Now that the market has run up around 10% from its recent lows in August, it may be prudent to look for more defensive investments that can hold up well during a market correction.
Eaton Vance Risk-Managed Diversified Equity Income Fund (ETJ) is a closed-end option strategy fund that uses various techniques to maximize income and control downside risk in return for giving up some upside potential. ETJ owns a portfolio of dividend paying blue chip common stocks in combination with the following option strategies:
- Buy longer term out-of-the-money index puts on the entire portfolio to provide overall downside protection against a big loss.
- Sell out-of-the-money put options on some individual stocks
- Sell short term index calls on a portion of the portfolio
ETJ was started in July, 2007 and held up pretty well in 2008 because of the protective index puts. Of course, its upside performance in 2009 was restrained by its hedging. In 2010, its market price performance has been poor, but most of this is due to the fact that ETJ sold at a 1.5% premium over NAV at the beginning of the year and now sells at a 5% discount.
The strategy used by ETJ has been called a Participating Collar. The down side is strictly limited by the put protection 2 to 3 percent out of the money. The upside is also limited but not completely, and there can be some decent upside in a very strong equity market.
ETJ is currently paying fairly stable quarterly distributions of 0.45 per share or 1.80 a year. Most of this is return of capital due to the option strategies.
An opportunity to purchase ETJ at a discount may have occurred due to a downgrade of ETJ from neutral to underperform by a sell-side analyst on September 1. The analyst downgraded ETJ at that time because the VIX was high and the S&P 500 put options used to hedge the portfolio were too costly. This could lead to erosion in the fund’s asset base.
I agreed with the analyst at the time of ETJ downgrade, since at that time ETJ was selling at a small discount to NAV of less than 1%. But three things have happened since then that make ETJ more attractive on a short term basis:
- The discount to NAV has widened to -5.5%.
- The VIX has decreased from 26 to 21 reducing the cost of future put options.
- The market has gone up about 10% in September and may be due for a pullback.
|ETJ Annual Performance |
(as of Sept 20)
|Year||NAV (%)||Mkt Price (%)|
|Top Five Stock Holdings||%Portfolio|
|JP Morgan (JPM)||2.52%|
|General Electric (GE)||2.21%|
|Intl Business Machines (IBM)||2.07%|
Eaton Vance Risk-Managed Diversified Equity Income Fund pays quarterly
- Total Assets= 1.035 Billion
- Fund Inception Date= July 31, 2007
- Annual Distribution (Market) Rate= 13.18%
- Income Only Yield= 0.99%
- Duration of S&P 500 Index Puts= 160 days (long)
- Duration of S&P 500 Index Calls= 16 days (short)
- % of portfolio with call options= 68%
- % of portfolio with put options= 100%
- Fund Expense ratio= 1.07% Discount to NAV= -5.47%
Full Disclosure: Long ETJ.