Portfolio Manager Perspectives

Jeff Benjamin

Collar Fund’s Schwab uses options to manage risk

Strategy offers downside protection, limits upside performance

Feb 9, 2010 @ 2:36 pm

By Jeff Benjamin

The volatility that has crept into the stock market over the past few weeks could turn out to be a selling point for The Collar Fund Ticker:(COLLX), managed by Thomas Schwab.

The fund uses put and call options to establish upper and lower boundaries on each stock in the portfolio.

The strategy can be particularly appealing during periods of market decline, as was illustrated in 2008 when the S&P 500 fell by 38%, but the strategy lost just 6.6%.

Of course, the flipside is the limits on upside performance during market rallies. Last year, when the S&P gained more than 25%, Mr. Schwab’s option collar strategy was up just 8.7%.

The mutual fund was launched in June 2009, but it uses the same strategy as a separate account that Mr. Schwab has been managing since 2005 as a founding member of Summit Portfolio Advisors LLC.

“It’s a momentum strategy with limited downside and the investment process is driven by option prices,” he said. “There’s a lot of fear in the market right now, and there’s not a lot of real conviction that the market is going to be moving up.”

The portfolio of about 75 stocks comes with a 100% average annual turnover rate and a very respectable 95-basis-point management fee.

The strategy, known colloquially as a full collar, sells calls on each stock to finance the purchase of put options on each stock. The puts introduce downside insurance to limit any stock loss at 10%. The goal of the call options is to get at least 15% upside, but that’s not always the case.

According to Morningstar analyst Nadia Papagiannis, the fund’s performance should fall between stocks and bonds, but with a risk profile that is more like a bond fund’s.

“The best scenario for this fund is if stock prices stay put or rise,” she said.

Ms. Papagiannis added that the fund might not appeal either to pure stock investors or pure bond investors, and it won’t be very tax efficient.

“But this fund has broad appeal to risk-averse tax-deferred investors,” she said.

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

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