Exchange traded fund investors who are seeking alternative yield-generating opportunities should consider the benefits of private credit and preferreds.
In the webcast, Virtus and VettaFi: A Primer on Private Credit and Preferreds, Marc Loughlin, director of CEF and ETF Trading Solutions at WallachBeth Capital; Jay Hatfield, CEO of Infrastructure Capital Advisors; and James Jessup, product manager at Virtus Investment Partners, argued that as market conditions are changing rapidly, investors can’t just rely on traditional fixed income alone. Alternatively, investors can turn to high-yield assets to help their portfolios to adapt to the current market environment and generate yields while mitigating risk today.
The strategists highlighted the challenging conditions that we continue to tackle, such as a Federal Reserve that is determined to combat inflation even if it means a weakening market outlook. Credit has to compete with U.S. Treasuries offering yields north of 4%. Meanwhile, market pressure has not been limited to risk assets, with core bonds down double digits year-to-date, or on pace for the worst performance in 35 years. The two- to 10-Year yield curve remains inverted, fueling fears of a recession ahead, which has historically occurred in other periods when the yield curve inverted.
“While interest rates are trending higher, we’re still in a relatively low-rate environment. Income-oriented investors with traditional stock and bond investments are still challenged to find meaningful levels of income. It’s our view that investors should consider a broader opportunity set of investments, including non-traditional sources of income,” according to Virtus.
For example, as investors turn to alternative yield-generating opportunities to diversify and enhance income generation, the strategists highlighted something like the Virtus Private Credit Strategy ETF (VPC), which follows the Indxx Private Credit Index, which provides exposure to private credit-focused assets such as business development companies (BDCs) and closed-end funds.
VPC offers passive exposure to the private credit market of a growing financing market for small- and mid-sized businesses in the United States. The fund can provide an attractive and complementary income opportunity for yield hunters. The ETF comes with quarterly distributions via a portfolio of exchange traded BDCs and CEFs with significant exposure to private credit instruments such as collateralized loan obligations (CLOs), mezzanine loans, and bank loans.
“The space is continuing to experience a wave of attention as faith in private credit has grown through COVID and investors seek additional alpha opportunities given traditional bonds rolling over and having one of their worst runs on record. The BDC industry continues to mature and institutionalize, becoming a competitive destination as the demand for yield continues. Cheap debt had been providing a boon to BDCs’ portfolio companies; BDCs had been taking advantage of the sea of liquidity by refinancing and extending maturities before rates trended higher. Private credit assets are floating rate, and they refinance quickly, which has historically provided one of the best hedges against inflation,” according to Virtus.
The actively managed Virtus InfraCap U.S. Preferred Stock ETF (NYSEArca: PFFA) also offers the potential for attractive yields while pursuing compelling total return results. The active management team takes security selection and weightings based on a variety of quantitative, qualitative, and relative valuation factors. Additionally, a modest leverage — typically 20% to 30% — is utilized to enhance portfolio beta, and options strategies are used to enhance current income.
“We continue to see that trading in high-yield preferred stocks is more influenced by idiosyncratic credit considerations than government bond yields. For the remainder of 2022, investors should continue to be more critical of the durability of revenue, asset coverage, and balance sheet liquidity in the face of the current economic slowdown. In this environment, we believe that active managers can continue to benefit from credit-driven considerations and market dislocations,” according to Virtus.
Preferred stocks are a class of equity security that typically pays fixed or floating dividends to investors and has a “preference” over common stocks. However, preferred stocks are subordinated to bonds. The issuing company must pay dividends to preferred stockholders before common stockholders, and, in the event of a bankruptcy or liquidation of the company’s assets, must put the claims of the preferred stockholders ahead of the claims of the common stockholders. Additionally, preferred stocks issue dividends regularly, but investors don’t usually enjoy capital appreciation on par with common shares.
In addition, the InfraCap REIT Preferred ETF (NYSEArca: PFFR) is the only ETF offering a diversified investment in preferred securities issued by Real Estate Investment Trusts (REITs). REIT preferreds tend to offer attractive yield potential, both fixed income and equity characteristics, and low equity beta. Compared to traditional preferreds, these securities are also typically exposed to less leverage with generally more predictable revenue streams than those issued by banks and insurance companies.
“Investors can potentially benefit from market rotations by investing in REIT preferreds. As interest rates rise from historically low levels, investors still have difficulty finding higher-yielding opportunities. Thus, preferred securities will continue to offer attractive yields and investors can still access REIT preferreds at discounted prices,” according to Virtus.
Financial advisors who are interested in learning more about private credit and preferreds can watch the webcast here on demand.