HITR Flash Q1 2024

                                                                                                                                           HITR Flash Q1 2024

The Next Big Thing

Investors are often trapped in a myopic position of looking at markets and investment returns on a day-by-day and monthly basis. It’s easy to get caught up in the crisis of the moment as media talking heads and their expert guest enablers jockey to say something more sensational and more headline grabbing than the last expert. Welcome to the world of soundbites and social media.

As investment managers, we are often faced with the daunting task of managing day-to-day client sentiment against the backdrop of longer-term investment trends. It’s often instructive to look back at any given moment in time and examine the consensus thinking. This thinking can often be wrong and at times breathtakingly wrong. It’s in that long-arc mindset that this report is written.

As of the end of the year, 12/31/2023, zooming out to a two-year performance table yields the following data:

Table courtesy of Kimble Charting Solutions

This compares to the HITR Portfolio that provided a total return of -0.04% before fees for the same period ahead of the S&P 500 and in-line with the NASDAQ while remaining ahead of all the other benchmarks (including crypto) on the above list for the same period while delivering an income stream of over 4% each year; thus, providing current income that is competitive with many bond products. We believe the HITR portfolio had distinguished itself over the past two years in a difficult environment but it’s easy to get caught up in market hype around mega-tech and lose sight of the real diversification benefits of this strategy.

Putting aside the daily machinations of the market, real trends emerge over longer periods, often a decade or more. The investor that recognizes these trends and positions accordingly will be rewarded because investment performance and alpha opportunities will be driven by the broad characteristics of the market environment and being on the correct side of those factors creates alpha opportunities.

A concise summary of factors by the decade is useful in putting this concept into perspective:

• 1960’s had a demand boom led by demographics which led to inflation
• 1970’s had persistent inflation that was finally broken by Paul Volker in 1981
• 1980’s & 1990’s had disinflation and falling rates from the Volker Peak
• 2000’s brought the Great Financial Crisis (GFC) and near financial collapse
• 2010’s global central banks delivered vast liquidity and zero interest rates
• 2020’s are now displaying persistent inflation and government fiscal interventions

The business experience of most senior investment professionals does not predate the GFC. Many have come to the business after the GFC and have only seen falling rates and accommodative monetary policy during their careers. With the rise in inflation caused by the central bank over-delivering massive liquidity during COVID, interest rates have now emerged as the most important lever of monetary policy. This has left inflation as a durable feature of the economic landscape and created policy trade-offs investors haven’t experienced in nearly half a century.

It appears that geopolitical tensions are creating new risks prompting policy makers to reconsider how the economy is configured, allocating public resources to industries considered strategically important such as green energy and microchips.  In addition, the excess liquidity has created a healthier private sector which has the collective balance sheet to leverage up under the right conditions. So, we see global governments that have become more highly indebted on a relative basis while shifting policy to play a more direct role in the economy and with more regulation of the markets than we’ve experienced in a long time. What does this mean for investors?

On a short-term basis this backdrop will be of minor importance, but over the next decade, these characteristics will define the experience of investors in the market. The time of abundant liquidity and zero rates that supported a massive run-up in risk assets is likely over for the time being. Higher rates and tighter monetary policy will reopen asset allocation options that have been all but closed for years. Value stocks, bonds, private credit vehicles, private equity and real estate will all become more competitive options. As the drivers of the risk asset rally in the years following the financial crisis continue to wane, the prospects for better asset performance will begin to broaden. This new era calls for reconsidering asset allocation. Let me explain.

Central bank interest rate policy has become the primary tool of monetary policy to modulate the business cycle. For the first time in well over a decade the cost of money isn’t free. Interest rates are no longer zero and real rates aren’t negative. The interest rate as set by central bankers underpins the value calculation for all other investment returns. After the GFC, 0% rates made cash a “sterile holding” providing no real return to holders. This encouraged investors to move out the risk curve seeking real returns for their cash. That situation has reversed and now there is a real return hurdle that alternative investments must overcome to be viewed as attractive or worthwhile by investors. With available risk-free yields at over 5%, and inflation sticky at 3%, investors are leaning into cash and fixed income proxies.

But it’s important to understand that inflation is no longer a “non-factor.” Even though inflation pressures have recently moderated, the longer-term secular backdrop has evolved from disinflationary to more inflationary. There are some key reasons for this shift. Decades of increasing globalization allowed business to access low-cost labor, primarily from China and other emerging economies. But, with the growth in geopolitical tensions and the known risks of supply disruption, businesses are investing in increasing the resilience of their global supply chains via nearshoring, onshoring and the use of alternative geographic suppliers.

Add to this mixture the investments and mandates being made by governments in curbing climate change and attempting to transition the world’s energy infrastructure.  This may save money longer-term by reducing potential climate damages over decades but are nonetheless an inflationary source of spending in the coming years.

Antitrust enforcement has also increased, limiting the ability of corporations to create scale and increase margin through acquisitions and generally making pricing less efficient.  Couple that with increased limits on immigration and ongoing demographic shifts that are leading to tighter labor markets in many countries. This emerging framework when compared to the post-GFC era is likely to have a higher embedded inflationary bias. It could be argued that 2% was about as high as inflation ever went since the GFC. We have argued in prior notes that 2% now looks more likely to be a floor than a ceiling and the road from 3% to 2% will be longer and slower than the market has expected.

We believe monetary policy makers will likely be slower to ease and quicker to tighten, providing less of a support for nonperforming financial assets and the broader asset economy. After decades where any economic and equity downturn was mild and short-lived given policy makers propensity to step in and meaningfully stimulate, policy makers will now face trade-offs in prioritizing economic growth or keeping inflation at a manageable level. Historically, if these trade-offs become more acute, swings in policy tend to be bigger, which is reflected in more attenuated economic cycles and, in turn, more volatile asset price moves.

What is Different?

Public sector indebtedness has never been so large outside of wartime and never so dependent on the Fed to fund it. And new debt continues to accumulate every day; the budget deficit is now as high as it’s ever been amid strong activity levels. In the next downturn (whenever it comes), the deterioration in government deficits will likely lead to a level of public sector funding needs larger than we’ve seen at any time other than the depths of COVID and wartime. So far, we have not seen any signs of the market being unwilling to finance these government debts—in contrast to the UK, for example, where in 2022 the Truss government’s aggressive fiscal plan spurred a spike in yields and a decline in the pound (this market-imposed fiscal discipline led to Truss’s immediate ouster and the scrapping of her government’s policies). But this could change and lead to additional constraints on policy, as well as pose a risk to the dollar.

The Biggest Global Share

The US has a kind of “Dutch disease” from its financial assets. The term Dutch disease was coined by the Economist Magazine to describe the negative impact of the growth of one economic sector at the expense of the growth of another.  It specifically referred to the decline of the Dutch manufacturing sector caused by the growth in the energy sector in the 1950’s. US assets are now the lion’s share of global asset markets. That, by default, makes the US a recipient of significant foreign inflows from savers. You can think of American financial assets almost like a “commodity”—one in which savers need to park their money. This leads to a special kind of “Dutch disease” akin to what economies experience when the world purchases their oil or other commodities. The dollar is secularly strong, and US assets have been less vulnerable to poor performance, with ample inflows to finance historically high government borrowing all continuing to push relative equity valuations upward.

Considering the long-term factors as described above, if the 2020’s are now displaying persistent inflation and government fiscal and policy interventions, this will likely lead to a decade into the 2030’s where inflation is higher and as a result, the equity premium, which is at a very low level historically, will need to rise. An easy way to think about the equity risk premium is to measure the difference between the S&P 500’s earnings yield and that of 10-year Treasurys. As bond yields have climbed, this gap has shrunk. Recently it touched the lowest level in more than 20 years, as the data below shows.

As mentioned previously, as the drivers of the risk asset rally in the years following the financial crisis continue to wane, the prospects for better asset performance will begin to broaden. This new era calls for reconsidering asset allocation and portfolios will benefit from broader diversification across asset categories that act as liquid alternatives for asset classes such as real estate, private and alternative credit, and global infrastructure all of which are categories in the HITR portfolio.

1Q24 HITR Flash Report Portfolio Segment Data:

Common Stock

With the stock market rallying 10+% for the second consecutive quarter (the S&P 500 was up +10.56% in 1Q24) on hopes that the Fed has finished the rate hikes and will begin cutting rates in 2024, our Common Stock allocation, at 26.2% of the portfolio, underperformed the S&P 500 in Q1 by 100 bps (and 158 bps as net performance).

The above extracted performance does not reflect an allocation of cash.  Total portfolio performance is available upon request.

Thematically within the common stock segment of the portfolio we have leaned into selected broad-based technology and biopharmaceutical healthcare themes that would benefit from continued inflation. A secondary theme of financials that benefit from higher yields is also a minor macro thread across the HITR portfolio.

Our top performing Common Stock, Coherent (COHR) was up +39.3% in Q1 as they reported better-than-expected earnings on the top and bottom lines, along with large increases to their Fiscal Year guidance with supply chain constraints easing. Our second-best performer, Caterpillar (CAT) was up +24.5%. They announced a nice bottom line beat of $0.47. In addition, the company saw increased demand for lithium, copper, and other mined materials that use CAT equipment to gather and process raw materials.

The biggest laggard this quarter, Cogent Communications (CCOI), was down -12.8% on weaker-than-expected EBITDA margin and softness in its internet access for small to medium-sized businesses. Our second-worst performer, InterDigital (IDCC) fell -1.5% as the CFO sold shares after a positive reaction to earnings.

Changes to the Common Equity allocation during the quarter included the purchase of Verizon Communications (VZ), after the leading communications provider reported better-than-expected results on the top and bottom line, and favorable EPS guidance.

Global Infrastructure

At 21.1% of the portfolio, the Global Infrastructure allocation outperformed the DJ Brookfield Global Infrastructure Index by 1226 bps (and 1166 bps as net performance) as our limited exposure in the alternative energy transition space helped to mitigate some of the underperformance from that sector.

The above extracted performance does not reflect an allocation of cash.  Total portfolio performance is available upon request.

Thematically, the Global Infrastructure segment is focused on a blend of new and traditional energy infrastructure companies.

Valero (VLO) was our top performer, up +32.3% as they benefitted from positive refining spreads and strong demand in the refined fuels markets. Diamondback (FANG), our next-best performer, was up +30.0% as they benefitted from higher energy prices and expanded production in the Permian Basin. Euronav (EURN) was the worst performer, down -5.5% during the quarter, as they suffered through shipping decreases as well as a hostile takeover attempt. Our second worst performer, Chesapeake Utilities (CPK) was up 2.2% as the Utilities sector lagged the broader Global Infrastructure market.

Changes to the Global Infrastructure allocation during the quarter included the sale of Bunge Global (BG), as the stock had a breakdown in price and volume during the quarter. Additionally, we sold our position in Mercedes Benz (MBGYY), due to electronic vehicles experiencing a lack in support. We initiated a position in OneOK (OKE), a leading natural gas processor after the company raised their dividend and announced a share repurchase program.

Other Income

Accounting for 26.2% of the portfolio, the Other Income allocation with a focus on preferred and convertible preferred securities underperformed in Q1 by 31 bps (and 87 bps as net performance).

The above extracted performance includes and reflects the portfolio allocation of cash.  Total portfolio performance is available upon request.

Thematically our focus in the Other Income segment has been focused on special situations with a bias toward out of the money convertibles which offer decent current yields and the possibility to capture some upside appreciation as the underlying company appreciates toward the conversion price.

Global X S&P 500 Covered Call ETF (XYLD) was our top performer this quarter in the Other Income segment, up +5.9%. This domestic covered call strategy in the S&P 500 cannot be replicated outside of the ETF in an equity-only portfolio, and enjoyed a positive quarter as many equities had muted moves to the upside during the first quarter. Our second-best performer, Medallion Bank preferred (MBNKP) was up +5.8% after a good earnings report that saw a higher-than-expected dividend payout for the preferred. EPR Properties preferred (EPR-PC) and Ellington Financial (EFC) were our worst performers, down -9.3% and -3.6% respectively, as both struggled in the face of rising bond yields.

Changes to the Other Income allocation during the quarter included the purchase of Ares Capital (ARCC), as a picks-and-shovels play on private credit after reporting positive earnings and strong demand growth in the private credit space.

REITs

REITs, representing 26.5% of the portfolio, outperformed Uniplan’s Custom REIT benchmark by 173 bps (and 118 bps as net performance) as our posturing in quality names helped in the face of rising rates.

The above extracted performance does not reflect an allocation of cash.  Total portfolio performance is available upon request.

Iron Mountain (IRM) led our REIT holdings, returning +15.6% in Q1. IRM, which operates Data Centers, has transitioned from an industrial storage REIT to a Diversified REIT and has been rewarded for this reclassification. Simon Property Group (SPG) was our next-best performer up +11.1%. The shopping center REIT has been able to projectably increase rents and cash flow. Our worst performer was Farmland Partners (FPI), which was down -10.6% after slight misses on the top and bottom line. Our second-worst performer, American Tower (AMT) which was down -8.5%, was negatively impacted by a rotation out of the Telcom Infrastructure REITs, as investors continue to migrate towards Data Centers for a purer play on artificial intelligence (AI) amidst continued tech outperformance in equity markets.

Conclusion

Secular trends emerge over longer periods, often a decade or more. The investor that recognizes these trends and positions accordingly will be rewarded because investment performance and alpha opportunities will be driven by the broad characteristics of the market environment and being on the correct side of those factors creates alpha opportunities. The 2020’s are displaying patterns of persistent inflation and government fiscal and policy interventions, which we project will likely lead to a decade into the 2030’s where inflation is higher and as a result, the equity premium, which is at a very low level historically, will need to rise. In this new environment, investment portfolios will benefit from broader diversification across asset categories that act as liquid alternatives for asset classes such as real estate, private and alternative credit, and global infrastructure, all of which are categories in the HITR portfolio which is well positioned to take advantage of The Next Big Thing.

Richard Imperiale
Andrew O’Neill

April 2024

The views in this letter were as of April 2024 and may not necessarily reflect the same views on the date this letter is first published or any time thereafter. These views are intended to help shareholders in understanding the fund’s investment methodology and do not constitute investment advice.

The Uniplan High Income Total Return (HITR) portfolio is focused on providing current income and long-term growth by owning dividend paying equity securities.  Within the portfolio these investments are grouped into the categories of Dividend Paying Common Stocks, Master Limited Partnerships (MLPs/Infrastructure) or their proxies, Real Estate Investment Trusts (REITs) and Other Income Equities (primarily preferred and convertible stocks, ETF’s, and ETN’s); This note revisits some of the thematic qualities of the portfolio within each of the categories and the performance by sector across the overall portfolio. 

Important Information: 1. Uniplan Investment Counsel (“Uniplan”) is a boutique investment firm, with roots dating back to 1984, that manages a variety of portfolios primarily for US clients. 2. The composite was created January 1, 2001. Performance is calculated in US dollars utilizing a time-weighted total rate of return. Total return for the composite is represented by the asset-weighted returns of the portfolios within the composite. Trade-date valuation is used. 3. Gross Performance is net of all transaction costs and Net Performance is net of transaction costs and (maximum allowable total) investment management fee, but before any custodial fees (that may be incurred separately by the client). 4. Primary Benchmark Index (HITR) – The Index was the Russell 1000 until 12/31/2023.  Thereafter, the Index is the Standard & Poor’s 500 Index (S&P 500).  The S&P 500 is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies.  5. Within the Uniplan High Income Total Return (HITR) portfolio investments are grouped into the categories of Dividend Paying Common Stocks, Global Infrastructure, Other Income Equities (primarily preferred and convertible stocks, ETFs and ETNs), and Real Estate Investment Trusts (REITs). These groups are represented by the following indices respectively. Dow Jones Brookfield Global Infrastructure (DJB Global) – The DJB Global Index is designed to measure the performance of pure-play infrastructure companies domiciled globally. The index covers all sectors of the infrastructure market.  Barclays Pfd & Cvt – Barclays Capital Aggregate Bond Index is a market capitalization index made up of US Treasury Securities (non TIPS), government agency bonds, Mortgage-Backed bonds, and corporate bonds, and a small amount of foreign bonds traded in the US.  Primary Benchmark (REIT) – The Index was the FTSE NAREIT All Equity REITs Index until 12/31/2023. Thereafter, a custom benchmark that uses the 150 largest market capitalization companies.  In creating a custom benchmark Uniplan applies a screening tool utilizing a KPI REIT universe.  From there, Uniplan uses the 150 largest market capitalization companies.  Basic exclusions from this universe include Commercial Real estate services & brokerage, real estate investment & services, and all Mortgage REITs.  Uniplan reserves the right to remove a company from the custom benchmark for any or no reason at all.  The Primary Benchmark is rebalanced quarterly and includes the reinvestment of dividends.  6. The indices are adjusted to reflect reinvestment of dividends. The index figures do not reflect any deductions for fees, expenses or taxes. It is not possible to invest directly in an index. 7. There are no guarantees that dividend-paying stocks will continue to pay dividends. Dividends are paid only when declared by an issuer’s board of directors, and the amount of any dividend may vary over time. Dividend yield is one component of performance and should not be the only consideration for investment. In addition, dividend-paying stocks may not experience the same capital appreciation potential as non-dividend-paying stocks. Diversification does not assure a profit nor protect against loss. Additionally, International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards. The portfolio may own ADRs on occasion, as such international investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards. 8. The dispersion of annual returns is measured by the standard deviation of asset-weighted portfolio returns represented within the composite for the full year. The standard deviation of the gross annual returns for the period January 1, 2001 through Error! Reference source not found. is Error! Reference source not found.% for the composite and Error! Reference source not found.% for the Primary Benchmark Index. 9. The composite does not have a minimum size criterion for composite membership. All fee-paying discretionary accounts with similar investment objectives are included. Leverage is not used in this composite as a means to generate higher returns. There may be non-fee paying portfolios in the composite. Individual account holdings may vary depending on numerous factors including the size of an account, cash flows, and account restrictions. 10. There have been no changes in the personnel responsible for the management of this composite. 11. The composite contains both traditional and wrap fee portfolios. Uniplan has a flexible and negotiable fee schedule reflecting the differences in size, composition and servicing needs of clients’ accounts. 12. Uniplan Investment Counsel does not claim GIPS compliance. The performance has been verified by an independent source as of 1/01/2011 – 12/31/Error! Reference source not found.. A complete description of investment advisory fees is contained in Uniplan’s Form ADV and is available upon request. Individual account performance may vary from the results shown because of differences in inception date, restrictions and other factors. 13. This information is not an offer to buy or sell a security nor does it constitute investment advice or an offer to provide investment advisory or other services. All information is subject to correction or change. Past performance is no guarantee of future results. Investment involves a risk of loss.

All investments carry a certain degree of risk, including possible loss of principal. REITs are subject to illiquidity, credit and interest rate risks, as well as risks associated with small and mid-cap investments. It is important to review your investment objectives; risk tolerance and liquidity needs before choosing an investment style. Value style investing presents the risk that the holdings or securities may never reach their full market value because the market fails to recognize what the portfolio management team considers the true business value or because the portfolio management team has misjudged those values. In addition, value style investing may fall out of favor and underperform growth or other style investing during given periods.

Uniplan is a registered investment advisor. The views expressed contain certain forward-looking statements which can be speculative in nature. Uniplan believes these forward-looking statements to be reasonable, although they are forecasts and actual results may be meaningfully different. This material represents an assessment of the market at a particular time and is not a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular security and is subject to change without notice. Prices, quotes and other statistics have been obtained from sources we believe to be reliable, but Uniplan cannot guarantee their accuracy or completeness. All expressions of opinion are subject to change without notice. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of this security. A list of securities purchased and sold in the portfolio during the past year, including the purchase or sale price and the current market price, is available upon request by calling 262-534-3000.

[1] Primary Benchmark Index:  Prior to 12/31/2023, the benchmark index was the FTSE NAREIT All Equity REITs Index; thereafter, a custom benchmark that uses the 150 largest market capitalization companies.  In creating a custom benchmark Uniplan applies a screening tool utilizing a KPI REIT universe.  From there, Uniplan uses the 150 largest market capitalization companies.  Basic exclusions from this universe include Commercial Real estate services & brokerage, real estate investment & services, and all Mortgage REITs.  Uniplan reserves the right to remove a company from the custom benchmark for any or no reason at all.  The Primary Benchmark is rebalanced quarterly and includes the reinvestment of dividends.  It is not possible to invest directly in an index. The index figures do not reflect any deduction for fees, expenses or taxes.