating. So you don't take any interest rate risk. Maybe not the greatest place to be here, because if we do get those cuts you get less incomes.

Speaker 2:

And convertible bonds. We have them here. You can add some of those, but you should recognize. The other column is the correlation. The s? P treasury's near zero me and he's near zero corporate bonds a little bit higher. The third's about half how you bonds 42 senior notes a little 13,. But convertible bonds are just really adding equities. So you might get a little bit better income but you're taking essentially the same risk with an equity income fund like our funds normally update as similar to this, like 0.81. So it doesn't give you that diversification but it is an asset class to consider that does have substantial dividends. You can usually get like a three or four plus equity upside. So it's not a bad asset class to be in. Really, probably what you should do. If you are targeting 50% debt or fixed income investing in your portfolio and you add 10% convertible, you should really treat half of that as equities and you really beat 45% fixed income and 55% equities. It's still an interesting asset class.

Speaker 2:

When do you kind of soften the prior chart? Something called effective duration is a mathematical way to estimate sensitivity to interest rates. What most people don't appreciate but you saw it from the chart before is that higher coupon securities they might have higher potential default risks. They're much higher or much lower sensitivity to interest rates. So, like our funds, bffa and BNDS held up quite well when interest rates were rising because they had higher coupon securities and we had sold. All of our. Pffa is actively managed, as is BNDS. So when the money supply was surging, we sold off all of our low coupon preferreds like 4% and those dropped from 25 to 12 and 13 and 14. So you can see where it's higher coupon securities held up well and some of them got called. So there's a big advantage, as long as you do the credit work, to come up higher yielding securities. And then this is an analysis. Like I said, default rates do matter.

Speaker 2:

The preferred sector has very low default rates. High yield is substantially higher, so it's important to have good credits that don't default. A lot of these are triple Cs or lower rated credits that we don't own. But the only thing that makes this chart look a little bit too negative is that high yield bonds have better recoveries than preferreds, and so the 3.2 might be effective loss ratio of like one and a half, whereas if a preferred security goes bankrupt you tend to lose the whole amount. So that does make those two asset classes track closer, but the burns on average will probably outperform money yield but be more volatile. So that's a trade-off Like. Pnds is almost half as volatile as PFFA, but PFFA is likely to do better in the long run. So, without risk, no return.

Speaker 2:

This isn't today'sFA, but PFFA is likely to do better in the long run. So, without risk, no return. This isn't today's business, but we still have opportunities. So this is a percent in the index that's trading above our percentage of the stocks that are trading above par. So it's only 5% right now. They're above par. But securities that are above the call price are not that attractive, particularly if it's a call is upcoming and or soon, and depending on how high the price is above the call price.

Speaker 2:

So index funds in the preferred sector do not track this because they have no smart beta rules like PFFR, and so we're able, in PFFA and to the extent that something gets eliminated at PFFR, sell these securities above par to the index funds that are getting inflows and buying additional securities. We can sell it to them and put profits and then recycle it. So you both avoid losses if you have an index fund and then we're benefiting from it by selling it to the index funds. Index funds are about 70% of preferreds. Then some details about the high-yield sector. Just you know, over time it's at lower volatility, then substantially lower volatility than the volatility of stock market, and it is conducive to active management and we, as I mentioned before, do a ton of work on each company, look at its, develop our own proprietary credit rating, so that's estimating the default risk. We pick securities with low default risk less than 1%, and attractive yields and that's worked really well with preferreds and is working well on with PNDS. On credit selection you do also with both of these asset classes.

Speaker 2:

It's difficult for retail investors to build their own fixed income portfolios. Preferreds is possible but it takes a ton of work. Most of the preferreds are listed. In fact, pffa we only have listed both the common stocks listed and the preferreds are listed. In fact, pffa we only have listed both the common stocks listed and the preferreds. So you can do that work. But we have 220 securities in PFFA and that does make sense because with fixed income you have limited upside, so that par is your upside but a lot of downside if there's a problem.

Speaker 2:

So you want to be diversified so that one company doesn't hurt you substantially because it's not like equity portfolios, like if you were smart and five years ago 10% of your equity portfolio was in video, well then you're up a gigantic amount because it has unlimited upside. But the thirds are not like that, or bonds, and that's so critical to be diversified. That's difficult to build, they're difficult to trade. They're listed for preferreds but high yield bonds are not listed, so or most of them are not listed. We have a higher percentage than most and BNDS that are listed. But in terms of building your own portfolios, you have to research 70 companies, go try to trade those securities, which is extremely difficult to do. So I would recommend you outsource your fixed income portfolios, just because of the diversification and liquidity, and with fixed income, those are really critical. There's no advantage, like I said, having a concentrated portfolio, which could be advantageous for an equity portfolio Not always, but it could be so.

Speaker 2:

The point of this chart, though, is just to show that high yield bonds are very attractive in terms of having really good annualized returns and not as much volatility as other fixed income securities. So we do think that everyone should have IEO bonds as a core portion of their fixed income securities, but, as you can see from the prior chart, they don't balance out your risk. So in a normal market, you have to exclude 22. But in a normal market, if you own treasuries which I don't necessarily recommend, but you can the Vanguard Total Bond Fund has a huge if you own that has a huge component of treasuries and mortgages, so you don't get really good long-term returns. But what is true? When the market's down a lot, they're usually up, but whereas high-yield bonds are going to be weaker. So you do have higher volatility with high-yield bonds, but you also have better returns.

Speaker 2:

So if you look at the ratio of the return to volatility, high-yield bonds are very attractive. So it's good to have about 10% of your portfolio in high yield. Well, on their fixed income portfolio, that would be like 5% of your total portfolio. So great long-term asset class. It's sort of got. You know this. High yields have sort of a sense of being super risky, but high yield bonds are less risky than stocks, so it's important to keep that in mind. Just another way of representing not just the total return, but the current yield is high relative to the volatility as well. So, like I said, a great way generating income and not adding that much volatility. And this is is just something called the Sharpe ratio. That's just a ratio that calculates what we just looked at. So if you build a portfolio with high yield bonds, you have a better Sharpe ratio than using munis or treasuries. And that kind of gets to that issue of what I was saying that you have really good income, which usually produces total return. So with better returns and somewhat similar volatilities, you get a better. It's called Sharpe ratio. It's the ratio of return to volatility.

Speaker 2:

And then just talking more about what we actually do with BFUS, we do almost exclusively have companies that are public, so the bonds aren't all listed, but their companies are. Why that matters. I know this from being an investment banker. Companies really care about their credit ratings. They tell their boards what their target rating is. They're regulated. They tell their regulators what their target rating is on either financial side or utilities. They never want to be downgraded, so they'll issue equity, they'll cut the common dividend, they'll sell assets to maintain their credit quality, whereas private companies are owned, usually by private equity firms. They get paid to take money out of the company and distribute it to their investors. They get 20% of whatever they distribute. So then you're on different sides and the only thing that protects you is covenants so that they can't take too much out.

Speaker 2:

But we don't want that. We want public companies. Liquid equities usually can access the bond market since they're public companies, so they tend to have lower default rates, even though the rating agencies don't fully take that into consideration. So if you are going to build your own portfolios which I don't recommend, but either try to look for those public companies or be in DSS almost exclusively companies or, being in the US as almost exclusively companies with listed, common and liquid access to your capital markets. So we just you know what we've already been talking about the yields are significantly more attractive on the high yield index by a lot. So again you have lower interest rate sensitivity, so attractive asset classes market and this is just looking at the performance of active high yield ETFs versus passive. And it's not difficult to outperform because it's not like equities where sometimes the worst equities, like james stock, outperforms everything else because things are callable par. There's no short covering rallies, so it's pretty easy to do this credit work look for attractively priced securities relative to their yield, sell them when they go up apart. So, um, active management doesn't make sense and you can see here that um, in terms of how we have this allocated, we this is not the equities you know the issuer. In other words, these are the listed bonds. We have more listed the green here is listed bonds and so our portfolios are more liquid than the index as a whole and liquidity makes more efficient trading so it can help returns over time. Then we have good diversification by sectors.

Speaker 2:

Energy sounds a little bit riskier than it really is. This is really mostly pipelines, like. Our biggest holding is Plains, which is a pipeline company, so these tend to be pretty asset rich companies, good credit quality, usually long-term contracts like the pipeline companies, and then you can just access this on the website. That's the details of how you and then just a little bit more details about preferreds. We saw from the chart that only default rates about 0.6. We don't really have any defaults in PFFA since we launched it. That's what we're spending a lot of time on is avoiding defaults. Yields are typically better than high yield bonds, so PFFA yields over 9. So you get paid for this inefficiency.

Speaker 2:

Other rating agencies don't really. They tend to over-penalize preferreds for being down on the capital structure, so they're below bonds, low bonds. But if you have a really good company like Energy Transfer, triple B plus credit, so it's the minimus default risk, like 0.1,. The rating agencies penalize them by three notches. So they're double B plus rated, which is high yield or non-investment rate. They prefer to well over 7%. Whereas if they only notched a long time, which is more a rational approach to what we would do in our ratings, then they would be strong BBB credits and would yield only about 5.5, 6. So you get this extra income and total return in the long run without taking that much risk just because the rating is used to best rate these preferred securities and then preferred dividends are normally have better tax characteristics than dividends, or interest.

Speaker 2:

Rather, that comes from bonds because it's preferred stocks. So because they're stocks, they benefit from the characteristics of the common stock. So with mortgage rates and pipelines, if there's excess depreciation you pay less tax on your preferred dividends, which seems very strange because you're not really taking full equity risk. You get paid before the common but you get their tax characteristics. Paid before the common but you get their tax characteristics. So they thought that tax rate on PFFA, using just style wise, if you paid 40, then your net taxes would be about 22 and a half. So it's the equivalent of everything being qualified dividends where you'd get an exclusion of roughly 58%. I mean that, by the way, is not true for BNDSU. You know if you get eight, you're going to pay close to eight tax on close to 8% Because, again, bonds do not have these positive tax characteristics. And then you can see that this is just the index, not our fund, because we have less than 11% private issuers, close to zero percent private issuers, close to zero High yield bond index, as 34 percent are private companies, and way higher default rates. So we think it's important to focus on the public issuers.

Speaker 2:

And then this was a chart. That is good because I was talking about it before. So over here on the left you have the capital stack. So secured debt's the best. And, by the way, those senior loan funds are usually secured, not always Unsecured debt is just the normal bond. A few bonds are subordinated debt, like in PFFA. We hold some SCE corp bonds Southern California Edison good credit has some fire risk but that's containable. But those are actually bonds and not prefers, which is great, particularly with the regulated utility. There's never been any losses on regulated utility bonds, but that's pretty unusual. That's just a very small part of the capital market.

Speaker 2:

So preferreds do get paid last in the fixed income stack, but keep in mind they get paid before common dividends. So that's why I said companies can suspend their common dividends and they're likely to continue paying their preferred dividend, and so for that reason, that creates extra safety. For that reason that creates extra safety. It's also worth noting that a very high percentage of PFFA is securities that are what's called cumulative, so there's really no benefit. So they don't pay you one quarter, they have to pay you back in the future. Non-cumulative, that's not true. They suspend it and they just start it up again and they don't get all the back dividends. So there's really no incentive from a cash flow perspective for companies to suspend their preferred dividends because they're gonna have to pay them back in the future. In fact, I serve on the board of a mlp that was fresher during the pandemic and did suspend their preferred dividends for like I think, two years. They've been paid them all back. So because the market approved after the pandemic was over, they were able to pay down debt, refinance and paid off all their accrued preferred dividends.

Speaker 2:

So and that was you know, we were in a pretty difficult situation. So even in a difficult situation you can still get paid back all of your deferred dividends. So cumulative is important if you're doing any investing on your own. So we just estimated this is just a graphic estimate of the effective yield. So if you get this based on the index, you know 7% yield, you'd only pay, in fact, some 5.8. So it's still better than Newton bonds. So you don't pay any tax roughly on Newton bonds, but you only get yields around four. So you get better tax adjusted yields on preferreds and we talked about this. You know, get monthly dividends. All of our funds pay monthly dividends, all six of our funds.

Speaker 2:

We are constantly looking at every stock selling above par, buying below par, actively managing three risks interest rate risk, default risk and call risk. So you can do it yourself, but if you have a diversified portfolio it's a lot of work. We dis-economize scale so you can do it yourself, but if you have a diversified portfolio it's a lot of work. This economy's scale. So in other words, you know, for us we have a pretty big position, probably millions of dollars of security trades above par. It's worthwhile for us to sit there and sell it steadily, take profits, whereas if you have 100 shares, some preferred, preferred, and you have other things to do, you may not notice. Oh, we traded above par. I should have sold those 100 shares. So economy is a scale to how to active managers work on your preferred portfolio. And this is where PFFA just are sharp ratio. So it's about double the index fund. So it's a ratio return to your volatility. It's more attractive than for the index fund and this is just charged. It's a little bit hard to follow.

Speaker 2:

But the problem with the index funds is they just buy securities to get out of the index. So a certain security abacus life got out of the index late, so the market makers can prepare for it. Stock traded all the way up to $35. We were able to sell. We sold between $30 and $35. And then you can see it crash back to $26. So this what happened is the index funds were buying it up at 35 and then they took a $10 loss when it went back to normal.

Speaker 2:

So you don't, these index funds are kind of a disaster because they rebalance every month and just plow into securities irrespective of price. This is unusual because it got out of the league in the index, but there's some of that activity going on every month. Because it got out of the league in the index, but there's some of that activity going on every month and it's very inefficient because they're selling those stocks with the lower market shaft. So it means they dropped in price and buying the ones that are increased in price. So they're doing the opposite of what you should do for fixed income. And then sector allocations, well diversified.

Speaker 2:

We're 27% financials where the index funds are more like 70. So they're kind of there's a lot of big financial issuance, so they're cap weighted, so they have a ton of financials. Better to be diversified, in our opinion, and that's what's led one of the reasons we've had superior returns, and then you can review these later. It's just all the return details, superior returns, and then you can review these sliders, install their return details, install on our website. These are both standard slides on our website. I'll just leave it on disclosures and I don't know, guy, if there's time for questions.

Speaker 1:

Yeah, I see a few of them here. Let me pull these up. So One of those opinion preferred stops. Do you have any specific favorites? So I know obviously we're talking about the funds here, but people do like to think about individual securities. I agree better to use a fund, but for anybody that's looking for some individual ideas, Absolutely, and we're all in favor of that.

Speaker 2:

I mean, we do think they should have a Duracepike portfolio, but it's perfectly fine made. You don't have to obviously have our ETFs, but you can have an ETF and then say, well, but I really like these securities, these individual preferreds, and I'll get a bigger position and I'll follow those more closely instead of having 200. So we're all in favor of that and you're welcome to send questions into our website or contact our IR people if you have questions about individual preferreds. We love talking about that. A couple of positions we like and it's fair to say that we like things that are a little bit controversial, where we do a ton of work and add value. So two examples of that I mentioned it already. Sc Corp has two fixed floating securities, so you're going to get more income. They've traded down. They were trading close to par or $25. Now trading around 22.

Speaker 2:

There is a reason that people are scared is because there was a big fire and Southern California Edison is liable for it. But there's a $25 billion fund and there's mechanisms that allow them, even if the liability is above $25 billion, to get a regulated return on that. So it's not great for the equity. So I don't recommend EIX as the public equity of Edison International which owns Southern California Edison. But the preferreds, you know, or actually subordinated bonds, go fixed to floating. A lot of times when they go fixed to floating they get called so they trade above bar. So both the Js and Hs we think are attractive. But just be aware there's that headline risk. Like yesterday there was a report which we already knew that Southern California Edison was responsible for fire, already knew that southern california was responsible for fire. I knew that like the first day you could see the fire started right below their lines. But the um market I guess wasn't prepared for that stock traded off. Like seven or eight percent bonds are down one, so not that big a reaction but we kind of knew that was coming. So, um, you can add to that over time maybe people start getting more nervous about the fire. But it's in our analysis, it's contained and there's a fund in california to pay for the fire. So it's an equity risk and not a bond risk.

Speaker 2:

And you're going to hear us say that a lot because you might call us up or send us an email, say, well, why are you in this company? I don't like the common stock and I said, well, yeah, I don't really like the common stock either, but I love the preferred. Another, a controversial one, is a company called flagstar. They have a security the hues, I believe, that are what's called a busted convert, so they're not callable. So that's very attractive Stock trading around 11.

Speaker 2:

It's controlled by a group led by Steve Mnuchin, who's a former Treasury Secretary, billionaire Goldman Sachs, former Goldman Sachs employees. So we believe strongly that, even if they're working through some credit problems, they have a lot of US exposure sorry to New York, but they're working through some credit problems. They have a lot of US exposure sorry, new York, but they're working through all those problems. They've got a great new management team and we believe that that private equity group that invested 2 billion will support the company even if there are problems. I actually like the equity. So it's not impossible not super likely, but not impossible that preferreds actually start to participate in the equity upside.

Speaker 2:

But for now last time I checked they're yielding right around 8%. A public company, great management, great private equity backing that gives them access to capital. That gives them access to capital. So those are two securities and they come off reselling from their highs so that you can take a look at. But again, we want to do something that we get really good yields. So we're not going to just recommend like southern company as um and sempra. If you want really, really, really low risk, they. They yield between six and seven de minimis default rates and default risk. But we're looking for more juice, more income and better total return. So to do that you have to have something with a little bit of complexity. That requires analysis.

Speaker 1:

And then there's a more of a macro question, because we saw a huge expansion of the money supply in 2020, wouldn't it be somewhat appropriate to maintain higher interest rates to help level out the inflation we saw as a result of that move?

Speaker 2:

Well, that's a great question. So the Milton Friedman theory of inflation was 100% proven correct. So there was a 70% increase, but then the Fed lowered the money supply back to a 60% increase. Nominal GDP grew at 38% and Milton Friedman's theory is if you grow the money supply above nominal GDP growth so it's not real, it's the inflation plus the growth then you'll get inflation. Well, it worked absolutely perfectly. So 60% growth, money supply, 38% nominal GDP, 22. Get inflation. Well, we're absolutely perfectly. So 60% growth, money supply, 38 nominal GDP, 22% inflation.

Speaker 2:

And a lot of people remain angry about inflation because rents are 22% higher.

Speaker 2:

Burgers are probably 22% higher.

Speaker 2:

Problem is to actually get the price level back to 2020, you might have to shrink the money supply by 30% and we would have a very, very, very deep recession.

Speaker 2:

So kind of can't put the genie back in the bottle. So now the Fed is shrinking it like 1% a year, which is deflationary, but you're not going to get back to 22% and it's probably not worth the pain to the overall economy to get back to 22%, and it's probably not worth the pain to the overall economy to get back to 22%, but we do aren't advocating for the Fed to have a money supply target, so like, in other words, a range like we grow the money supply 4% to 6% a year, so you don't get these wild swings. We're up 60, where before the great financial crisis, the money supply was flat for three years, which precipitated the great financial crisis. It's dangerous to not have money growing roughly at nominal GDP and it's dangerous, therefore, to have the price level be volatile either on the downside or upside, so it's better just to maintain consistent money supply growth. But it's a great question because if you really wanted to turn back time, we would have to have this deep recession, which would not be fun.

Speaker 1:

And then I see a couple of other questions around where this webinar is going to be available. I'm catching up giving all my travel on all the prior videos, but those should be available on the YouTube channel soon enough. I'll also stream it across X and all the various platforms. I appreciate those that are here. Again for the CE credits. I promise I will email all of you. Get your information, get this submitted to the CFP board. Please make sure you follow Jay Hatfield and Infrastructure Capital and we should close off Jay with the website wwwinforcapfundscom, and we have a monthly webinar where we go over a lot of these issues macro, the funds.

Speaker 2:

You can ask questions, so I recommend that to everybody as well.

Speaker 1:

Appreciate those that attended. We'll see you all next time. Thank you, jay, appreciate it.

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Michael A. Gayed, CFA

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