Quarterly Commentary - Virtus InfraCap MLP ETF
Returns in the midstream master limited partnership (MLP) sector
outperformed returns in the broad stock market in the second quarter
of 2022. During the quarter, the Alerian MLP Infrastructure Index
(Benchmark Index) was down 7.96% while the S&P 500® Index was
The domestic macroeconomic outlook was a function of an international
war, rising interest rates, persistently high commodity prices, and a
heightened sensitivity to inflation. High inflation data, low unemployment
rates, large wage gains, and tailwinds from businesses reopening
and increased travel have all supported the rationale behind interest
rate hikes and quantitative tightening. Despite geopolitical risks,
the predominate market risk is the impact of the Federal Reserve’s
(Fed) conclusion of its asset purchase program (liquidity risk) and
subsequently whether it sticks to its targeted rate hikes plan in 2022
(impact on valuation, liquidity, and growth). We still believe the Fed
has lost control over inflation and forecast that true run-rate inflation
is currently over 10%. In contrast to the past decade, the Fed has
transitioned to a predominately hawkish focus on reducing inflation.
Nonetheless, Russian sanctions and tensions from the Ukraine-Russia
War led to historically high commodity prices, which have remained
elevated. Demand for LNG (Liquified natural gas) exports increased
substantially in Europe as Russian gas exports were halted. During
the year, WTI crude oil rose 40.62% while natural gas and natural gas
liquid prices rose 45.42% and 16.24%, respectively.
Many midstream companies implemented measures during the
previous quarters to protect their balance sheets with cost-saving
initiatives and cancellations or reductions to capital spending.
Midstream free cash flow has progressively grown, and free cash
flow after distributions has recently moved positive. Therefore,
companies have transitioned to paying down debt and, in the case
of larger midstream companies, instituted share buybacks to return
cash opportunistically. Share repurchases and incremental dividend
increases should help close the valuation gap between private
market value and public market value. We believe these activities
by management will help midstream companies successfully operate
during periods of volatile energy prices.
How The Fund Performed
During the second quarter, the Fund had a net return of -9.66%. This
compares to a net return of -7.96% for the Fund’s Benchmark Index.
During the last twelve months, the Fund had a net return of -0.28%
compared to the Benchmark Index return of 3.76%.
The Fund’s most recent distribution was $0.22 per share, while NAV per
share at quarter-end was $26.57. At the end of the quarter, the Fund’s
30-day SEC Yield1
was 10.66%. This annualized figure reflects the MLP
distributions and dividends received during the period, after the deduction
of Fund expenses.
We decreased our relative position in Hess Midstream (HESM). We
increased our position in Energy Transfer LP (ET) and Western Midstream
Partners LP (WES). We utilized proceeds to reallocate toward higher
conviction names. Regarding HESM, we decreased our position in response
to the dilutive Sinclair transaction, guidance cuts, and continued questions
surrounding the parent-sponsor relationship between HES and HESM. We
increased our positions in ET and WES as they stand to benefit more from
rising commodity prices or LNG export demand.
We continue to monitor geopolitical tensions rising from the UkraineRussia War and the subsequent impact on already-elevated commodity
prices. Combined with other factors, such as OPEC+ induced supply
changes, macroeconomic factors related to infrastructure spending and
Fed policy, OPEC’s continued caution on adding barrels to the market,
and disciplined domestic E&P budgets, we expect upward price
pressure on commodities and $100-120 oil prices in 2022. After a
period of capital discipline from U.S. oil and gas producers, investors will
be gauging the balance of OPEC returning barrels, an increasing U.S. rig
count, and oil demand recovery in a normalizing environment despite
A key focus for the remainder of 2022 will be the current energy crisis
impacting much of Europe. In the fourth quarter of 2021, European gas
futures averaged more than six times what they were in the same period
of 2020 and European utility companies are currently struggling to meet
their commitments. The situation signals a need for additional U.S. gas
production and LNG infrastructure to support this energy demand.
In the second half of 2022, we expect midstream companies to continue
transitioning to share buybacks and modest distribution growth. We have
seen considerable consolidation in the upstream sector and anticipate
that the recent uptick in domestic rigs will show up in 2022 production.
We continue to be positioned to take advantage of M&A activity that we
consider likely to occur soon. In addition, proposed increases in corporate
taxes will decrease the advantages of MLP C-Corp conversions.
For full commentary, portfolio details and charts, go to: Quarterly Commentary - Virtus InfraCap MLP ETF