The Curious Case Of ETV, A 9% Yielding CEF

Thesis

Eaton Vance Tax-Managed Purchase-Write Alternatives Fund (NYSE:ETV) is an fairness purchase write fund. The car has a expertise tilt when in comparison with the S&P 500, a characteristic which on paper ought to have helped the fund navigate an astounding 2023 for tech:

Nonetheless, ETV is up solely 6% this 12 months, when in comparison with the S&P 500’s complete return which exceeds 12%:

On this article we’re going to have a look at a number of the structural options for this fund and get behind its lagged efficiency.

Firstly, allow us to talk about what the CEF does precisely. As per the fund’s literature:

The Fund invests in a diversified portfolio of frequent shares and writes name choices on a number of U.S. indices on a considerable portion of the worth of its frequent inventory portfolio to hunt to generate present earnings from the choice premium. The Fund’s portfolio managers use the adviser’s and sub-adviser’s inside analysis and proprietary modeling methods in making funding choices. The Fund evaluates returns on an after tax foundation and seeks to reduce and defer federal revenue taxes incurred by shareholders in reference to their funding within the Fund.

By writing choices on the S&P 500 the fund is ready to monetize choices premiums, which ought to assist the fund (theoretically) outperform in a variety certain market.

So, on paper, the construct ought to have helped this car in 2023, a 12 months which has been characterised up to now by an outperformance in expertise shares and lengthy intervals of time of vary certain markets.

Components behind ETV’s underperformance

1. Premium/Low cost to NAV

As a closed finish fund, ETV has a premium and low cost to NAV, which may vastly influence its market worth:

We will see from the above graph that the CEF has seen its premium transfer to a reduction this 12 months. The online influence to the fund’s market worth is someplace round -5%, which has negatively affected the fund.

There are a number of explanations for this characteristic, probably the most preeminent one being that volatility, as mirrored within the VIX index, has collapsed:

In 2022 we by no means noticed the VIX go beneath 20 in a sustained trend. In impact a preferred theoretical commerce final 12 months was to purchase the S&P 500 when the VIX hit 20 and promote the index when the VIX hit 30. That technique would have generated a complete return in extra of 30% final 12 months.

The story is totally different in 2023, with the VIX now beneath 15! The VIX is a volatility measure:

The Cboe Volatility Index, or VIX, is a real-time market index representing the market’s expectations for volatility over the approaching 30 days.

As a buy-write fund ETV is brief volatility. When volatility strikes decrease there may be much less and fewer of an incentive to brief it (as a result of you don’t get compensated for it). So proper now an investor ought to probably not brief vol as a result of the draw back is greater than the upside. In our thoughts this is among the causes for the fund shifting to a reduction to NAV. We want to see ETV lower the quantity of portfolio coated by choices right here.

2. Portfolio Protection / Choices Overlay

The fund writes choices for a lot of the portfolio:

We will see from the actual fact sheet (the fund has eliminated the choices overlay particulars from its web site) that as of the final reporting date the CEF was protecting 97% of its portfolio with calls. That’s an aggressive stance that works very well in a down market or a variety certain one, however penalizes the fund when there are sudden vital strikes up in shares. That is the precise characteristic that explains the lagging transfer buy-write funds expertise in structural bull markets. They mainly hand over a variety of the upside by writing calls.

Once more it very a lot is determined by how the market strikes. Very small beneficial properties over lengthy intervals of time don’t have an effect on the efficiency right here, sudden vital strikes do although. Allow us to take an instance. If the market strikes by 3% in the present day the fund mainly has exhausted its upside. Structurally it might want to wait for one more 14 days to have the ability to seize any additional transfer up. So if within the following interval there are vital beneficial properties, ETV is not going to take part. Why? As a result of it has written name choices which might be 2.5% out of the cash and have a 15 days expiration. So the CEF will get paid a premium however solely participates within the first 2.5% of the up transfer within the two week interval.

For the fund to have the ability to underwrite extra of the upside, it must lower the ‘% of Inventory Portfolio’ overwritten with name choices.

Conclusion

ETV is an fairness purchase write CEF. The fund has lagged the S&P 500 this 12 months, up solely 6% when in comparison with the 12% return posted by the index. The article analyzes a number of the components behind this underperformance, in mild of a curious 12 months which, on paper, ought to have favored ETV. Round 5% of the underperformance is as a result of widening of the low cost to NAV for the fund for the reason that starting of the 12 months. We attribute this transfer to the unbelievable collapse in VIX and the unattractiveness of shorting volatility at these very low ranges. The market is mainly punishing ETV for shorting the VIX at historic low ranges (by no means commerce to have). The second motive behind the underperformance is represented by how the market has moved. ETV covers 97% of its portfolio with calls which have solely 2.5% upside. Sudden strikes up that complete greater than 2.5% in a two week interval will end in ETV underperforming. The CEF would want to lower the portfolio possibility overlay so as to have the ability to partake in the next upside share. We personal this CEF and are on Maintain with respect to the fund, proud of receiving the dividends.