“Each market environment presents a unique combination of opportunities and risks, and decision-making based on judgment and experience is more reliable than quantitative triggers or rigid rules-based approaches.”
He adds that the firm’s long history in the business also provides more of a track record than that of newer rules-based alternatives, and most members of the management team have been with the firm for over a decade. With an expense ratio of 0.77%, institutional class shares have lower expenses than many stock or liquid alternative funds.
Another distinguishing feature of Gateway is that it sticks exclusively to index options because these have lower transaction and implementation costs than options on individual securities, as well as more predictable settlement features. The strategy also makes the fund more tax-efficient than many of its competitors. With options on individual stocks, profits are taxed at short-term capital gains rates.
In contrast, index options are subject to the 60/40 rule, with 60% of profits taxed at favorable long-term capital gains rates and 40% subject to short-term capital gains treatment. Because the fund uses index options and harvests tax losses, it has not had a capital gains distribution since 2000.
A More Volatile Future?
Market volatility is important to the fund because it allows the managers to capitalize on the spread between the realized volatility of the market and the implied volatility priced into the index options it sells. When stock indexes are cruising along smoothly, as they have been for most of the last decade, the Gateway Fund’s returns tend to lag the indexes by a substantial margin. On the other hand, when volatility rises above historical averages, the fund has historically either outperformed the market on the upside or provided more protection on the downside.
Earlier this year, a sharp 10% decline in the market in a matter of days stoked fears that the long upward market trajectory would be ending. Despite political tensions, including Middle East unrest, North Korean nuclear threats and China’s growing influence, the market remained evenly tempered and stocks advanced steadily last year. After the sharp decline, market volatility rose but has still been within historical averages recently.
Buckius says that if volatility returns to equity markets for the rest of 2018, the trigger may more likely be tied to earnings or the economy than to politics. With equity market valuations high and the Fed committed to normalizing monetary policy, there may be less valuation support and less policy support to prevent the next pullback from developing into a correction, or worse. And if earnings growth fails to meet expectations and the market softens, the Fed’s response could be muted unless it is willing to abandon its commitment to raising rates.
“I’m terrible at predicting where the market might be headed,” Buckius says. “But at current valuations, a lot of the right things have to fall into place to keep the bull market running.”