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By Philip Guziec, CFA | 05-08-2013 12:00 PM

Gateway's Unique Approach to Protect From Market Cataclysms

Gateway's Harry Merriken discusses how the fund's stocks-and-options strategy hedges against volatility to keep people invested in equities, while its tax efficiency is an added bonus.

Securities mentioned in this video
GATEX Gateway A

Phil Guziec: Hi. I’m Phil Guziec, alternative investing strategist with Morningstar, and I'm here with Harry Merriken, chief investment strategist of Gateway Fund Advisors. Thanks for joining me.

Harry Merriken: We appreciate the opportunity to be here.

Guziec: So talking about Gateway Fund. It's a hedged equity fund that’s tax-efficient. Can you walk me through the value proposition of the hedge? And then maybe we’ll talk a little bit about the tax efficiency.

Guziec: Sure. What we feel Gateway is, and Gateway Fund has been around for about 35 years, is that our investors are investors who want exposure to the equity markets, but are concerned about the risk involved in owning equities. In particular, over the last 35 years we’ve seen a number of bear markets, particularly since the turn of the century. So what we try to do at Gateway is give people the opportunity to have equity exposure, but to mitigate the downside and limit that volatility. We do that with a two-pronged hedging program. The first part of the program is specifically designed to limit volatility. We're looking at the total return of equities historically in the neighborhood of 10%, the majority of that return comes from capital gains. The rest, obviously, is from dividends. Dividends are somewhat stable, somewhat predictable; nothing guaranteed, of course. So most of the volatility of owning equities comes from the capital gain or price fluctuation. 

So at Gateway we do something very simple. We simply sell off the upside on our stock portfolio. We own a stock portfolio that replicates the return of the S&P, and we sell off the upside in return for an option premium that we receive.

Guziec: So instead of the uncertain gains, you’re smoothing it all out with a certain payment today?

Merriken: Exactly. Once we sell that call, we know how much premium we have to earn, and the return is going to be equal to that amount of premium, and since we sold off the upside, it's the amount of premium less any depreciation in the stocks. Now, we can stand a certain amount of depreciation because we have the option premium as an offset. But if we get a significant sell-off in that stock portfolio, we want to be protected so that we mitigate the downside, and we, using our moderate return or income strategy, were able to make back that loss. So we take a portion of the option premium from the calls--and this is where the second prong of the approach comes into play--and we buy out-of-the-money put options.

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