It was a tough time for investors in 2022. For bonds, for equities, and markets across the globe—almost all risk-on assets ended the year down. But amongst all the bad, there was a diamond in the rough. Purpose Premium Yield Fund (“PYF”) boasted a year of very strong absolute and relative performance.

Key Takeaways

• Options strategies are designed to thrive in challenging but manageable negative market environments.
• In 2022, Purpose Premium Yield Fund delivered +5.24% returns over a period of largely negative performance.
• With market forecasts calling for a flat recovery with volatility throughout the year, we believe this kind of environment is entirely conducive to continued strong relative performance for PYF.

Purpose Yield Fund’s Option Writing Strategy

PYF, which was designed to be a low-risk way to generate stable income from equities using our options-writing strategy, delivered +5.24% net over a period that was universally negative. But, given the nature of PYF’s strategy, this doesn’t surprise us. The result reflects how PYF is designed to generate stable income through equity options.

In a negative environment where equities sell off in a more orderly fashion (as distinct from a more extreme Q1 2020 scenario), our options-writing strategy enables the fund to largely keep risk thresholds moving down ahead of market declines.

An easy way to wrap your head around an options-writing strategy is to think of options like they’re insurance policies. Just like with insurance policies, it can be beneficial to be a buyer or a seller of options, depending on your investment objective. Learn more in our video below.

Options Writing Strategy, Explained

In the case of PYF, where market dips are more pronounced, the strategy naturally adds risk as short puts are exercised, creating the opportunity to sell back into bear market rallies– all while generating yield along the way. This is essentially what happened in 2022.

While we don’t have a crystal ball, most market forecasts seem to be calling for more of the same in 2023: if not in terms of absolute decline, few expect a return to the days of low volatility and rampant gains.

At Purpose, our house view is that we don’t think we’ve hit bottom (for a more thorough look at our expectations for the year ahead, check out “Purpose 2023 Outlook – Bear Market End Game”). When we arrive at the bear market’s end, we expect the overall trajectory of recovery to be much flatter with greater volatility throughout.

Option Strategy Design and Anticipated Results

The strategy is expected to perform best relative to major asset class benchmarks in market scenarios that fall toward the middle of the distribution. In other words, while we would anticipate underperformance in an extreme selloff or sharp rally, we expect outperformance when markets are negative but orderly, flat, or moderately positive.

Premium generation was notably strong given the environment’s volatility and returns came principally from selling puts but also selling calls against direct equity exposures. Direct equity exposure was the most meaningful detractor. This relates to net losses on positions that were assigned to the portfolio as counterparties exercised in-the-money hedges. As much as we can add value by trading the ranges in these circumstances, a modest loss here is not surprising or alarming in the context of the market’s overall decline.

Looking at a chart of fund performance against the S&P 500 Index, we can see how the fund generally preserved capital during periods of market weakness, building meaningful exposure into the troughs and participating favourably in periods of positive market performance.

Sources: Purpose Investments and Bloomberg.

In the chart above, the performance of SPX Index, presented as growth of $1000, is depicted by the red line, while the performance of Purpose Premium Yield Fund, presented as growth of $1000, is the green line.

Key Observations

• January to March: SPX sells off. Fund performance remains flat due to premium collection. Direct equity exposure remains low.
• Mid-March to April: SPX bounces. Fund participation is moderate.
• April to June: SPX turns more sharply negative. The fund largely preserves capital and picks up direct equity exposure deeper into the decline.
• June to mid-August: SPX stages a large bear market rally. The fund participates meaningfully through direct equity exposure accumulated through the prior selloff and largely sells into this period of market strength.
• Mid-August to October: SPX rolls over. Fund performance remains flat, effectively preserving capital against market declines.
• October to December: SPX is generally sideways and volatile. Fund performance continues to be generally positive through this period as equities largely remain within risk thresholds (above short put strikes), enabling premium generation to drive returns. The cash held against short put exposure also becomes a more meaningful source of return as the era of zero interest rates comes to an end.

Looking Forward

Although PYF’s strategy and specific performance drivers can be complicated, at its core, the fund is designed to perform in challenging but manageable negative market environments. Last year, PYF did just that.

The fund delivered on its objectives to:

1. Monetize high volatility
2. Enhance performance by being tactical
3. Serve as a diversifier between credit and equities, generating absolute returns when traditional risk assets struggled

With an uncertain view on the market’s direction from here and a greater likelihood of more of the same, we believe it remains an excellent time to maintain meaningful exposure to the Purpose Premium Yield Fund.

Commissions, trailing commissions, management fees and expenses all may be associated with investment funds. Please read the prospectus before investing. If the securities are purchased or sold on a stock exchange, you may pay more or receive less than the current net asset value. Investment funds are not guaranteed, their values change frequently and past performance may not be repeated.

The content of this document is for informational purposes only, and is not being provided in the context of an offering of any securities described herein, nor is it a recommendation or solicitation to buy, hold or sell any security. The information is not investment advice, nor is it tailored to the needs or circumstances of any investor. Information contained in this document is not, and under no circumstances is it to be construed as, an offering memorandum, prospectus, advertisement or public offering of securities. No securities commission or similar regulatory authority has reviewed this document and any representation to the contrary is an offence. Information contained in this document is believed to be accurate and reliable, however, we cannot guarantee that it is complete or current at all times. The information provided is subject to change without notice.

Certain statements in this document are forward-looking. Forward-looking statements (“FLS”) are statements that are predictive in nature, depend on or refer to future events or conditions, or that include words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” intend,” “plan,” “believe,” “estimate” or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS. FLS are not guarantees of future performance and are by their nature based on numerous assumptions. Although the FLS contained in this document are based upon what Purpose Investments and the portfolio manager believe to be reasonable assumptions, Purpose Investments and the portfolio manager cannot assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on the FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed, that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise.