Real Assets, Real Income?

Tom Bailey:

Hello everyone and welcome to today’s webinar.

My name is Tom Bailey, Head of Research at HANetf, and I’ll be moderating today’s discussion.

Before we begin, a quick reminder that this webinar is for professional investors only. As always, when you invest in ETFs, your capital is at risk.

Today we will be discussing income from real assets and asset-backed cash flows, and why investors may want to look beyond traditional bonds and other sources when building income portfolios.

I’m very pleased to be joined today by:

• Jay Hatfield, Founder, CEO and Portfolio Manager at Infrastructure Capital, which manages the Infrastructure Capital Preferred Income UCITS ETF (PFFI).
• Dean Orrico, President and CEO of Middlefield, with whom HANetf has partnered on the Middlefield Canadian Enhanced Income UCITS ETF (MCTP).
• Harry Halewood, Product Specialist at HANetf, who will discuss the Illyrian Midstream Dividend Energy UCITS ETF (MLP).

This will be a panel discussion rather than a formal presentation.

We encourage audience members to submit questions throughout the webinar.

Dean Orrico:

Thank you very much for having me here today.

When we talk about real assets, I think our portfolio reflects what those assets represent in terms of producing real cash flows.

The focus is not on manufacturing income, but on companies that generate income through ownership of assets.

These assets include energy infrastructure, particularly pipelines, power generation facilities and real estate assets.

These businesses generate significant amounts of income, and in many cases that income is contracted, providing visibility around the cash flows being generated.

This translates into the dividends paid out to investors.

The strategy we run with HANetf has existed for more than 20 years. While we converted it into an ETF recently, it previously operated as an investment trust since 2006.

Over that period, the strategy has focused on owning real assets that generate income.

Jay Hatfield:

We have a similar approach, focusing on asset-intensive businesses.

These businesses tend to perform well through cycles because they are supported by physical assets.

However, there is an important distinction between our approach and an equity strategy.

PFFI is a preferred stock fund, so it is a form of fixed income. It is junior fixed income, meaning it ranks below traditional debt holders but ahead of common shareholders.

This can provide lower volatility compared with equities.

The trade-off is that over the long term, preferred shares would generally not be expected to deliver the same returns as equities.

The benefit is that investors receive income with a different risk profile.

Preferred shares are also issued by public companies, which have various options available to maintain their credit position, including issuing equity or selling assets.

Harry Halewood:

The Illyrian Midstream Dividend Energy UCITS ETF focuses on the midstream function of the energy supply chain.

This includes pipelines, storage facilities and processing infrastructure that help move energy products from extraction through to final delivery.

These assets provide an essential function within the energy industry.

Because of their importance, they can have significant barriers to entry, including high setup costs and the need for established infrastructure networks.

This can provide a level of defensibility around the cash flows generated by these companies.

Tom Bailey:

Dean, Canada is well known as a resource economy. However, Middlefield’s recent content has focused on changing sentiment around this area.

Could you explain what has changed and what the opportunity looks like today?

Dean Orrico:

Canada and the US are very different markets.

The US has historically been viewed as a growth market, while Canada is much more focused on natural resources.

Canada is a major producer of resources including oil, natural gas, uranium and potash.

For many years, this part of the market was out of favour as investors focused heavily on growth, technology and artificial intelligence.

Canada’s market is more concentrated around financials, energy, mining and materials.

Over recent years, sentiment towards Canadian natural resources has changed.

The panel discusses how energy security, supply chains and demand for natural resources have increased the focus on reliable resource producers.

Dean Orrico:

When investors, particularly in the UK and Europe, think about North America, Canada and the US are often grouped together, but they are very different markets.

The US has historically been viewed as a growth market, whereas Canada is much more focused on natural resources.

Canada is one of the world’s leading producers of major natural resources, including oil, natural gas, uranium and potash.

For many years, this area of the market was out of favour because investors were focused heavily on growth, technology and artificial intelligence.

The Canadian market has traditionally been concentrated around financials, energy, mining and materials.

Over the last few years, the perception of Canadian natural resources has started to change.

Previously, global investors looking for natural resource exposure faced challenges due to policy uncertainty and concerns around developing new projects.

However, the panel discussed how the investment environment has shifted, with greater attention being placed on energy security, reliable supply chains and the importance of natural resources.

Canada has increasingly been viewed as a stable supplier of commodities due to its resource base and political framework.

Dean Orrico:

The current environment has highlighted the importance of reliable energy and resource supply.

Events around the world have shown that energy and minerals can become strategic assets.

Canada stands out as one of the largest stable suppliers of natural resources.

The panel discussed how increased focus on energy security has contributed to renewed interest in Canadian resource companies and infrastructure.

Tom Bailey:

Harry, there is clearly a broader theme around Canada becoming an important supplier of natural resources.

A similar theme applies to midstream energy infrastructure in North America, particularly with growing demand for US LNG and energy security.

Could you discuss some of the growth drivers for midstream energy?

Harry Halewood:

The Illyrian Midstream Dividend Energy UCITS ETF has approximately 65% exposure to the US, with around 70% of the portfolio focused on natural gas-related businesses.

A key driver of demand growth has been increasing exports, particularly liquefied natural gas (LNG).

US LNG exports are expected to continue expanding, which requires significant investment in export capacity, transportation infrastructure and processing facilities.

This includes the development of:

• LNG export terminals
• Connecting infrastructure
• Processing facilities
• Liquefaction plants

These investments demonstrate the scale of capital required to expand energy infrastructure.

Another important driver is the growth of artificial intelligence and the associated expansion of data centres.

AI and data centres are among the fastest-growing consumers of energy globally.

A significant proportion of global data centres are located in the US, and natural gas currently provides an important source of energy for these facilities.

The continued expansion of data centres is increasing demand for reliable energy supply.

Many hyperscale operators are looking at dedicated energy solutions because connecting large facilities to existing grids can create challenges around capacity and reliability.

This has led to interest in solutions such as:

• On-site generation
• Gas-powered facilities
• Dedicated pipeline connections

The panel discussed how this could support demand for midstream infrastructure.

Historically, natural gas infrastructure investment was driven by supply growth.

As US production increased, companies built infrastructure to transport and store additional energy.

However, the panel discussed how the market has increasingly become more demand-driven.

Large users, including data centres and other industrial consumers, are increasingly influencing infrastructure investment decisions.

These longer-term demand commitments can support planning and investment across the energy supply chain.

Tom Bailey:

Jay, you mentioned preferred shares and where they sit within the capital structure.

Could you explain why preferred shares may be considered as part of an income portfolio rather than simply looking for higher yields through higher-risk bonds?

Jay Hatfield:

We think both high yield bonds and preferred shares can play an important role in fixed income portfolios.

The key difference is the balance between income and risk.

Preferred shares provide income while ranking ahead of common equity holders.

For PFFI, the focus is on selecting lower-risk credits with attractive yields.

The strategy targets income generation while managing credit risk.

One of the benefits of preferred shares is that they typically have limited sensitivity to interest rates compared with traditional fixed income.

A large proportion of the return comes from the credit spread rather than changes in government bond yields.

Preferred shares do carry risk, including credit risk.

However, Jay discussed how historical default rates for preferred securities have been relatively low compared with high yield bonds.

The argument presented was that preferred shares can provide a balance between traditional investment-grade bonds, which may offer lower yields, and higher-risk assets such as equities or high yield bonds.

Jay highlighted the importance of active management within preferred shares.

Preferred securities can have characteristics that require additional analysis, including:

• Callable structures
• Credit quality
• Interest rate exposure
• Pricing differences between securities

An active approach can allow managers to assess individual securities and adjust portfolios based on changing market conditions.

Tom Bailey:

You have previously commented on Federal Reserve policy.

What is your outlook for US interest rates and what could this mean for preferred shares?

Jay Hatfield:

Our view is that the market may be underestimating how flexible future Federal Reserve policy could be.

The key point is that preferred shares are not solely dependent on interest rate movements.

With yields driven largely by credit spreads, interest rate changes are only one factor affecting returns.

If interest rates decline, this could potentially provide an additional tailwind for preferred securities.

However, the main focus remains on income generation and credit quality.

The panel also discussed the impact of energy markets on inflation.

Energy prices can influence inflation expectations, particularly when geopolitical events affect supply chains.

The speakers highlighted that energy infrastructure remains important because reliable supply is required regardless of short-term market movements.

Tom Bailey:

Harry, how does inflation affect midstream energy infrastructure?

Harry Halewood:

Inflation creates two key considerations for income-focused investors.

The first is whether companies can continue generating cash flows and maintaining distributions.

The second is whether income payments maintain their purchasing power over time.

Midstream infrastructure can provide some protection through contractual arrangements.

Many midstream businesses operate through long-term contracts, often lasting between five and twenty years.

These agreements can provide visibility around revenues.

Many infrastructure contracts include inflation adjustments.

For example, pipeline operators may adjust rates based on inflation-related measures.

These mechanisms are designed to help revenues adjust over time as costs and price levels change.

The panel discussed how this structure can help support the durability of cash flows.

Harry Halewood:

Midstream energy infrastructure businesses can provide some level of resilience in an inflationary environment because many operate through long-term contractual arrangements.

These contracts can provide visibility around revenues and help support cash flows through different economic conditions.

Many agreements also include inflation adjustments, allowing payments to increase alongside changes in price levels.

For example, some pipeline operators use inflation-linked adjustments based on measures such as the Producer Price Index for Finished Goods (PPI-FG).

These mechanisms allow infrastructure providers to adjust rates over time, helping to reduce the impact of inflation on real cash flows.

Jay Hatfield:

One additional point is that midstream energy infrastructure has historically shown limited interest rate sensitivity.

When looking at the data, midstream companies behave differently from traditional fixed income assets.

They have relatively low sensitivity to interest rates and relatively low correlation with broader equity markets.

While energy prices can influence sentiment, midstream companies are primarily focused on the movement of energy products through infrastructure networks.

Lower energy prices do not necessarily mean lower volumes moving through pipelines.

In some cases, lower prices can increase demand, resulting in more product flowing through infrastructure.

Tom Bailey:

Both Middlefield and Infrastructure Capital manage active ETFs, which is an area of growing interest among European ETF investors.

Could you explain why an active approach makes sense within your specific asset classes?

Dean Orrico:

We are an active manager, and all of Middlefield’s strategies are actively managed.

Our approach is based on building high-conviction portfolios.

Typically, we own around 30 to 40 companies within each strategy.

Because the portfolio is concentrated, we need to understand each company in detail.

We regularly meet with management teams, both in Canada and internationally, to better understand the businesses we invest in.

The portfolio is built around three core areas:

• Financials
• Energy and infrastructure
• Real estate investment trusts (REITs)

Canadian financials represent an important part of the portfolio.

The Canadian banking system has historically been viewed as stable, supported by strong capital positions and conservative management.

Canadian banks have historically maintained dividend payments through different market environments.

Energy and infrastructure are another major component of the portfolio.

The strategy has significant exposure to energy producers and pipeline companies.

The panel discussed how energy security, resource supply and infrastructure investment have increased focus on Canadian energy companies.

Pipeline businesses were highlighted as examples of companies that can generate recurring income through essential infrastructure.

The portfolio also includes Canadian REITs.

The discussion highlighted recent activity within the Canadian REIT market, including acquisitions and consolidation.

The panel noted that underlying fundamentals, including supply and demand dynamics, remain important drivers of performance.

Jay Hatfield:

We believe active management is particularly important in fixed income.

Fixed income investors need to manage several risks:

• Credit risk
• Interest rate risk
• Security structure risk

Preferred securities have additional characteristics, including call features, which require careful analysis.

A passive approach may not always account for differences between individual securities.

Active management allows managers to evaluate:

• Credit quality
• Valuation
• Yield characteristics
• Call risk
• Interest rate exposure

Preferred securities can trade differently depending on their characteristics.

For example, when a security trades above its redemption value, there may be limitations to future returns because the issuer may have the ability to redeem the security.

An active manager can adjust exposure based on these factors.

The panel discussed how this flexibility can be important in managing income portfolios.

Tom Bailey:

Harry, although the Illyrian Midstream Dividend Energy UCITS ETF is not actively managed, could you explain how the underlying index is constructed?

Harry Halewood:

The index focuses on companies involved in the midstream energy sector.

The universe is selected from companies with exposure to midstream energy infrastructure.

The selection process includes a requirement that companies have paid distributions in each of the two quarters before assessment for inclusion.

After companies pass the inclusion criteria, they are weighted based on factors including:

• Shares outstanding
• Distribution paid per share

This approach focuses exposure towards companies that have historically demonstrated consistent dividend payments.

The objective is to provide exposure to companies within the sector that have established distribution histories.

Tom Bailey:

Thank you, Dean, Jay and Harry.

This has been a very interesting discussion covering real assets, infrastructure, preferred shares and income strategies.

For investors looking beyond traditional fixed income, these areas provide different approaches to generating income from asset-backed businesses.

Thank you to everyone who joined today.

If you would like more information on any of the strategies discussed, please reach out to the HANetf team.

Thank you again to our panellists and audience.