As volatility persists amid a period of economic and financial uncertainty, the Main BuyWrite strategy remains popular among investors seeking enhanced income and reduced volatility.
2022 in the Rearview
Volatility was unusually high in 2022, even when compared to prior bear markets. Rather than a single event-driven shock that took down markets – like the 2020 Covid Bear Market – last year had compounding and consistent negative stretches. Figure 1 shows the distribution of daily returns of 2022 compared with the average of prior Bear Markets, as well as an average of all years going back to 1928.
We can see in Figure 1 that relative to history, 2022 had a high number of ±1% daily price moves, and abnormally few larger moves. The result is that volatility remained high throughout the year as uncertainty around inflation, the Fed, geopolitics, a recession, and more remained in focus.
Onto 2023
As we continue in 2023, it does not appear as though we will return to an average year. Many major macroeconomic factors appear to have “peaked”, including inflation, the U.S. Dollar, and the yield curve inversion. Additionally, the Fed seems to be near the end of the hiking cycle according to market forecasts. While past performance does not guarantee future results, these key inflection points have historically resulted in a wider range of outcomes – with the variance of forward returns significantly higher than average. Figure 2 visualizes this uncertainty – the returns of the S&P 500 vary much wider during these periods than the market average. In other words, using history as a roadmap shows increased uncertainty, and that uncertainty may lead to increased volatility.
Figure 2: S&P 500 paths following key economic and financial inflection points show wider variation than the typical year.
Our Solution
With uncertainty going forward, an alternative strategy may benefit a portfolio by having a low correlation with traditional asset classes. The Main BuyWrite strategy may fit within this alternative sleeve, as it invests in a global ETF allocation paired with a covered call option overlay – with both components of the portfolio managed synergistically. During the allocation process, the underlying ETF positions are selected with their respective options liquidity in mind. The strategy is actively managed from the top-down, using passive index-based ETFs with appealing risk-adjusted potential for some price appreciation as well as call-writing opportunities. We pair this with a bottom-up approach by focusing on fundamentals, valuations, and industry trends. The options can be written in-, at-, or out-of-the-money based on the Investment Committee’s outlook on the overall market as well as the more specific areas contained in the portfolio.
Figure 3 visualizes the three-pronged return stream of the Main BuyWrite strategy. The first potential return stream comes from underlying ETF allocation based on fundamental analysis that Main Management has been doing for 20 years. The second potential return stream comes from the options premiums generated by selling covered call options against the underlying ETFs, which can range depending on the expiration and where they are written (in-, at-, or out-of-the-money). The final stream is dividend income from the underlying equity holdings which historically has augmented the other two prongs.
Results Across Market Environments
An advantage of the Main BuyWrite strategy is the different levers that the Investment Committee can pull depending on market and sector outlook. In a down-market, the underlying ETF allocation can shift to more conservative tilt, and the calls may be written in-the-money as protection. In an uncertain market, the ETF allocation may shift to opportunistic, and the calls may be written with a barbell approach to limit market exposure. In a strong up-market, the ETF allocation may be more aggressive, and the calls can be written more tactically.
Figure 4 depicts how the Main BuyWrite strategy has performed across various market environments. In times of strong market performance, characterized by double-digit returns in the S&P 500, the strategy has historically captured a portion of the market’s upside. However, when the market has experienced negative returns, the Main BuyWrite strategy has historically outperformed on average. Given the anticipated uncertainty and volatility of the market ahead, the Main BuyWrite strategy can potentially benefit an investor’s portfolio by utilizing its multiple asset allocation levers with the goal to generate a diversified income stream and reduce volatility.
Main Management, LLC (“Main Management”, or the “Firm”) is an investment adviser registered under the Investment Advisers Act of 1940, as amended. The Firm was founded in 2002 and provides investment management services primarily to high net worth, family groups, foundations/endowments, and serves as a sub-adviser to third-party investment advisers & broker-dealers. The information contained herein was prepared using sources that the Firm believes are reliable, but the Firm does not guarantee its accuracy. The information reflects subjective judgments, assumptions and the Firm’s opinion on the date made and may change without notice. The Firm is not obligated to update this information. Nothing herein should be construed as investment advice or a recommendation to purchase or sell securities. The information is not intended as an offer to provide advisory services in any state or jurisdiction where such offer would not be permitted under applicable registration requirements. All equity investing entails risk of loss. In preparing this material, Main Management has not taken into account the investment objectives, financial situation or particular needs of any individual investor. Many securities transactions are risky and are not suitable for all investors. All securities investments carry risk, including a risk of loss of principal.
*Data is displayed for the period: 9/6/2004 to 12/31/2004. N.A. – Information is not statistically meaningful due to an insufficient number of portfolios in the composite for the entire year. The composite dispersion presented is an asset-weighted standard deviation calculated for accounts in the composite for the entire year. The Chicago Board of Options Exchange Buy-Write index is used as the benchmark (CBOE BXM). The Chicago Board of Options Exchange Buy-Write Index (BXM) is a benchmark index designed to track the performance of a hypothetical buy-write strategy on the S&P 500 Index. The BXM is a passive total return index based on (1) buying an S&P 500 stock index portfolio, and (2) “writing” (or selling) the near-term S&P 500 Index (SPXSM) “covered” call option, generally on the third Friday of each month. The SPX call written will have about one month remaining to expiration, with an exercise price just above the prevailing index level (i.e., slightly out of the money). Performance is presented gross and net of fees. Additional information regarding the policies for calculating and reporting returns is available upon request. **Firm assets including investment advice provided to Model Delivery Platforms are shown as supplemental information. ***Three-year annualized ex-post standard deviation of the composite and annual composite dispersion are calculated using gross-of fees returns. The BuyWrite composite has an inception and creation date of September 6, 2004. Main Management, LLC claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Main Management, LLC has been independently verified for the periods August 14, 2002 through December 31, 2021. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. The Buy-Write composite has had a performance examination for the periods September 6, 2004 through December 31, 2021. The verification and performance examination reports are available upon request. GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. Main Management, LLC (“Main Management”, or the “firm”) is an investment adviser registered under the Investment Advisers Act of 1940. The firm was founded in 2002 and provides investment management services primarily to high net worth, family groups, foundations/endowments, and serves as a sub-advisor to third-party investment advisors & broker-dealers. The information contained herein was prepared using sources that the firm believes are reliable, but the firm does not guarantee its accuracy. The information reflects subjective judgments, assumptions and the firm’s opinion on the date made and may change without notice. The firm is not obligated to update this information. Nothing herein should be construed as investment advice or a recommendation to purchase or sell securities. The information is not intended as an offer to provide advisory services in any state or jurisdiction where such offer would not be permitted under applicable registration requirements. All equity investing entails risk of loss. The firm cannot assure any potential client that it will achieve the investment objectives discussed in these materials. In addition, potential clients should not assume that their returns, if any, will be comparable to returns that the firm earned in the past. In preparing this material, Main Management has not taken into account the investment objectives, financial situation or particular needs of any individual investor. Many securities transactions are risky and are not suitable for all investors. All securities investments carry risk, including a risk of loss of principal. Recommendations that the firm makes in the future may not equal the performance of the securities mentioned in this information, if any, or even be profitable at all. Securities mentioned herein do not represent all of the securities purchased, sold or recommended for the firm’s clients. Policies for valuing portfolios, calculating performance, and preparing compliant presentations are available upon request. The firm and its clients, affiliates and employees may, from time to time, have long or short positions in, and buy or sell, the securities or derivatives (including options) thereof, of the ETFs mentioned in these materials and may increase or decrease their positions. Composite Definition: Main Management’s BuyWrite composite is a long only equity and fixed income strategy that seeks to generate income and dampen volatility from selling covered calls on its underlying holdings. The BuyWrite strategy seeks to generate an income stream from selling covered calls at the money, or slightly out of the money or in the money, on multiple asset classes. This strategy was designed to achieve capital preservation and provide income with low fees, low turnover and minimal taxes. Our objective for the BuyWrite composite is to seek superior risk adjusted returns by investing in multiple asset classes and to generate premium income by selling covered calls, at a monthly duration, on the underlying investments in the portfolio. The underlying asset class selection is supported by fundamental research with reversion-to-the-mean coupled with a catalyst. The Portfolio Manager will use options on 70%-100% of the portfolio. Frequency will vary depending on the market environment. The sell discipline includes taking into consideration state and federal capital gains taxes. Benchmark is the CBOE BXM. The composite’s minimum account size is $100,000. Accounts are included in each composite after the first full month of performance to the present or to the cessation of the client relationship with the firm. Investment results are time weighted performance calculations representing total return. Reported returns include all realized and unrealized gains and losses, all dividends and interest income and expense and all transaction costs. Performance results are presented gross and net of management fees. Net-of-fee returns are calculated using actual management fees charged. Management fees are payable in arrears in quarterly installments at the beginning of each calendar quarter and are based on a percentage of net assets in each client’s portfolio. The annual investment management fee for the composite is currently 0.85%. Trade date accounting has been used to value the composite throughout the periods presented. Valuations and returns are computed and stated in U.S. dollars. Policies for valuing investments, calculating performance, and preparing GIPS Reports are available upon request. Past performance does not guarantee future results. Benchmarks are unmanaged and do not take transaction costs or fees into consideration. It is not possible to invest directly in a Benchmark. Performance figures assume reinvestment of dividends and capital gains. The SMA fee includes all charges for trading costs, portfolio management, custody, and other administrative fees. For accounts that have been charged an SMA fee, net of fee performance has been reduced by custody and administrative fees in addition to portfolio management and trading fees. In 2016 the firm assets under management (AUM) were previously overstated due to inclusion of the model delivery platform assets. Since then, AUM have been distinguished from assets under advisement (AUA) which consist of model manager platform assets. In 2020 the BuyWrite composite assets under management (AUM) were understated in marketing presentations due to exclusion of the firm’s private LP Fund, the Core Endowment Portfolio II. The Gross of fee Wrap account performance includes all charges for trading costs, custody and other administrative fees. The Net of fee Wrap account performance includes portfolio management fees in addition to trading costs, portfolio management and other administrative fees. Prior to September 30, 2011, the composite did not include any accounts paying a bundled fee. Main Management will provide a complete list of composites and Limited Distribution Pooled Fund descriptions and list of Broadly Distributed Pooled Funds upon request. No part of this material may be copied in any form, by any means, or redistributed without the firm’s prior written consent. A verification has been performed by ACA Performance Services for the periods January 1, 2017 through December 31, 2021, and by Ashland Partners & Company LLP for the periods August 14, 2002 through December 31, 2016. The verification and performance examination reports are available upon request. On June 28, 2017, ACA Performance Services acquired the investment performance service business of Ashland Partners & Company, LLP
