The buy-write strategy and the investment approach used by the Single Family Office have proven to be very successful. Consequently in December 2013 we decided to open the strategy as a “Public Status” Mutual Fund to the broader market with the launch of the Equity High Yield & Premium Income Fund.
We believe that the investment environment today is about products that are easy to understand, liquid, daily traded, transparent and have zero leverage. It is about determining the correct asset class and being able to generate sustained growth over a long period. That is why the Equity High Yield & Premium Income Fund offers investors returns plus liquidity, transparency and no leverage.
This Fund invests in defensive, consumer staple, quality stocks that provide dividend yields of between 4-6%. The strategy also enhances returns by writing covered calls to generate premium income; this is an advantage when equity markets decline (like we saw in 2008 and in 2011) as it limits any potential downside.
The portfolio consists of semi-monopolistic stocks with inelastic demand, solid balance sheets and quality fundamentals; stocks such as Sydney Airport, AstraZeneca and HSBC. It provides investors an opportunity to benefit from the high dividend yield and premium income strategy that many semi-monopolistic, stable, large capitalization companies offer today and this makes it an excellent substitute for many long-only developed market equity funds.
Careful identification of stocks and subsequent reviews are vital to the successful performance of the strategy. We look for strong cash generative companies where cash flow is either expanding or remains constant. Balance sheet strength helps to identify dividend sustainability; dividends are only sustained by companies economically able to produce them. A typical way to judge this is to look for a good track record of dividend payments. A more practical approach is by looking at what happened in 2008 and finding corporates that remained cash generative. The fund invests in companies located in, but not limited to, Australia, Germany, Holland, the United Kingdom, Singapore, the Unites States, Japan and Hong Kong. Defensive, non-cyclical sectors, such as pharmaceuticals, utilities, infrastructure and telecommunication companies make up the majority of the holdings.
The second element that is critical to this strategy is the generation of premium income, namely a simple process of writing out of the money covered calls on the underlying equities in the portfolio. Writing covered call options does potentially cap the full upside in the underlying equity performance, yet generates income when equity prices decline. This strategy, combined with buying stocks in consumer staple industries that provide above average dividend yield allows the fund to outperform in a sideways or downward moving market.
2013 was a unique year with the Federal Reserve’s stimulus programme pushing equity markets to historical highs whilst expectations for 2014 are much more modest. At Castlestone Management we believe that despite the strong performance of developed world equity markets over the past few years, in the long run, developed world equity markets will provide little direction.
Under quantitative easing, the Fed’s bond purchases pushed asset prices considerably higher and a correction appeared to be in the cards as emerging markets took a tumble earlier in January, but the correction was short-lived. We are witnessing a reduction in capital outflows and a return to inflows across specific emerging market countries like Turkey and Indonesia. However, it seems we will have to wait another few months before the consequences of the Fed’s tapering start to show.
To find out more please visit www.castlestonemanagement.com or send an enquiry to info@castlestonemgmtinc.com
