Gateway follows a hedged-equity strategy that uses a combination of stocks and options to give investors tax-efficient exposure to the broad stock market with less volatility. The fund holds a basket of approximately 250 stocks optimized to mirror the S&P 500 index, but with a dividend-yield tilt. To generate income, the fund sells S&P 500 Index call options, with expirations approximately 30-50 days out and strike prices approximately at-the-money, on 100% of the notional value of the stock portfolio. The fund also protects against downside losses by purchasing S&P 500 index puts, with expirations 40-60 days out and strike prices approximately 6%-10% out-of-the-money. As the net income received from the options generates short-term capital gains, management sells losing stocks to offset option income. With the fund's current strategy and under current tax laws, investors who hold shares in taxable accounts only pay tax on the qualified dividends received on the underlying stocks (minus the expense ratio of the fund), or when they sell the fund shares. Barring extreme events on the last day of the trading year that would make tax management challenging, fund management simulations predict that the fund could avoid distributing a capital gain for at least the next two decades.
Gateway wasn't always so tax-efficient. In fact, when Gateway Investment Advisers was founded in 1977 by Walter Sall and a group of Cincinnati businessmen, the strategy was decidedly tax-inefficient. At the time the fund executed a covered-call strategy on individual stocks, without the protective puts, with Peter W. Thayer as manager (he would stay with the fund until 1997). The tax inefficiency was the result of a regulation known as the "short-short rule," which prohibited mutual funds from generating more than 30% of their income on positions held for less than three months. This regulation forced Gateway to realize long-term capital gains on some of the underlying stocks (to increase the total income denominator) and to use some less-optimal, longer-dated options. At the time, however, the strategy was so lucrative that taxes and hedging were an afterthought. From 1977 until 1985, the fund continued to sell covered calls on individual stocks, but in 1985, the fund migrated to selling options on the S&P 100, as those options became sufficiently liquid, and then to the S&P 500.
As evidenced by the impact of the short-short rule on the fund, the success of Gateway's strategy is dependent on securities and tax regulations. In fact, as of this writing, a legislative proposal for the tax treatment of derivatives could put the fund's tax strategy at risk. The proposal would treat all profits from option positions as ordinary income, preventing the fund from offsetting gains with losses on the underlying shares. The proposal would also treat all option positions as if they had generated a sale of the underlying security at year-end. While this proposal may proceed no further down the legislative process, its existence highlights the vulnerability of tax-efficient strategies to changes in regulation.
For now, at least, investors can take advantage of Gateway's two value propositions: superior risk-adjusted returns to the S&P 500 and tax efficiency. For most investors, the fund can be used as a low-volatility replacement for some core equity exposure. The fund targets approximately a 0.4 beta to the market, so it won't make as much money in rallies, but it won't lose much in downturns. At 0.94% for the A-shares, the fees are lower than the average large-cap long-only stock funds.
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Look at the M* fund quote page for Gateway, especially the "Growth of 10K"...S&P 500 beats it by a mile in the 10-year and Maximum views.
This fund is garbage.
This fund is garbage.
An interesting concept but I have to agree with another poster. How in the word could the author not discuss the fund's 5.75 load?
Eric, Hybrid funds like VWINX may have generated better risk adjusted returns, but it holds 70% in corporate bonds. You mentioned that income stocks may have been bid up lately, but what about the corporate bonds over the last 10/5/3 years? And all the duration risk? This fund only invests in stocks and uses a covered call strategy. It's really an apple vs. oranges comparison.
If you look at the results for 10/5/3/1 years and compare this to VWINX (Vanguard Wellesley Income Fund) you see that VWINX beats this in every time period and with less volatility (even in 2008/2009). Sure, recently the income stocks held by VWINX have been bid up, but that doesn't explain the prior periods. One big difference is the expense ratios involved (and note that this didn't even include the 5.75% load which doesn't show on the charts). Of course, these are different animals and this one might shine in a really bad crisis, but so would gold--and that doesn't make a high-gold portfolio the best idea.
Apologies for an argument over semantics, but it's hard for me to define Gateway as an "alternative" investment when it's returns are completely correlated to the S&P 500. They may be good or may not be good risk-adjusted returns, but they're not really an *alternative* at all.
And, when I've looked at the fund's returns in a little bit more detail, the actual performance isn't materially any different (on the basis of either total return or volatility) than if you had a portfolio that was ~45% invested in the S&P 500 and 55% invested in short-term bonds.
And, when I've looked at the fund's returns in a little bit more detail, the actual performance isn't materially any different (on the basis of either total return or volatility) than if you had a portfolio that was ~45% invested in the S&P 500 and 55% invested in short-term bonds.
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