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Quarterly Commentary - Virtus InfraCap MLP ETF

Market Overview

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

down 16.11%.

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.

Portfolio Changes

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

the pandemic.

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



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