A Leveraged Covered Call Fund?

Of course, the stock market is off to a very good start this year. I write all the time about managed futures as a diversifier and being able to live with the reality that managed futures will probably struggle when stocks are going up. The space languished for most of the 2010's. This year is kind of an anomaly so far. Stocks are up and so are a lot of the managed futures funds. 

The black line is the S&P 500 and the rest are a sampling of managed futures mutual funds and ETFs. The fund I use is smack in the middle of the pack. The group did fantastically well in 2022 of course when equities and bonds cratered. In 2023, many in the group were down modestly, due in my opinion to a vicious whipsaw in the treasury market last March that they didn't recover from. 

I talk all the time about small positions into diversifiers like this one in case something goes wrong. That whipsaw was a perfect example. One interesting note is that the pink line fund that has done the best this year by a wide margin was the worst performer last year by a wide margin. 

The Miller Value Partners Leveraged ETF (MVPL) might turn out to be a wild one. At a very high level, the fund will use very short term signals to rotate from being 100% SPDR S&P 500 (SPY) or 100% in the ProShares Ultra S&P 500 (SSO). So it will either be 100% or 200% in equities. The Miller in question is Bill Miller's firm but it looks like his son is the lead manager.

Miller the elder made his bones at Legg Mason a while ago with a very long streak of beating the S&P 500. The tide sort of went out on him when the internet bubble popped and then again in the financial crisis. He's also been in the news for betting heavy on Bitcoin and making a fortune. The negative take on him would be that he is a bull market genius, the positive take on him would be that he is a gifted risk taker able to emotionally wait out periods of huge declines. 

There is nothing defensive about the fund. 100% long isn't defensive. The stock market goes up most of the time so I am guessing the return will be positive most of the time but that doesn't necessarily mean the fund will meet whatever objective they actually have in mind. I would also guess that in a down trending market the fund might have to lag. If at any point it is long SSO as the market goes down then it would lag and it seems plausible that it will at times be wrong footed in either SSO or SPY.

There are at least two risks here beyond equity exposure. One is whether the signal they are relying on will work the way they hope and there is the tracking risk of the 2x fund. We've looked at SSO's tracking quite a few times before. Most of the time it has been sort of close but there can be no certainty about how it will track in the future and "sort of close" is obviously very subjective.

The fund just came out on Feb 28th. It's initial impression certainly could be worse. 

Yesterday, I poked a little fun about stacking investment fads. Well here's another one in a filing from Direxion with a hat tip to Eric Balchunas.

Eric reports that these will be 1.5X the JP Morgan covered call funds which are actively managed. We'll just look at the first one which will be 1.5X the JP Morgan Equity Premium Income Fund (JEPI). JEPI is fairly new, had great performance in 2022 and lagged the S&P 500 by varying amounts in every other year it has existed. 

Although JEPI's history is too short to draw a solid conclusion, since it's inception in 2020 it has kind of been a 75/50 fund meaning it has captured about 75% of the S&P 500's upside with only 50% of the downside. The numbers aren't exact but is in the neighborhood. For anyone new, 75/50 will outperform over the long term with less volatility. Most of JEPI's success though is attributable to 2022 when it outperformed the S&P 500 by 1466 basis points. 

The above backtests 1.5X JEPI back to JEPI's inception. The proposed 1.5X JEPI backtests very well. It had a higher CAGR than the S&P 500 with slightly less volatility. It did outperform the SPX by a lot in 2022 of course but it also outperformed in 2021 and for the seven months in 2020 it only lagged the S&P by 104 basis points. 

If 1.5X JEPI ever lists then I think there is a capital efficiency angle to the fund that we could explore. I put the following together. The 90% in JEPI would really bein 60% in 1.5X JEPI which works out to 90% covered call, 10% managed futures and 25% in T-bills. 

Obviously the concerns I mentioned above are still relevant but the result would have had very low volatility, 75% of the upside and a lot of cash set aside for sequence of return risk. It is another example of leveraging down as I like to describe it, using a capital efficient fund to build a full portfolio in a smaller portion of the portfolio and instead of adding on top, leveraging up, we can build in a large cash buffer. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.