Infrastructure Capital, a New York boutique, has bypassed the buoyant market in London-listed debt funds to launch the first actively managed Dublin-based exchange traded fund (ETF) investing in US preferred shares.
The Infrastructure Capital Preferred Income Ucits ETF has been listed by ETF provider HANetf on the London Stock Exchange under the PFFI ticker as well as Germany’s Xetra and Italy’s Borsa Italiana exchanges.
PFFI aims to provide a high monthly income from a portfolio of mostly US preferred securities, a hybrid form of debt equity that sits between unsecured bonds and ordinary shares in a company’s capital structure. They generally yield more than investment grade corporate bonds and their coupons take priority over dividends to ordinary shareholders.
ETF not trust
The use of an open-ended ETF structure may raise questions in some quarters given the relatively illiquid asset class of US preferred shares arguably could have suited a closed-end fund less vulnerable to sudden investor redemptions.
Supporters of London-listed investment companies may query why Infrastructure Capital did not launch one given debt funds in the London capital are bucking a prolonged sector downturn and are currently enjoying a purple patch.
Data from the Association of Investment Companies shows that in contrast to the wider sector, where shares languish on an average 13% discount to portfolio valuations, high-yielding loan and bond funds currently stand on a 2.8% premium to net asset value. Last week CVC Income & Growth (CVCG) and Twenty Four Income Fund (TFIF) launched share issues in response to strong investor demand.
However, Infrastructure Capital, which was founded by former Morgan Stanley investment banker Jay Hatfield in 2002, may have taken its cue from the less positive example of EJF Investments (EJFI). The £76m investment company invests in the regulatory debt issued by US banks. It offers an attractive 8.6% yield but its shares trail on a 22% discount which may reflect investor wariness with an unfamiliar asset class.
Infrastructure Capital could also have been daunted by the prospect of having to raise up to £100m to achieve a successful investment company launch. By contrast, although it will doubtless have to work hard raising money, the firm was able to list PFFI with just under $1m.
In opting for an ETF structure, PFFI becomes the 107th active exchange traded fund to launch in Europe, most of them in Dublin and Luxembourg, signifying a burgeoning sub-sector of a giant fund market previously synonymous with “passive” index tracking.
According to our records, 39 of these active ETFs are fixed income funds investing in a range of bonds and corporate credit globally and also in the US, Europe and the UK. However, PFFI is the first to concentrate on US preferred shares.
Preferred opportunities
Hatfield, Infrastructure Capital’s chief executive and chief investment officer, says the $192bn US market in preferred shares is smaller than the $1tn one in high yield bonds, but is less volatile than non-investment grade debt and offers more scope for value opportunities.
This gives the manager, who also previously ran income funds at SAC Capital, the potential to generate capital growth and income from an asset class currently yielding around 6%.
Hatfield, whose firm has $2.5bn under management in a range of ETFs and hedge funds, will be assisted by co-manager Andrew Meleney, who before joining Infrastructure Capital in 2016 was an oil and gas equity analyst at Parker Global Strategies in New York.
The pair will focus on companies they think are well positioned to maintain high levels of profitability and can access additional capital.
The portfolio currently has 64 holdings and charges total expenses of 0.8%. Its biggest position is a 3.6% weighting to the 9.25% perpetual bond issued by Energy Transfer, a private “midstream” energy company.
Hatfield has a long association with the sector. A former head of research at Zimmer Lucas Partners, a hedge fund focused on the energy and utility stocks, Hatfield went on to help launch NGL Energy Partners from the merger of several oil transportation and storage providers. It floated in 2021 and he remains a general partner in the New York listed company.
Risk ratings
The fund managers will produce their own in-house credit ratings believing the three big ratings agencies spectacularly failed to spot credit risk in the 2008 global financial crisis and the 2023 US regional banking crisis.
In the case of preferred stocks, they claim ratings agencies like Moody’s, Standard & Poor’s and Fitch over-estimate their risks and assign ratings that are often three grades too low, even though they say default levels on preferreds are lower.
A key part of risk management will also be assessing “call risk” with many preferred shares trading above the price at which companies can buy them back, exposing investors to potential capital losses.
Inflation risk “irrational”
Hatfield takes a slightly contrarian view on inflation, dismissing forecasts that US tariffs will worsen cost-of-living pressures as “completely wrong”.
In a presentation for the PFFI launch, he argued that many forecasts focused on the inflationary impact of the sharp fall in the dollar in the first half of the year but ignored the rally in the US currency after President Trump’s election win last November, and its subsequent recovery in the third quarter.
The consumer prices index measure of inflation rose slightly to 2.9% in August but Hatfield predicted it would start to fall. “Anticipation of Trump policies have caused the dollar to strengthen by 10% which is highly deflationary,” he said.
Hatfield remains bullish on bonds, and by implication preferred shares, saying fears of accelerating US inflation are “completely irrational”. Although a “hawkish” Federal Reserve kept the funds rate at 4.5% this year before cutting to 4.25% last month, he says there has been almost 120 basis points (1.2%) of “tightening in financial conditions and associated increase in the dollar that has not yet been reflected in economic growth or inflation.” Like other commentators, he believes the Fed will cut interest rates again to avoid a sharp slowdown in the US economy.
“Inflation is caused by excessive monetary growth and energy shocks and is not significantly impacted by other government policies,” he added.
