Main Play: Selling Options As A Long-Term Strategy With ETFs

January 09, 2009

Taking a low-turnover GARP approach to core ETF portfolios, ex-Montgomery Securities money managers overlay an options strategy.


When four Montgomery Securities executives decided to break away from the large West Coast investment brokerage in 2002 to start their own asset management shop, they opted to use only exchange-traded funds.

"Even though we all came from a background of managing money using individual stocks, we felt the bear market of 2000-2002 really exposed the advantages of using ETFs," said Kim Arthur, one of the institutional money managers who left to start Main Management LLC.  

Since opening its doors in the heart of San Francisco's financial district more than six years ago, the firm's founders say they've focused on asset allocation in portfolios rather than individual security selection.

Taking A GARP Approach

Arthur is responsible for running Main's investment committee and constructing client portfolios. "We're more reversion-to-the-mean investors than buy-and-hold investors. So when market volatility is higher, we tend to make portfolio changes a little more quickly," said Arthur.

When sectors drop out of favor, Main's analysts and managers like to move into what they see as underappreciated parts of the market.

But Arthur and his staff don't consider themselves deep-value investors. Before initiating positions in an ETF, they demand that at least one catalyst for growth be present with demonstrated abilities to lift a sector's performance.

Typically, Main's team is looking for catalysts that can spur improvements in an industry's bottom line within a quarter or two. "It can take much longer for a new growth cycle to be fully realized," said Arthur. "But if we don't see positive movement of some type within a quarter or two, then we'll typically formulate an exit strategy for funds we're using to capture that segment of the market."

He says another important ingredient in the firm's investment approach is to wade into positions as sectors show greater promise. "It's a process that keeps us out of value traps and can be described as a little on the GARP-ish [growth at a reasonable price] side," said Arthur.

Tilting To U.S. Equities

The firm's average client portfolio has an annual turnover ratio of around 25%, according to Main analysts. Among mutual fund managers categorized as focused on growth, industry statistics show those portfolios average more than 100% in turnover a year.

"We make changes on the edges of portfolios," said Arthur. "We're looking to hit singles, not home runs."

Main's managers start with a model allocation, which is reviewed and reallocated yearly. But Arthur and his co-managers monitor portfolios throughout the year and make tactical tweaks as market conditions demand, he says.

One of those came in the fourth quarter of 2008. When the S&P 500 dropped to the 780 level, Main's investment committee decided to reduce cash positions and buy more equities. "We thought from a valuation standpoint, it was a good time to replenish our clients' equity positions, which had fallen quite a bit below their allocation targets," said Arthur.

The firm bought SPDRs (NYSE: SPY), the iShares Russell 1000 Growth Index (NYSEArca: IWF) and the iShares S&P MidCap 400 Growth Index (NYSE: IJK).

"All of these ETFs have Technology and Consumer Discretionary exposure. Those are the sectors that usually move more aggressively in bear market rallies," said Arthur. "We're not trying to market-time. But we continue to rebalance portfolios into growth sectors that tend to outperform in a bear market rally."

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