Whilst the Australian share market has delivered a solid average return of 12.1% p.a. in the last decade, it’s been anything but a smooth ride for investors over that period. Well over 70% of this return was achieved in just three individual calendar years, with the remainder characterised by sideways markets, punctuated by occasional violent corrections forcing investors to endure the stress associated with substantial (albeit temporary) drawdowns in their capital.
Too many investors pay excessive fees to big fund managers, to blindly take them on this volatile ride, merely tracking an inefficient benchmark. We think there is a better way…
By combining a diversified blue-chip Australian share portfolio with a buy-write overlay, the Bellmont Buy-Write Portfolio (BBW) is able to generate equity-like returns, but with far lower volatility and downside risk. The Bellmont Buy-Write Portfolio is comprised of two components:
A diversified, blue chip equities portfolio with a distinct value bias, providing investors with intelligent exposure to the earnings growth, dividends and franking credits of 30 of Australia’s biggest companies.
A conservative strategy using index options that swaps the possibility of ‘blue sky’ returns in any period, for the certainty of regular premium income – serving to reduce overall volatility and significantly decrease downside risk.
The Bellmont Buy-Write Equity Core is a diversified, blue-chip equities portfolio, giving investors direct exposure to the earnings growth, dividends and franking credits of 30 of Australia’s biggest companies.
The portfolio is designed to exhibit high correlation with the ASX200, yet with a distinct value bias – systematically adopting overweight positions in companies that are trading at lower than average valuation multiples, and underweight positions in those that are trading at above average multiples.
This systematic approach avoids the common cognitive biases that affect most investors, ultimately detracting from their performance. It also allows the strategy to be rigorously tested, enabling a far better understanding of its risk and return characteristics.
In our own testing of the strategy over the 20 years to December 2013, the portfolio outperformed the market by an average of almost 3% per annum, with risk adjusted returns more than 25% greater than the benchmark index.
Whilst the fundamental assumption underlying traditional financial market theory remains that markets are generally efficient, there are a number of anomalies that have been identified that show this is not always the case. Perhaps the most well documented and extensively researched of these is the ‘value effect’ – the observation that stocks with low market prices relative to their fundamental value (value stocks) tend to outperform stocks with high market prices relative to their fundamental value (growth stocks).
Numerous empirical studies have been undertaken examining the value effect – both attempting to confirm its existence, and more recently attempting to explain why it exists and has persisted for such a long period of time.
One of the first studies to prove the existence of the ‘value effect’ was conducted by Sanjoy Basu (1977), who found a significant negative relationship between Price to Earnings ratios and average returns for US stocks. Similar results have been obtained through examination of Price to Book multiples (Stattman 1980; Fama and French 1992), Price to Sales (Fisher 1984), and Dividend Yield (Fama and French, 1988; Siegel, 2005).
In recent years, research has increasingly shifted from proving the existence of the ‘value effect’, to explaining its remarkable persistence. Whilst many theories exist, in our view the most intuitively appealing explanation attributes the persistence of this anomaly to cognitive biases that can lead to over-reaction and under-reaction on the part of investors (De Bondt and Thaler, 1985; Barberis, Shleifer and Vishny, 1998). Cognitive biases such as representativeness (investors over-reacting to trends in data) and conservatism (investors reacting too slowly to new and surprising data points) lead to investors consistently mis-pricing securities, resulting in lower long-term returns.
By utilising an entirely systematic portfolio construction approach with a value bias, we are able to eliminate the potential to be influenced by these damaging cognitive biases, and instead ensure that our portfolio is positioned in such a way as to profit from the remarkably persistent ‘value effect’.
The objective of our own portfolio research was to identify an entirely systematic way to construct a diversified, blue-chip Australian equities portfolio, with a high degree of correlation with the ASX200 Index, yet with a distinct value bias – allowing us to profit from the well documented benefits of the ‘value effect’.
Focusing on the key valuation metrics most commonly examined in the academic literature (Price to Earnings, Price to Sales, Price to Book and Dividend Yield), we generated an adjustment factor that could be applied to market-capitalisation weightings, to systematically adopt over-weight positions in stocks that were trading at below average valuation multiples, and under-weight positions in stocks trading at above average multiples.
By examining stocks in relation to all four metrics, we reduced the likelihood of unintentional skews as a result of anomalous data points in any single factor. In order to minimise transaction costs and maximise tax-efficiency of the portfolio, the portfolio was set to be re-balanced on an annual basis.
The results of our testing correspond broadly with the conclusions of previous studies. The generated portfolioI outperformed the market by almost 3% per annum over the entire testing period (January 1994 – December 2013), and by a more modest, but still significant 1.8% per annum over the last 10 years to December 2013. Outperformance of the index was also relatively consistent, with positive outperformance recorded in 16 of 20 years tested.
The increased returns did come at the expense of slightly higher risk, with standard deviation of returns for the Bellmont Buy-Write Equity Core of 17.52%, compared with 16.95% for the index. This slight increase in risk was more than offset by the increased returns however, with risk-adjusted returns (Sharpe ratio) of 0.45 vs 0.36 for the index.
A summary of the performance statistics can be found below:
|Average Return (1994-2013)||Average Return (2004 – 2013)||Standard Deviation||Sharpe Ratio|
|BBW Equity Core||13.58%||13.96%||17.52%||0.4547|
|ASX 200 Accum.||10.59%||12.13%||16.95%||0.3616|
I All performance figures quoted are the result of back-testing and do not represent actual performance of any client account. The information is based, in part, on hypothetical assumptions made for modeling purposes that may not be realised in the actual management of portfolios. No representation or warranty is made as to the reasonableness of the assumptions made or that all assumptions used in achieving the returns have been stated or fully considered. Alternative modeling techniques or assumptions might produce significantly different results and prove to be more appropriate. Past hypothetical, back-test or simulated results are neither indicators nor guarantees of future returns. Unlike an actual performance record based on trading actual client portfolios, hypothetical, back-tested or simulated results are achieved by means of the retroactive application of a back-tested model itself designed with the benefit of hindsight. The back-tested performance includes hypothetical results that do not reflect the deduction of advisory fees, brokerage or other commissions, and any other expenses that a client would have paid.
 Stattman D. (1980). Book values and stock returns. The Chicago MBA: A Journal of Selected Papers, 4, 25-45.
 Fisher, K. (1984). Super Stocks, Dow Jones-Irwin
 Siegel, J. (2005). The Future for Investors, Crown Business
 Jarnecic, E. (2004). Return and risk of buy-write strategies using index options: Australian evidence. Research Project, SIRCA.
 Mugwagwa, T., Ramiah, V., Naughton, T., & Moosa, I. (2012). The efficiency of the buy-write strategy: Evidence from Australia. Journal of International Financial Markets, Institutions and Money, 22(2), 305-328.
The Bellmont Buy-Write Option Overlay is a conservative strategy that uses index options to smooth the returns from our core Equity holdings.
By agreeing to forgo the potential for ‘blue-sky’ returns in any particular period, the buy-write overlay generates regular premium income that reduces overall volatility and significantly decreases downside risk.
Originally popularised as a result of academic research undertaken on the US market, the buy-write strategy has been extensively studied around the globe, in an attempt to confirm and explain its ability to consistently outperform the index on a risk-adjusted basis.
Our own research examined various dynamic versions of the buy-write strategy, to see whether it was possible to further improve its risk-adjusted performance. Our results indicate that it is indeed possible, with our dynamic buy-write overlay comfortably outperforming the passive version of the strategy on both an absolute and risk-adjusted basis. I
Our optimised, dynamic buy-write overlay outperformed the market by an average of 2.2% per annum over our testing period, whilst reducing volatility by more than 20%. The resulting risk adjusted returns were more than 75% greater than the benchmark index.
The first study to comprehensively examine the Buy-Write strategy over an entire market cycle was undertaken by Whaley (2002), who examined a passive, index based buy-write strategy on the S&P 500 from June 1988 to December 2001. His results showed that the buy-write strategy generated a similar, but slightly lower average return (13.2% pa vs 14.2% pa), but substantially lower volatility – at less than 65% of the index level. On a risk-adjusted basis, the buy-write portfolio significantly outperformed the index.
Subsequent studies have not only confirmed the outperformance of the buy-write strategy on a risk-adjusted basis, but many have also shown outperformance on an absolute basis. Hill et al (2006) extended the analysis period of Whaley’s original study (1990 – 2005), and found that during this period, the buy-write strategy actually outperformed the index by an average of around 0.6% pa, while still finding that volatility was reduced by more than 30%.
Similar results have been found in studies conducted on international markets, including Australia (Jarnecic, 2004), Hong Kong (Che and Fung, 2011), Taiwan (Lin, Chen and Hsieh, 2012) and Switzerland (Groothaert and Thomas, 2003).
As with all strategies that appear to violate the Efficient Market Hypothesis, significant academic attention has been directed towards understanding the contributing factors that enable the buy-write strategy to deliver superior risk-adjusted returns. The original thesis proposed by Whaley (2002) was that excessive demand for index put options (for portfolio insurance) also pushes up the price of index call options, through the options arbitrage relationship of put-call parity. The result is that the implied volatility of index call options is on average higher than realised volatility, enabling option sellers to profit from the sale of these ‘over-priced’ options. Subsequent examination of this theory by Hill et al (2006) and Kapadia and Szado (2007) confirm this volatility effect, adding to the weight of evidence for this explanation.
Special thanks to Dong Yeop Kim, Professor David Michayluk, Dr Kristoffer Glover, Dr Matthew Clifton and the Capital Markets Co-operative Research Centre for their assistance with our research.
Our own research into the buy-write strategy focused on dynamic management of the call option, to see whether it was possible to further improve the risk and return profile beyond that of a passive implementation of the strategy. We also examined alternatives regarding the re-balancing frequency, to determine the optimal time period over which to write the options. Finally, we examined the resulting returns not only on the basis of standard performance and risk measures, but also using measures that take into account the inherent non-normality of returns from a Buy-Write strategy.
Our examination of dynamic option management strategies focused firstly on various methods of determining the appropriate moneyness (distance from the current market price) of the written call options, based either on fixed ranges, or by taking into account variables such as volatility and momentum. We then also compared the results achieved from passive management of the option prior to expiry, versus active management based on movements in the underlying market, or changes in various option pricing fundamentals. Interestingly, almost all of our tested variations of the buy-write strategy generated higher returns that the benchmark index, with lower volatility and significantly higher risk adjusted returns under assumptions of both normality and non-normality. Pleasingly, several of our variations also displayed significantly improved performance figures when compared with the basic, passive buy-write strategy as tested in previous studies, suggesting that the use of a dynamic management approach could indeed further improve the risk adjusted return of the strategy.
When examining rebalancing intervals, our research was consistent with Mugwagwa et al (2012), finding that in the Australian market, quarterly rebalancing periods outperformed monthly rebalancing across the range of moneyness, in terms of both mean return and Sharpe ratio. This is in contrast to results in the US market that find shorter rebalancing intervals are more efficient (Figelman, 2008), suggesting that the demand for portfolio protection in the Australian market may be skewed towards the greater liquidity available in the quarterly contract months, exacerbating the over-pricing in those periods.
In order to gain the most thorough understanding of the performance characteristics of our dynamic option management strategy, we tested it for the entire period that data is available in the Australian market (2001 – 2013). We tested for mean return, as well as risk adjusted returns under assumptions of both normal and non-normal return distributions. We also dissected the study period into bull markets, bear markets and sideways markets in order to more fully understand the strategy’s likely performance in different market environments.
Our dynamic option management strategy comfortably outperformed both the market index and a standard passive implementation of the Buy-Write strategy, in terms of both mean return and risk adjusted return. Even after adjusting for the non-normality of returns of a buy-write strategy, both the basic and optimised versions of the strategy outperformed the index.
|Performance Measures||XJOAI (ASX200 Accum)||Basic Buy-Write||BBW Buy-Write Overlay|
|Annual Mean Return||8.93%||9.49%||11.22%|
|Annual Standard Deviation||16.81%||13.08%||13.44%|
|% Return > 0||62.50%||77.08%||64.58%|
|% Return > Index||0%||62.50%||52.08%|
Dissecting the results further on the basis of the underlying market conditions was also instructive.
|Performance Measures||Bull Market||Neutral Market||Bear Market|
|Annual Mean Return||32.21%||26.31%||5.32%||6.32%||-35.28%||-12.02%|
|Annual St. Deviation||14.00%||11.33%||13.84%||11.40%||31.53%||24.41%|
Bull Market Periods – 01/07/04 – 31/10/07, 01/03/09 – 31/10/09, 01/12/12 – 29/06/13
Neutral Market Periods – 01/07/01 – 30/06/04, 01/11/09 – 30/11/12
Bear Market Periods – 01/11/07 – 28/02/09
As expected, our dynamic buy-write overlay underperformed the benchmark index during strong bull market conditions, generating average annualised returns of 26.31%, compared with 32.21%. Interestingly, this underperformance was far less pronounced than that of a basic, passive buy-write overlay, suggesting that our consideration of momentum and volatility, and our dynamic management of the option position were effective in allowing us to more fully participate in strong equity market rallies – conditions where basic, passive buy-write strategies struggle.
In neutral market conditions however, the reverse was the case. Whilst our dynamic buy-write overlay slightly outperformed the benchmark index, generating average annualised returns of 6.32%, compared with 5.32%, the outperformance was only modest. This is in contrast to the basic, passive buy-write strategy, which substantially outperformed the benchmark index in this environment. This result suggests that the dynamic aspects of our overlay that allow the strategy to perform more strongly in trending markets, actually detract from its relative performance in sideways markets – although still allowing some modest outperformance of the benchmark index.
In bear market conditions however, our dynamic buy-write overlay produced outstanding results, recording an annualised fall of only -12.02% in exceptionally weak and volatile markets, compared with -35.28% for the benchmark index. Whilst the basic, passive buy-write strategy also outperformed the market over this period, its outperformance was far less pronounced than that of our dynamic buy-write overlay, as our active management of the option allowed us to regularly adjust our exposure and provide far greater downside protection.
Testing of our dynamic buy-write overlay shows average outperformance of the benchmark index of 2.29% pa, with volatility reduced by around 20%. On a risk-adjusted basis, the strategy substantially outperforms the benchmark index, with a Sharpe ratio more than 75% greater than the market.
The vast majority of this outperformance is likely to occur in weak markets, when our dynamic option management strategy enables us to generate substantial income, to offset against falls in the value of underlying equity holdings. In strong bull markets on the other hand, the strategy is likely to underperform, whilst still delivering attractive absolute returns.
When compared with the basic, passive buy-write strategy, our dynamic buy-write overlay increases average annualised returns by 1.73%, with only a very modest increase in volatility. The resulting Sharpe ratio increases substantially, from 46.25% to 57.89%. Performance in sideways markets is more modest, whilst returns in both rapidly rising and rapidly falling markets is greatly enhanced.
Investors in our portfolios can choose between holding their portfolio in a traditional stockbroking account (Bellmont Direct Accounts) or a Separately Managed Account – SMA (Bellmont Managed Account), where a custodian and responsible entity handle all correspondence on the investors’ behalf. Both structures provide full beneficial ownership of shares to the end client, complete transparency and EOY reporting.
Bellmont Managed Accounts provide an online portfolio login as well as annual audited returns and lower fees making it the ideal choice for most investors. The Bellmont Direct Accounts give clients the option to veto investment decisions which can be useful for those clients looking for greater control, and may provide more flexibility regarding administration and reporting for some wholesale intermediaries.
|Managed Account (SMAs)||Direct Account|
|Access to Bellmont’s Portfolios|
|Beneficial Ownership of Holdings|
|EOFY Taxation & Performance Reporting|
|24 Hour Online Access|
|Ongoing Paperwork Managed by Bellmont (eg: Corporate Actions & Dividends etc)|
|Ability to Veto Investment Decisions|
|Minimum Account Size||$100,000 AUD||$1,000,000 AUD|
|Telephone Access to the the Portfolio Managers|
The fees levied on your Bellmont Buy-Write Portfolio depend on the type of account.
The following management fees are payable, monthly in arrears.
|Portfolio Value||Total Fee|
|$25,000 – $499,999||1.60% *|
|$500,000 – $1,000,000||1.40% **|
|> $1,000,000||1.20% ***|
All figures quoted are exclusive of GST
Brokerage on Managed Account transactions will be charged at 0.10%
Brokerage on Direct Account transactions will be charged at the greater of $20 or 0.10%
* Managed Account Fee Breakdown: Custody & Administration 0.40% Investment Management 1.20%
** Managed Account Fee Breakdown: Custody & Administration 0.40% Investment Management 1.00%
*** Managed Account Fee Breakdown: Custody & Administration 0.40% Investment Management 0.80%
The minimum investment for a Bellmont Buy-Write Portfolio is $100,000.
To receive account forms, or speak to a Bellmont representative about how a Bellmont Buy-Write Portfolio can meet your specific needs, please contact the dealing desk on 1300 368 294 or click here to complete our new client enquiry form.