The power of outcome-oriented strategies

Hamilton Reiner, head of the U.S. Equity Derivatives team, delves into the power of outcome-oriented investing in an uncertain world.

What is the biggest issue you see facing investors today?

Equity markets have been resilient so far in 2023, but the rally has left investors feeling uneasy about what to do next. Many are wondering if they’ve “missed it” and, as such, are still sitting in cash trying to figure out when to enter the market. Therefore, one of the biggest risks facing investors is not putting their money to work. Our team runs a variety of portfolios that can help investors maintain their strategic asset allocation and get money off the sidelines and into equities with a lower beta approach. Our hedged equity strategies seek to provide explicit downside protection, while our equity premium income strategies seek high and consistent levels of income.

How have you leveraged your 35 years of experience in equity derivatives to help investors own more equities?

We launched the hedged equity strategy 10 years ago for a simple reason: to help investors get invested and stay invested in equities, especially during periods of elevated volatility and uncertainty. By investing in an approach that utilizes an explicit downside hedge, investors are able to participate in a portion of market upside while knowing they are hedged on the downside. The goal of a hedged equity strategy is to provide investors with the optionality to adjust their risk level while maintaining exposure to equities. 

Where are clients allocating to a hedged equity strategy within their portfolios?

A hedged equity strategy can be used to help investors add equity exposure in a more defensive way or reduce their equity beta, depending on what they need. The most popular use cases we’ve seen include:

  • For investors underweight equities, a hedged equity strategy allows them to dip their toes into equity markets, without having to dive headfirst into full beta strategies.
  • For those who may be overweight risk assets, it provides a way to reduce equity risk without having to move into more defensive asset classes like fixed income or cash.
  • Given the similarity in risk profile of the hedged equity strategy to that of a 60/40 balanced portfolio, investors can fund a position in equal parts from equities and fixed income, resulting in additional equity exposure and reduced fixed income, without materially changing the portfolio’s risk profile.

As part of the equity premium income platform, you also run the largest active ETF in the world*. Why do you think the market has adopted these strategies so quickly?

Investors are looking for a differentiated way to generate total return in equities. With the equity premium income strategies, the primary outcome is income, which is balanced with the potential for capital appreciation. Our approach seeks to deliver total return in three ways:  

  • Dividends from the underlying equity portfolio
  • Options premium from selling out-of-the-money calls
  • The potential for some capital appreciation

We manage two different equity premium income strategies with distinct underlying equity portfolios: (1) a higher quality, defensive underlying equity portfolio benchmarked to the S&P 500 and (2) a lower tracking error Nasdaq 100 benchmarked portfolio. We then generate income in these strategies through an options overlay that consists of selling out-of-the-money index-level calls. With both the equity premium income and Nasdaq equity premium income strategies, we are willing to forego some upside in exchange for steady monthly income, without using leverage and without taking on interest rate or duration risk.

With the backdrop of an uncertain market, what are the opportunities for using the equity premium income strategy?

We have observed three common use cases for the equity premium income strategy:

  • Within an income model, a modest allocation can act as a “booster shot” to income.
  • The strategy can be used as a diversified and lower beta equity alternative. Since a large portion of the total returns will be generated through options premium and the underlying equity portfolio looks different as compared to the S&P 500, we have seen many investors use this strategy to complement traditional equities.
  • Equity options-based strategies can replace or complement higher yielding bonds without adding duration or credit risk and offering comparable—if not higher—income potential in exchange for more beta.

Looking ahead, while the direction of equity markets is unclear, there is a strong opportunity for the equity premium income strategy. If the 2023 market rally continues and expands outside of the few mega-cap stocks (the “magnificent 7”), this strategy may be poised to capture a greater portion of market upside given its more diversified and higher quality nature. On the other hand, should we see a market selloff,  higher volatility may provide elevated levels of income while also participating in less of the downside. Finally, should we see a choppy market that remains more rangebound, equity premium income strategies may still provide a healthy total return through income generated by the options.

Given the highly concentrated market leadership this year, how are clients utilizing the Nasdaq equity premium income strategy?

Like its S&P 500 benchmarked predecessor, the Nasdaq strategy seeks less volatility and beta than the index while providing a balance between income and total return. For investors who like growthier, more tech-focused names, this strategy can provide that exposure with a more conservative approach and a steady stream of monthly income.

Given that the Nasdaq 100 is a more volatile index than the S&P 500, the income payout on the Nasdaq strategy tends to be slightly higher on average. We see investors choose between the two strategies based on what kind of equity exposure they seek. With the different and complementary nature of their underlying exposures, we also see many of our clients combining the two strategies in their portfolios. This combination can help clients align sector exposure with that of the S&P 500 while still delivering a lower beta and volatility profile with healthy monthly income.


*Source: Morningstar. JEPI Based on 2023 Global Actively Managed ETF AUM as of 9/30/23.