So far, so good is in no way the official marketing strategy of the
Schooner Hedged Alternative Income Fund (SHAIX), but it certainly fits the fledgling fund's seven-month history.
Having gained 12.7% since the start of the year, the fund with just $81 million in assets should start hitting some financial advisers' radar, even if there are also screens in place to weed out newcomers.
The fund's performance compares to a
market-neutral category average this year of 0.6%. The S&P 500 is up 4.1% over the same period.
Greg Levinson, president and chief investment officer of Schooner Investment Group, admits the fund has been riding a wave of an optimal environment for the strategy, which essentially benefits from an increasingly cautious mood in equity markets.
The portfolio is technically an income-generating vehicle that earns its performance through the sale of put options on between 100 and 200 underlying stocks.
SELLING PUT OPTIONS
A
put option gives the owner the right to sell a stock back to the fund at a preset price, typically after the actual price of the stock has fallen below the option value.
For example, Tesla Motors Inc. (TSLA) is currently trading at more than $254 per share, and a put could be sold on the stock for $220. This means that the owner of the option could sell the stock back to the fund for $220 if the stock price falls below $220 before the option expires.
“We generate our premium from the put sales,” said Mr. Levinson.
That income, he added, acts like a bond, without the same kind of duration, credit, or other bond-like risks.
But even as Mr. Levinson is selling puts based on the outlooks for each underlying security, he admits there is risk associated with a broad market decline that could pull down all stocks at once.
To help guard against that kind of punishment on the portfolio, the fund uses some of the income from the put sales to buy put options on the S&P 500.
The broad equity market has not seen a lot of volatility to test the insurance, but there have been 10 examples this year when the S&P fell by more than 1% in a day, days in which the fund eked out a positive return.
The first instance was Jan. 5, when the S&P fell by 1.83%, and the fund gained 0.15%. On March 10, the index fell by 1.7%, while the fund was up 0.11% for the day.
Last Friday, the S&P finished the day down 54 basis points, and the fund gained 14 basis points.
“The nature of the strategy is that you have exposure to the stock market, which means you have systematic and idiosyncratic risks, but by buying the index put we take out the systematic risk,” Mr. Levinson said. “You wind up with streams of cash flow that is not correlated to the traditional fixed-income markets, and it's also not directly correlated to the equity markets.”
Even though the fund is selling puts on individual stocks, the portfolio doesn't actually own the underlying stocks. But it is required to hold enough cash to purchase the stocks to meet any put option requests.
“The portfolio is really just a pile of cash used as collateral,” said Mr. Levinson.
That cash pile adds a certain level of security, but it's the put options purchased on the broader indexes that is most appealing to Thomas Meyer, chief executive of Meyer
Capital Group.
A FIXED-INCOME ALTERNATIVE
He uses the fund for his clients as a fixed-income alternative.
“Those index puts can really kick in and buffer a portfolio, and that's what we're all after,” Mr. Meyer said. “Even though it hasn't really been battle tested yet, I like it because it's simple and you can understand it.”
The battle test will eventually come but in the meantime, the fund's biggest risk factor might be managing growth as money starts to move in.
“The fund is small and can be as nimble as it wants to be right now,” said Todd Rosenbluth, director of mutual fund and ETF research and S&P Capital IQ.
“But its success in the short term can cause inflows and that can force management to increase positions, and then their ability to get the exposure they want could be more difficult as it doubles or triples in size,” he added. “The fund has seven months of history, and it has been strong versus the broader market, but that's not enough time to see how management handles greater volatility and a shift in investor sentiment toward other sectors.”
