Buy-Write Portfolio Case study

During extended periods of sideways market movements it can be very difficult to generate strong returns from a broadly diversified portfolio. One way of improving investment returns in such conditions, whilst at the same time reducing volatility, is to generate additional income through the conservative use of derivatives. The Bellmont Buy-Write Portfolio is one such application of this type of strategy.

The 30th of June 2011 saw the end of the first full financial year for the Bellmont Buy-Write Portfolio. We are very pleased with the out-performance of the investment strategy to date, and provide below a case study which follows the transactions made on an actual Buy-Write Portfolio client of Bellmont Securities who agreed to all of our recommendations during the period.
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Bellmont Buy-Write Portfolio Performance 2010-2011

Summary of Portfolio Events

Initial balance

Initial balance as at the 30th of June 2010 for this client was $117,285.27. Of this initial balance, the portfolio was over 95% percent invested in a core, diversified portfolio of blue chip Australian shares with an ASX index call option written over the portfolio to significantly reduce the portfolio’s overall volatility, as well as generate additional income.

Rebalance

In November 2010 we undertook a rebalancing of the holdings within the Bellmont Buy-Write Portfolio. Transactions were undertaken based on our outlook for the Australian equity market and our fundamental investment selection criteria, whilst ensuring a strong positive correlation with the ASX200 share index.

Income generating hedging strategy

Throughout the year call options were written over the core portfolio holdings in order to generate additional income. This strategy significantly cushioned the portfolio from downside risk, as well as contributing to portfolio out-performance as the overall Australian market travelled sideways.

Dividend income

As all investments in the Bellmont Buy-Write Portfolio are held directly in the client’s name rather than through a managed investment structure, the client received the full benefit of all dividend income, as well as distributed franking credits. By adhering to our investment selection criteria we were able to meaningfully contribute to the client’s portfolio performance through the distribution of significant dividends and franking credits.

Off-market buy-back

On the 11th of April 2011 BHP completed a $6 billion off-market share buy-back. BHP Billiton bought back 147 million shares, representing 4.4 per cent of the issued share capital of the company. The final price for the buy-back was set at $40.85 per share, representing a discount of 14 per cent to the market price of $47.4985 per share, the volume weighted average price for the five days up to April 8.

The BHP Billiton buy-back comprised a capital component of $0.28 per share and the balance was a fully franked dividend. Given the buy-back price was $40.85, the dividend the client received was $40.57 per share ($40.85 – $0.28), fully franked – which equates to a total value received for the shares, including franking of $58.24 per share.

By holding the BHP shares in the client’s name as opposed to through a managed fund it was possible to take advantage of this extremely lucrative opportunity.

Interest accrued

During the year, funds accrued through the sale of call options and not invested funds were held in the client’s Cash Management Account. During this period these funds were generating interest of approximately 4.75% pa.

Fees

The fees and charges levied on the Bellmont Buy-Write Portfolio can be broken down into two separate areas:

Management fees:

The management fees on this client’s account were 2.0% per annum (plus GST), calculated and deducted quarterly. (Portfolios greater than $500,000 are eligible for management fee discounts)

Brokerage:

Brokerage fees on the recommended transactions were charged at the greater of $20, or 0.10%, (plus GST).

Closing balance

As at the 30th of June 2011 the client’s Buy-Write Portfolio closing balance was $127,579.99 which in itself is an excellent return. However, in this case the client elected to have company dividends paid to an externally managed cash account. Therefore, including dividends and franking credit entitlements the portfolio’s total value was $137,306.26 which is a net return (after all costs) of $20,020.99 or 17.1%.

*Returns inclusive of franking credits are calculated by attributing a cash value to each franking credit.

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