Portfolio Manager Perspectives

Jeff Benjamin

A fourth asset class? Investors are piling in

Hedged-equity funds offer downside protection — and some upside

Jan 10, 2013 @ 1:09 pm

By Jeff Benjamin

If asset flows can be trusted as a guide, the appetite among financial advisers for hedged-equity exposure is reaching a fever pitch, and that suggests plenty about the growing unease in the financial markets.

Exhibit A is the $7 billion Gateway Fund Ticker:(GATEX), which took in more than a billion dollars last year by employing a strategy that is designed to capture at best about half the performance of the S&P 500.

“For our investors, their goal is not necessarily to capture 100% of upside of the market but to protect gains,” said Harry Merriken, chief investment strategist of Gateway Investment Advisers LLC, an affiliate of Natixis Global Asset Management SA.

Last year, the fund gained just 4.5%, while the S&P 500 gained 16%. And yet the money keeps pouring in.

The fund did better in 2011, when its 3% return beat the index's 2.1%, but investors are not turning to this 36-year-old mutual fund for outperformance. “We think of it as a wealth preservation strategy,” Mr. Merriken said. “It is essentially a fourth asset class, to supplement cash, bonds and stock.”

The strategy employs put and call options on a portfolio of about 250 stocks that are managed as a proxy for the S&P 500. The fund's total return is enhanced through the sale of one-, two- and three-month call options, while the downside is limited through the purchase of put options.

When the fund was originally launched, it sold only call options on individual portfolio holdings because there were no index call options available in the late 1970s. The strategy was altered to its current form in 1987 when Gateway started purchasing put options for the downside protection, making the fund a vehicle for low-volatility investing.

Recent performance notwithstanding, the fund's long-term track record delivers what is being promised. The five-year annualized return is 1.3%, compared with 3% for the S&P 500. The 10-year annualized return is 4.1%, compared with 6.8% for the index. And the 15-year annualized return is 4.6%. Over that same period, the S&P 500 generated a 5% return.

In monitoring the fund's three share classes, Mr. Merriken said most of the inflows over the past year have come from institutional-class investors, including private banks, fee-based advisers and wrap fee brokerage accounts.

“We emphasize the low-volatility-to-equity aspect because people should realize the strategy is still correlated to equities, even if it is lower-risk,” Mr. Merriken said. “However, we do have a low correlation to fixed income.”

Portfolio Manager Perspectives are regular interviews with some of the most respected and influential fund managers in the investment industry. Visit InvestmentNews.com/pmperspectives for more information.

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