JEPI - BUYW: Stellar Short-Term Performance May Not Be Repeatable

2023-10-12 02:07:11 ET

Summary

• Main Buywrite ETF opportunistically writes call options on a basket of various ETFs the manager deems to be attractive.
• BUYW ETF has outperformed in the short term due to a stellar 2022, when the fund avoided losses. However, it is unclear how this performance was achieved.
• Overall, if we exclude the 2022 performance, the BUYW is a middle-of-the-pack buywrite fund that charges a high expense ratio. I am not confident the 2022 performance is repeatable.

Investment funds that employ the Buy-Write strategy are not unique. Basically, these investment funds all employ a 'covered call' strategy that buys an underlying asset and sells call options against the asset in order to generate premium income and reduce overall portfolio volatility (Figure 1).

For example, Global X offers a popular suite of covered call ETFs like the S&P 500 Covered Call ETF ( XYLD ) and the Nasdaq 100 Covered Call ETF (QYLD) writing monthly at-the-money ("ATM") call options on the S&P 500 and Nasdaq 100 indices, with $2.9 billion and 7.8 billion in AUM respectively. Similarly, JP Morgan offers the gigantic JPMorgan Equity Premium Income ETF ( JEPI ) that writes call options on large cap stocks with $29.5 billion in AUM.

What is unique about the Main Buywrite ETF ( BUYW ) is that it claims to handpick a basket of exchange-traded funds ("ETF") to invest in using 'reversion to the mean' analysis while adding an options overlay to generate premium income and reduce portfolio volatility.

Investment Strategy

According to the fund's literature , the fund manager, Main Management Fund Advisors ("MMFA"), is a 'value investor' and seeks to own investments at attractive valuations. In order to avoid 'value traps', the manager looks for catalysts that will lead to near-term price appreciation (i.e. mean reversion). However, MMFA's strategy is implemented via ETFs in the BUYW ETF (Figure 2).

While many investment managers self-identify as 'value investors', this is probably the first time I have read of a manager being a 'value investor' but using ETFs to express their investment ideas. The two simply do not go together.

ETFs typically allow investors to invest in a broad basket of securities. For example, the SPDR S&P 500 ETF Trust ( SPY ) contains 503 holdings. The main purpose of ETFs is diversification, i.e. investors use ETFs to gain broad exposure to the markets (i.e. the SPY ETF), a specific sector (i.e. the VanEck Semiconductor ETF, SMH), or an asset class (iShares Treasury Floating Rate Bond ETF, TFLO) while avoiding idiosyncratic risks with any particular security. Unless the manager considers the whole market or sector to be undervalued, they usually do not express 'value investing' via ETFs.

The BUYW ETF's strategy also writes call options on 0-100% of the underlying holdings in order to generate premium income and achieve the fund's 6% target yield. The manager may write options in, at, or out of the money ("ITM, ATM, OTM") depending on the manager's discretion.

Conversion From Mutual Fund To ETF

Readers should note that the BUYW ETF was recently converted from a mutual fund structure to an ETF structure in late 2022. It was formerly called the Main Buywrite Fund, with inception date of December 29, 2015.

Portfolio Holdings

Figure 3 shows the holdings of the BUYW ETF as of October 9, 2023. The fund's long exposures are 96% invested in equities, split between 44.7% in the SPY ETF, 13.5% in the Invesco QQQ Trust ETF ( QQQ ), 13.2% in the SMH ETF, 12.3% in the Industrial Select Sector SPDR Fund ETF ( XLI ), 11.8% in the Consumer Discretionary Select Sector SPDR Fund ETF ( XLY ), 9.8% in the iShares MSCI EAFE ETF ( EFA ), and 6.7% in SPDR S&P Biotech ETF ( XBI ).

With respect to the written call options, the BUYW ETF has written deep ITM calls on SPY (December 385 strike calls with the SPY ETF currently trading near $435), SMH, QQQ, and XLY. The calls on EFA are ATM (December 68 strike vs. EFA currently trading near $70). With the exception of the XBI and TFLO positions (~10% of the portfolio), the BUYW ETF has overwritten 100% of its portfolio: for example, the BUYW ETF holds 315,100 shares of the SPY ETF and has written 3,151 call option contracts, covering 315,100 shares.

Given many of these written options are deep ITM, they have very high deltas, so the BUYW ETF has retained very little upside of the underlying ETFs at the moment. For example, the SPY US 12/15/23 C385 options currently have a 0.89 delta, which means for every 1% move in SPY, the written call options move 0.89% (Figure 4).

Returns Have Flatlined

In fact, looking at the historical price chart of the BUYW ETF, it appears the BUYW ETF has flatlined since early in the year. This is because the written calls became deep in the money and thus any upside on underlying ETFs has been 'sold away' (Figure 5).

Deep ITM By Design Or By Accident?

One question I have is whether the writing of deep-in-the-money options was by design or by accident. Analyzing ETF prices from December 2022 may offer some clues.

In December 2022, the SPY ETF was trading near $380 / share, so it appears the BUYW ETF simply wrote 1-year ATM options on the SPY ETF (Figure 6).

Similarly, the QQQ ETF was trading near $265 in December 2022, close to the strike of the options written that are expiring in December 2023 (Figure 7).

Ditto for SMH (Figure 8).

The long-term nature of BUYW's written call options is also worth investigating. According to the prospectus, the BUYW ETF typically targets monthly options "although options of any strike or maturity may be utilized". However, looking through the semi-annual and annual reports of the BUYW ETF and its predecessor fund, option expiries of longer than 1 month are often used, counter to the stated strategy.

Long-Term Performance Has Been Poor

Although the BUYW ETF has delivered solid performance in the past year due to the fund writing ATM call options in December that became deep ITM (and thus the BUYW ETF was able to capture part of the YTD upside in addition to the premiums received), long term performance for the strategy has been poor, with the fund returning 4.7% p.a. over 5 years and 4.8% p.a. since inception (Figure 9).

In fact, on an annual basis, the BUYW ETF tends to significantly lag the markets, as represented by the SPY ETF (Figures 10 and 11). For example, in 2017, the BUYW ETF returned 8.6% while the SPY returned 21.7%. In 2018, the BUYW ETF returned -7.6% compared to -4.5% for the SPY ETF.

Superb Trading In 2022

The only exception was 2022, when the BUYW ETF was able to return 1.0% vs. an 18.1% loss in the SPY ETF. Unfortunately, the fund's annual report was very brief and did not elaborate on how the BUYW ETF was able to avoid steep losses in 2022 when the markets suffered steep losses.

From what I can deduce, the predecessor Buywrite Fund had written call options at year-end 2021 prices, i.e. as of April 30, 2022, the BUYW Fund had written SPY calls with December 16, 2022 expiry and $450 strike (Figure 12).

Also, as of April 30, 2022, the Buywrite Fund had only lost 2.4% in the preceding 6 months (Figure 13). The small declines in the 6 months to April 30, 2022 were plausible as we can see the BUYW Fund had sold options for proceeds of $13.4 million but these options were only worth $7.4 million, so the BUYW fund had paper gains of $6 million to offset some of the declines in the underlying ETFs.

However, by October 31, 2022, the option strikes on written calls in the BUYW ETF portfolio have been lowered, for example, SPY calls now have $380 and $385 strikes (Figure 14). Other securities in the portfolio have also been shuffled, for example, the iShares U.S. Home Construction ETF ( ITB ) was added while the VanEck Oil Services ETF ( OIH ) was removed.

But the markets have declined by ~18%, as shown by the 2022 YTD to October returns of the SPY ETF (Figure 15).

Yet the BUYW ETF was able to contain losses to just 1.9% for the trailing 12 months to October 31, 2022.

Perhaps the BUYW ETF was able to buy back the December 2022 options at the higher strikes and write new options at lower strikes to generate additional premium income when implied volatilities were elevated during 2022. However, it is hard for analysts like myself to understand how the BUYW ETF was able to overcome the magnitude of the underlying ETF declines without more commentary from the portfolio managers.

Moreover, the 2022 outperformance may have been a one-time occurrence due to the unique opportunities available, since the predecessor fund had not shown similar outperformance in prior years.

Distribution & Yield

The BUYW ETF pays a monthly distribution with a trailing 12 month distribution of $0.66 or 5.0% yield.

Readers should note this is slightly less than the 6% target yield. However, this yield is comparable to the fund's long-term average annual returns of 4.7% p.a. over 5 years, so I believe it should be sustainable.

BUYW vs. Peers

Comparing the BUYW ETF against other Buywrite funds that I have reviewed, the BUYW ETF is the most expensive, charging a 1.31% total expense ratio (Figure 18).

However, it does have the best 3 year average annual return because it avoided the 2022 drawdown. This also leads to strong 3 year risk metrics, with the BUYW ETF showing the lowest volatility and highest Sharpe ratio.

However, on a longer 5-year time frame, the BUYW ETF's 4.7% average annual return is middle the pack, as is its Sharpe Ratio.

The BUYW ETF also pays the lowest distribution yield out of the peer group, at only a trailing 5.0%.

Overall, the BUYW ETF compares well against peer Buywrite funds, mostly due to its strong performance in 2022. On longer timeframes, the BUYW ETF does not excel. Investors considering the BUYW ETF need to ask whether BUYW's 2022 outperformance is repeatable.

Conclusion

The Main Buywrite ETF opportunistically writes call options on the basket of various ETFs that the manager deems to be attractively priced. The BUYW ETF has performed well in the short term by avoiding drawdowns in 2022. However, the fund's longer-term historical performance suggests the outperformance may not be repeatable.

Overall, I am cautious about the BUYW ETF, as I am not able to explain how the fund outperformed in 2022 with its strategy of selling 1-year ATM options. I rate the BUYW ETF a hold .

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