Nontraditional Strategies to Consider in a Rising Rate Environment

Virtus Investment Partners, a multi-manager asset management business, discusses why advisors should consider preferreds, bank loans, and utilities for investing in, the importance of diversification in a client’s portfolio, and strategies for considering and approaching non-traditional allocations in a webcast moderated by Tom Lydon, CEO of ETF Trends.

George Goudelias, head of leveraged finance, senior portfolio manager at Seix Investment Advisors, discusses that as interest rates rise, it will be important to watch if the yield curve steepens or flattens in response.

“We are out of practice on rate hikes; it’s been a dozen years now where we’ve had a very benign interest rate environment, and certainly there are people who kind of only know this,” says Goudelias. Looking ahead, he believes that advisors should be cautious in their investments and look towards reducing duration.

The current environment should be good for leveraged loan issuers and bank loans. Goudelias discusses that the economy has probably seen its strongest growth and that a GDP of around 3.5% growth this year would be positive. It’s a time when active management is crucial and advisors are judged not just by the successes in what they do invest in but also the pitfalls they manage to avoid in a volatile market.

Jay Hatfield, CEO of Infrastructure Capital Advisors, explains that he anticipates that preferreds with 5-8% yield will generate income this year, although they are somewhat sensitive to stock markets. He remains constructive on interest rates because of an aging population with $52 trillion in assets, yield curve flattening, and slow growth in Europe and China.

“Most, and we only do publicly traded companies and publicly traded preferreds, care about their credit ratings, and most of them are targeting investment-grade and usually BBB because of that cost of capital. So they’ve made commitments to rating agencies, their board, other constituencies to maintain their credit quality, which is different than private high-yield bonds,” says Hatfield.

John Bartlett, CFA, president, portfolio manager, and analyst at Reaves Asset Management, believes that utilities could be a good play because although they do have interest rate sensitivity, it is to their own yield. Utilities are positioned positively for this year, Hatfield thinks, because as the Fed removes liquidity from the market, momentum stocks suffer while defensive dividend stocks such as utilities typically do well.

“Our attitude is that, broadly speaking, plain old utilities are a much better fixed income substitute,” Bartlett says.

He believes that utilities should be their own asset class because they are acyclical and their rates are set by the assets invested into their company, with the expectation that over time, earnings are correlated to investments. Essentially, that means that as long as a utility can keep investing in itself, it’s going to keep producing revenue, and the position that utilities are in now is among the best that Bartlett has seen in his career.

Investing Strategies

The Virtus InfraCap U.S. Preferred Stock ETF (PFFA) is focused on income, offers the potential for attractive yields, pursues compelling total return results, is actively managed, and has a modest leverage of 20-30% that’s used to enhance the portfolio’s beta while options strategies are used to try to enhance current income.

The IncraCap REIT Preferred ETF (PFFR) is the only ETF that offers diversified investment in preferred securities issued by REITs, which generally have attractive yield potential with fixed income and equity characteristics, as well as low equity beta. This particular security subset has less leveraged exposure equating to a more predictable revenue stream compared to banks and insurance companies.

The Virtus Seix Senior Loan ETF (SEIX) is actively managed, provides fundamental credit risk management, and emphasizes BB- and B-rated loans, investing in some of the healthiest and most undervalued credits within the non investment-grade space. Leveraged loans can offer the potential for lower correlations to fixed income classes as well as the possibility of higher income.

The Virtus Reaves Utilities ETF (UTES) seeks to deliver strong risk-adjusted performance through energy exposure that is actively managed utilizing a long-term strategy that focuses on companies the subadvisor is very familiar with.

Financial advisors who are interested in learning more about strategies in rising rate environments can watch the webcast here on demand.

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