CANADA TIP SHEET: Options Add Income At Sherpa Funds
by Monica Gutschi
TORONTO (Dow Jones) -- When the principals at Calgary-based McLean and Partners Wealth Management were looking for a way to offer their high-net-worth clientele more income without additional risk, they turned to Sherpa Asset Management.
The Vancouver hedge-fund company manages alternative investment strategies for institutional investors, including one of the country’s largest pension plans. It runs long-short strategies with an options overlay that is intended to maximize upside, minimize downside, and add yield.
“Everything we do follows the same priorities,” says portfolio manager David Guarasci. “Number one is capital preservation, then yield, then upside participation. Always in that order.”
Guarasci manages the Alternative Income Fund and Alternative Growth Fund that McLean has begun to offer its clients, all of whom have a minimum of C$1 million in investable assets. McLean’s in-house investment team manages the traditional global pooled funds that form the core of a typical client’s portfolio. Dave Sherlock, director of product management at McLean, says around 7%-8% of a typical portfolio would be allocated to the alternative funds.
Sherpa’s funds deviate from a traditional long-short strategy through the extensive use of options, Guarasci says. He establishes his long position in equities by buying the Standard & Poor’s 500 index or individual stocks, as well as buying calls and selling puts. Similarly, he short-sells specific names, but also sells calls and buy puts. What that does, he says, is provide income from the options premiums while allowing the funds to outperform in a falling market as well as participate when markets rally.
The Alternative Growth Fund is net 40%-45% long, giving it equity exposure plus yield generated from the options. The Alternative Income Fund, which targets zero net exposure to equities, aims to have annual returns of 6%-10% and issues quarterly distributions of 1.25%, taxed primarily as capital gains income.
The funds have a maximum 5% weighting in any particular holding and Guarasci usually has only between 10 and 25 names in the portfolio, as he prefers to take his equity bets through Exchange-Traded Funds such as iShares Canadian S&P/TSX 60 Index Fund (XIU.T).
Any specific names are there for “opportunistic “ reasons, Guarasci says, and have to be very large interlisted companies where there is a liquid options market. Among them, he is net long on Royal Bank of Canada (RY, RY.T), Toronto-Dominion Bank (TD, TD.T), Canadian National Railway (CNI, CNR.T) and Research in Motion (RIMM, RIM.T).
While the last name may surprise given the BlackBerry maker’s well-publicized problems, Guarasci moved to a long position from a short one in the past six months as he believes the current stock price--it’s now trading at about C$14--is “closing in on some core value.”
That could encourage a takeout, he says, and also limits the downside while improving the potential upside. Because he has been selling calls against the stock, and it has been highly volatile, it’s also producing a positive yield.
While many hedge-fund managers will go long on one stock and hedge that bet with a short position in a peer company, Guarasci avoids that strategy, arguing it holds a “decoupling” risk when there is a company-specific event.
The funds were launched in 2008, just ahead of the eruption of the credit crisis and subsequent recession. In its first year, Guarasci says, the growth fund lost only 7% compared to a 35% drop in the S&P 500.
According to McLean and Partners’ website, the growth fund has lost 1.78% in 2011 as of the end of November, compared to a 7.13% decline for the Toronto Stock Exchange’s key index, and a 3.56% gain for the S&P 500. In 2010 the fund gained 7.21% versus the TSX’s 18.12% rise and the S&P 500’s 12.66% advance.
Since inception, the fund has returned 14.35% versus an 8.07% loss for the TSX and a 1.4% decline for the S&P 500.
Company website: www.sherpaam.com
