Not your typical covered call ETF – Dynamic Funds delivers unique options strategy

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Portfolio manager Damian Hoang pulls the curtain back on an options strategy that’s generating attractive returns in uncertain markets

It was a slow start for the Canadian fund industry this year. With a net inflow of just $3.7 billion by the end of March, it was the worst quarter since the financial crisis 15 years ago, according to data from Investor Economics, an ISS Market Intelligence (ISS MI) business. But while some funds have struggled, there are two funds that have been very successful at attracting the attention of investors: Dynamic Premium Yield Fund and Dynamic Premium Yield PLUS Fund. How successful? Of that $3.7 billion of net fund inflows in the first quarter of 2023, a significant portion went to these two funds alone . They’ve caught fire with investors in Canada. The funds are clearly doing something differently. To explain the success of these funds, Wealth Professional recently spoke with Damian Hoang, Portfolio Manager at Dynamic Funds, to learn more. Unlike most funds that trade options, Dynamic Premium Yield Fund and Dynamic Premium Yield PLUS Fund focus on writing puts instead of the much more common options strategy of writing covered calls. It’s an approach that’s proved to be very successful over the years. Since the inception of the Premium Yield Fund in 2013, its risk-adjusted returns have outperformed the S&P 500 index as well as the CBOE S&P 500 PutWrite and CBOE S&P 500 BuyWrite indices. And this outperformance applies to almost any time frame you choose – whether it’s year to date; one, three, or five years; or since the fund’s inception.

Dynamic Funds was established as a small investment club in Montreal in 1957. Since then, we have evolved to become one of Canada’s most recognized asset management firms. We offer a comprehensive range of products and services, spanning every major sector, geographic region, and investment discipline. Our financial solutions include open- and closed-end investment funds and fee-based, tax-advantaged, and customized high-net-worth programs.

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“Our risk-adjusted return has outperformed, whether it's the PutWrite, BuyWrite, or the S&P 500, as of June 30”

Damian Hoang, Dynamic Funds

“Our risk-adjusted return has outperformed,” Hoang says, “whether it’s the PutWrite, BuyWrite, or the S&P 500, as of June 30.” The reasons for this success, Hoang adds, are twofold. First, there are the general benefits of writing cash-secured puts versus covered calls. Second, there’s the specific advantages of Dynamic Funds’ put-writing strategy. In simple terms, writing a cash-secured put is a promise to buy a stock at a certain price – and reserving the cash in case you need to buy the stock at the put strike price – in return for a fee, or premium; whereas writing a covered call is a promise to sell a stock at a certain price, also in return for a premium. Hoang says a put-writing strategy has three key advantages over covered calls: less immediate risk, higher premiums, and something he calls “survivorship bias.”

When writing a put, the writer backs their promise to buy a stock with cash. However, with a covered call, the writer needs to already own the underlying stock, and that creates instant exposure to the stock’s movement in the market. For example, if the writer of a covered call collects a premium of 1 percent of the value of the stock they’re holding but the price of that stock falls by 1 percent in the market, then the gain from the premium is erased, at least on paper. Now compare this to what happens with writing a put, which is

The third key benefit of writing puts versus covered calls lies with the quality of your portfolio after a year or two of options trading. This is because a writer of covered calls that honours an obligation to sell a stock at a certain price ends up reducing their outperforming stocks (i.e., the outperforming stocks are called away), while retaining all the underperforming stocks in their portfolio. In a way, this is the survival of the least fit. Meanwhile, a put-writer that honours obligations to buy certain stocks is systematically adding those stocks to their portfolios. And, since these trades usually involve blue-chip stocks, the put-writers are steadily improving the quality of their portfolios, as they will be adding quality stocks on a dip. “The survivorship bias favours put-writers,” Hoang says. “If you write a lot of puts over time, you usually end up owning stocks that you want to own anyway.” This is a useful summary of why writing puts can be more beneficial than writing covered calls, but this only goes partway to explaining why Dynamic Premium Yield Fund and Dynamic Premium Yield PLUS Fund have generated strong performance for so long.

Founded almost 70 years ago in Montreal, Dynamic Funds is one of Canada’s most recognized asset management firms, with a history of bringing timely, innovative, and active solutions to the marketplace. At its core, Dynamic Funds believes that good financial advice can guide investors toward sound investment decisions and that a financial advisor can help investors find the right solutions. Hoang, who combines fundamental analysis with advanced quantitative strategies, attributes the funds’ success to a process-driven approach when trading options. “We write puts all the time, allocating around 60 to 70 percent of our assets to put writing, and we rarely write calls,” he says. “I like to say we write puts systematically, whereas we write calls opportunistically.”

Although they focus heavily on put-writing, Hoang is careful to explain that writing puts is actually secondary to their more fundamental goal of owning a promising stock. “If we write a put on Microsoft, it’s not just because we love the premium income we can generate from writing a Microsoft put – it’s because we want to acquire Microsoft stock when it pulls back. The income is a very nice benefit, but it’s not the goal. “The goal is increased exposure to blue chips we like at a lower price, typically at an average discount of 10 percent, whether it’s Microsoft, Google, Eli Lilly, Pfizer, or others.” Hoang also points out that this average target of 10 percent differentiates them from other put-writers, which will often write puts for lesser margins of safety. A 10 percent margin of safety is significant, he says, because their options contracts don’t get triggered until the S&P 500 suffers a double-digit decline. “Our portfolios hold up extremely well when the market is down 6, 7, 8 percent – basically during any mild correction,” Hoang says. “And when the market falls further, we’re prepared with protective puts on market indices. About 10 to 30 percent of the premiums we collect go towards buying these protective puts.”

Group of people planning strategies .Investment strategies

Less immediate risk

Winning strategy

Published 28 July 2023

“There’s a lot more people who want to buy puts to protect their portfolio than there are people who want to buy calls to speculate. So, more supply of calls and more demand for puts adds up to more attractive premiums for put-writing”

Damian Hoang, Dynamic Funds

Founded in 1957, Dynamic Funds is a subsidiary of Scotiabank

backed with cash and not by holding the actual stock. “When you write a put, you set the strike at a number of percent below where the stock is currently trading,” Hoang says. “You don’t get hurt until the stock falls to the price where you wrote the put (i.e., the strike). It comes with a downside buffer built in.”

Put-writing has a second advantage over writing covered calls when it comes to premiums, and this is due to the basic arithmetic of supply and demand. There are far more covered call funds in Canada than there are funds dedicated to put-writing, and that competition puts pressure on the amount of premiums they can collect from writing the calls. Interestingly, the demand side of the equation favours put-writers as well. “There’s a lot more people who want to buy puts to protect their portfolio than there are people who want to buy calls to speculate,” Hoang says. “So, more supply of calls and more demand for puts adds up to more attractive premiums for put-writing.”

Higher premiums

Survivorship bias

Dynamic performance

In the case of Dynamic Funds, the extra work is clearly worth it. Although 2022 was a tough year for the markets, Dynamic Premium Yield PLUS Fund was up 20 basis points. And, so far this year, the fund is again outpacing the overall market with returns of about 16 percent. “Our strategy works in both good and bad markets,” Hoang says. “In fact, over the past 9.5 years, Dynamic Premium has never underperformed the market on the downside.”

The focus on put-writing has delivered attractive returns for Hoang and his funds over the years. Asked why more managers don’t write puts versus the much more common covered calls, he says it’s a lot harder. People often write calls because they already own a stock and not much effort is needed to add a covered call. Writing a put requires a lot more work. “You need to know what you’re doing,” Hoang says. “The analysis and risk management is a lot more difficult.”

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PutWrite vs BuyWrite Performance

Over any meaningful time period the S&P 500 PutWrite Index has outperformed the S&P 500 BuyWrite Index

YTD

Returns

1yr

3yr

5yr

SIR*

10 yrs

20 yrs

30 yrs

S&P 500 PutWrite Index

12.5%

12.1%

13.6%

6.3%

6.9%

7.2%

7.4%

8.6%

S&P 500 BuyWrite Index

10.5%

9.0%

10.6%

4.4%

6.0%

6.3%

5.8%

7.3%

S&P 500 Index

16.9%

19.6%

14.6%

12.3%

12.1%

12.8%

10.0%

Dynamic Premium Yield Fund (series F)

14.7%

21.6%

13.1%

7.6%

8.0%

Risk-Adjusted Returns

YTD

1yr

3yr

5yr

SIR*

10 yrs

20 yrs

30 yrs

S&P 500 PutWrite Index

1.73

1.09

1.22

0.41

0.54

0.57

0.56

0.68

S&P 500 BuyWrite Index

1.32

0.77

0.90

0.28

0.46

0.48

0.42

0.55

S&P 500 Index

1.17

1.01

0.80

0.57

0.68

0.73

0.52

0.54

Dynamic Premium Yield Fund (series F)

2.60

2.43

1.31

0.66

0.86

Data as of 06/30/2023. *Inception for Dynamic Premium Yield Fund of 10/28/2013 and for Dynamic Premium Yield PLUS Fund of 10/28/2013. Source: Bloomberg. Indices are not managed, and it is not possible to invest directly in an index.

Risk Return Profile

-2

Return (%)

Risk (%)

Dynamic Premium Yield PLUS Fund (Series F)

Dynamic Premium Yield Fund (Series F)

S&P/TSX

MSCI World

S&P 500

US Corp Bonds

Cdn Corp Bonds

US Govt Bonds

Cdn Govt Bonds

Source: Bloomberg Data as of 10/09/2018 to 06/30/2023

Commissions, trailing commissions, management fees and expenses may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated. The indicated rates of return are the historical annual compounded total returns including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or incomes taxes payable by any securityholder that would have reduced returns. Indices are not managed and it is not possible to invest directly in an index. Series A units are available for purchase to all investors, while Series F units are only available to investors who participate in eligible fee-based or wrap programs with their registered dealers. Differences in performance between these series are primarily due to differences in management fees and fixed administration fees. Performance results for Series F units may also appear higher than for Series A units as the management fee does not include the trailing commission. Views expressed regarding a particular investment, economy, industry or market sector should not be considered an indication of trading intent of any of the mutual funds managed by 1832 Asset Management LP. These views are not to be relied upon as investment advice nor should they be considered a recommendation to buy or sell. These views are subject to change at any time based upon markets and other conditions, and we disclaim any responsibility to update such views. To the extent this document contains information or data obtained from third party sources, it is believed to be accurate and reliable as of the date of publication, but 1832 Asset Management L.P. does not guarantee its accuracy or reliability. Nothing in this document is or should be relied upon as a promise or representation as to the future. Copyright January 2023. 1832 Asset Management L.P. All rights reserved. Dynamic Funds® is a registered trademark of its owner, used under license and a division of 1832 Asset Management L.P.