Transcription of Finance News Network Interview with Northward Capital CEO and Portfolio Manager, Darren ThompsonClive Tompkins: Hello Clive Tompkins reporting for the Finance News Network. Joining me on the three-year anniversary of the Northward Equity Income Fund is Portfolio Manager, Darren Thompson. Darren welcome back and congratulations on the first three years of operation. First up, can you start by introducing the Fund?
Darren Thompson: Thanks Clive. The Northward Equity Income Fund is a portfolio of quality stocks which our investment team feels are undervalued. And then we in turn, sell option premium over those stocks to generate consistent income. So we sell options to others who are trying to buy upside. The attraction for the Fund and for investors in the Fund is that that generates a consistent income stream, which we add to the dividend income and the franking credits of the Fund generates, to produce our targeted eight to 10 per cent per annum income. And that’s what the Fund has delivered, over the period of the three years since we’ve been running.
Clive Tompkins: How would you characterise the last three years and were there any surprises?
Darren Thompson: Look it’s been an eventful three years, although probably the last two seem reasonably benign, because the market’s been quite strong. We launched in a period when the market was down quite significantly. So within the first three months after operation, the market actually was down 15 per cent at one point. So it was quite an eventful period. And pleasingly, the Fund has performed to expectations through those very different market conditions. As an example, when the market was down 15 per cent in the early days, our Fund was down only two per cent.
So in keeping with the Fund’s strategy, there’s very strong capital preservation focus. And that goes to the option writing that we do, and also the hedging that we take over the overall portfolio. Certainly then as the market’s grown, we quickly reclaimed that capital and moved into the black, and have generated consistent income over the three years. But certainly we have lagged as the market has in periods when the market grew very strongly.
Clive Tompkins: Darren now to the derivative positions within the Fund. What has been the contribution of options income to the total return of the Fund?
Darren Thompson: Yes, good question. So as I mentioned, the key to the success of the Fund in our view, is that it generates income from multiple sources. So we hold a portfolio of stocks which generates dividend income, it generates franking income and also there’s expectations of capital growth, which we’ve delivered over a period of time. The options that we write, again we would write options over about 80 to 85 per cent of the stocks we hold, and that generates about four to five per cent per annum or about 40 to 50 per cent of the expected return, of the Fund.
Clive Tompkins: And what about the last 12 months?
Darren Thompson: Yes and so certainly it’s been in that 40 to 45 per cent mark over the last 12 months. It’s worth knowing that there’s some – I think there’s some attractive offsets in the way the Fund operates. In periods when the markets go down, volatility tends to go high and you get more option income. In periods when the markets are strong, although the option income comes down, you get compensated for by way of capital growth. So that helps to produce that steady income that we’re looking for.
Clive Tompkins: Now the Fund also purchases index puts for protection. What does this mean for the Fund in terms of exposure to the market, versus a long only Fund?
Darren Thompson: Good question, so our expected market exposure or our target market exposure, is around 50 per cent of the market. And that means that the Fund exhibits far lower volatility, than you would get if you invested directly in the Stock Market. And part of that strategy is our hedging. So certainly in our view, and I alluded to the fact that when the market was down 15 per cent in the early parts of the Fund’s history, we were down two. That goes to the hedging strategies that we put in place. That means that we buy a put over the overall market, which means we have the right but not the obligation, to sell if the market falls. And that in turn provides some protection if the market hedging does go down. So sort of like insuring your house or your car, it provides that safety net and that peace of mind.
Clive Tompkins: Great, so how much does that protection cost on an annualised basis?
Darren Thompson: The overall cost of putting the hedge in place has been 1.6 per cent per annum, over the life of the Fund.
Clive Tompkins: Darren the SMSF sector is the largest segment within superannuation. What impact are SMSF having on the top 50 stocks that your Fund invests in?
Darren Thompson: I think that SMSF trustees are putting a great allocation to equities, as are retail investors at large. And I think they’ve tended to move into names with which they’re familiar, which is quite reasonable. You know, the large four banks, Woolworths
(ASX:WOW), Wesfarmers
(ASX:WES), Telstra
(ASX:TLS). They’re names which I think, trustees and retail investors gravitate towards. So I think that is having a modest impact in terms of pushing prices of those stocks towards, you know, reasonably full levels.
I guess our task is obviously to identify value continuing in the market and we certainly focus on and research a deeper pool of stocks. And we also have the ability to write options over those other stocks as well. So that’s where we’re looking to, I guess, compete against those investors in terms of generating superior returns.
Clive Tompkins: Last question Darren. If this isn’t unreasonable, what does the next three years have in store for Equity Income Funds?
Darren Thompson: OK thanks Clive. Well look I think essentially, the trends around investors’ desire for income will continue to grow and become stronger. Now the demographic trends with an aging population are only going to continue to exacerbate that trend. And certainly I think that alternate sources of income, whether they be cash or term deposit, in our view are not likely to rise rapidly at any time in the near future.
So with that in mind, the demand being strong with alternate sources of income being more modest, I think investors looking for income certainly with a view to lower volatility and lower risk, means that Equity Income Funds should have an increasing place in investor appetite, and investor asset allocation.
Clive Tompkins: Darren Thompson, thanks for the update and congratulations again on the first three years.
Darren Thompson: Thanks very much Clive, we look forward to seeing you in another three.
Ends
