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 in 2022. 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. Divergences on
credit still persist as lower-rated, higher-yielding credits outperform on correlation to equity markets and higher-rated, lower-yielding credits underperformed on correlation to Treasury yields.
How The Fund Performed
For the quarter, the Fund returned -10.87% at NAV, while the Fund’s benchmark, the S&P U.S. Preferred Stock Index (Benchmark Index), returned -8.09%. The Fund paid a monthly dividend of $0.1625 per share for each month of the quarter, while NAV at quarter-end was $20.92. As of quarter-end, the Fund had a 30-Day SEC Yield1 of 9.85%. This annualized figure reflects the distributions and dividends received
during the period, after the deduction of Fund expenses. The Fund maintained large overweight positions in the real estate and industrial sectors relative to the Benchmark Index. Our view is that the yield and credit profiles of these sectors are more attractive than the financial sector. At the end of the quarter, the real estate allocation was 26.5%, compared to 8.4% for the Benchmark Index, and the
allocation to the industrial sector was 13.6% versus 3.3% for the Benchmark Index. The Fund’s underweight to the financial sector is substantial, with a weighting of 5.6% compared to 66.1% for the Benchmark Index. We believe the real estate and industrial
sectors are best positioned for higher yields and total returns. The Fund ended the
quarter with leverage of 29.0% of net asset value, in line with the trailing twelve-month
average. The Fund has a 50.0% weighting in fixed-to-floating-rate preferred shares.
The Fund expects to pay a monthly dividend of $0.1625 per share. The Fund’s strategy of
maximizing yield-to-call (YTC) generated substantial optimization profits during the quarter.
The use of leverage also contributed to the amount of income available for distribution.
We increased our holdings in Algonquin Power & Utilities. Algonquin Power
& Utilities is a renewable power generation company that owns sustainable
infrastructure assets across North America.
Despite tailwinds from the reopening of the U.S. economy in 2021, the predominate market
risk is the impact of the Fed’s conclusion of its asset purchase program (liquidity) and
subsequently whether it sticks to its targeted rate hikes plan in the second half of 2022. We
still believe the Fed has lost control over inflation and forecast that true run-rate inflation is
currently over 10%.
In 2021, legislators removed corporate tax rate increases and scaled back other taxes in
recent proposed legislation, which was positive for the market in 2022. Corporate tax rates
are 33%, negatively correlated with growth globally. However, recent proposed tax increases,
projected interest rate increases, and the suspension of stimulus payments may slow
economic growth in 2022. As a result, we have continued to diligently add issuers with
higher liquidity and credit quality. Further, we’ve increased both the yield and YTC of the
portfolio in anticipation of a rising interest rate environment.
Additionally, the vaccine rollout has continued to progress with increased availability of
booster vaccines. As of July 6, 2022, approximately 78.3% of the U.S. population has
received at least one dose and 66.9% is fully vaccinated.
Based on our relative value quantitative and qualitative screens, we continue to add
issuers with high liquidity credit quality. We believe that the historically expansive monetary
policy implemented by the Fed has quelled short-term liquidity concerns that may return
in 2022. In the long term, macroeconomic headwinds in the form of rising interest rates,
tightening liquidity, increasing commodity prices, and inflation pressures are risks that we
continue to monitor.
To reiterate, we expect market uncertainty to continue in 2022 as inflation remains high,
Fed policy transitions toward tightening, and interest rates rise. As individual preferred issues
continue to recover and trade closer to par, we look to opportunistically add new issues to
maintain an above-average YTC versus the Benchmark Index.
For full commentary, portfolio details and charts, go to: Quarterly Commentary - Virtus InfraCap U.S. Preferred Stock ETF