Can A Covered Call Mutual Fund Work?

A few weeks ago the Madison Claymore Covered Call Equity Strategy Fund popped back up on my radar. I owned the closed end fund version, which trades under symbol MCN, personally and for clients back before the Financial Crisis. It did pretty much what I hoped it would do in terms of lower volatility than the S&P 500 index most of the time, and of course the yield. It did get hit hard in the financial crisis.

In addition to the closed end version there's also open end or traditional fund versions too. Like all mutual funds it seems, there's an alphabet soup of symbols, the one I'm looking at at MENYX. If you look at the Morningstar page you'll see it's a four star fund, so that's promising but then if you look at the chart on Yahoo, it looks awful. Here it is for 5 years compared to its benchmark which is the CBOE BuyWrite Index (BXM) and the S&P 500. 

Up 3% in an up 24% world? How does it have four stars from Morningstar?

It should not be expected to track the S&P 500, it is a low vol income proxy but measuring against BXM is fair. I put SPX in there because if we're going to use a fund like this, we want to know whether or not we are diversifying away from plain vanilla equities and by how much.

I reached out the the fund company figuring someone in marketing or customer service could help solve the puzzle, pretty helpful though, the portfolio manager reached out and we had a very informative conversation. It turns out Yahoo does not report the payout correctly because very little of it is actual dividends from the equity portfolio, most of it is option premium which are characterized as capital gains. When I looked at Morningstar's chart, they had it wrong too. I mentioned that to the PM and he said they needed to get that corrected. Either they did or I did something wrong but Morningstar appears to have it correct now.

 

Here's a five year chart into June 30th that includes BXM, thanks to Madison Claymore for the Bloomberg screen shot.

 

You can see that MENYX tracked BXM closely but then started pulling way in mid-2019. MENYX offered no protection during the 2020 Pandemic Crash and you can see from the hover in the next chart it had a very good first six months of 2022 which so far has been the worst of the bear market.

 

VFINX is the Vanguard S&P 500 Index Fund. 

In a crash, I think it would be total luck of the draw as to whether something like MENYX would help soften the blow. In more of a normal bear market, bear markets rollover slowly before declines start to accelerate, I would hope that something like MENYX would help soften that blow. The result it logged for the first 6 months of 2022 would exceed any realistic hope I might have on this front however. Great if it does just as well on the next go around but I would not count on that. 

To the extent it is an equity proxy, it is a lower vol equity proxy which means it won't go up as much most of the time and shouldn't go down as much most of the time. If it is working, it is smoothing out the ride. It could also be thought of as an income proxy. The fund targets 6-8% in distribution yield. Morningstar has the yield at 4.51% while the most recent fact sheet shows it yielding 6.82% for 2021. 

We talk all the time about not being able to get a safe 8% yield in a 2% world, so is the 6.82% safe? MENYX is not an investment grade bond proxy. It's an equity proxy albeit with lower volatility. It crashed with the S&P 500 in 2020 like I said and then it came back. It's not that you shouldn't take on an 8% yield, or 6.82% in this case, in a 2% world but you have know what risk you are taking. With MENYX it is some measure of equity risk. I was curious to see if MENYX might be a proxy for high yield bonds. That seems plausible to me but I couldn't find a high yield fund that tracked with MENYX. If you find one, please let me know the symbol.

I've mentioned a couple of times that I am test driving MENYX for possible use in client accounts. If I do buy it, I would probably only buy it in qualified accounts and I am leaning toward reinvesting the payout because that is so much of the total return. I will update if I do buy it, or another share class, for clients.