2nd Quarter 2010 Commentary
The Fund held up relatively well during the second quarter of 2010, as well as the beginning six months of the year, compared with the S&P 500 Index. That said, we view that performance as a somewhat hollow victory given that performance still suffered a decline in aggregate. Our ability to minimize the Fund's losses was almost entirely a function of its options strategy. Both the premiums the portfolio received from selling Call options and the gains that were recorded from owning index Put options were the major drivers for the outperformance versus the index. Indeed, the gains on the Put positions were substantial during the most recent quarter.
We employ a hedging strategy in the portfolio that typically attempts to buy Put options aggressively when the Chicago Board Options Exchange Volatility Index (VIX) is 20 or less and to liquidate those positions when the VIX is between 40 and 50. This approach caused us to buy index Puts early in the year and to sell almost all of them in June. Although this currently leaves the portfolio in a less hedged position, it allows for the capture of any potential advance after the market selloff in June.
The shift in the Fund's hedged position begs the question of whether the portfolio is now overly exposed to a market decline from the current level. The employment of index Put options is a function of the level of the VIX, not management's opinion of the market. Still, we believe that the risk/reward outlook for the next six-to-12 months is decidedly towards the upside. With company earnings still increasing and interest rates for high-quality debt remaining extremely low, we are at a point where the relationship between the S&P earnings yield and any fixed-income alternatives is at an historical extreme. In the past, this has been the pre-condition for an increase in equity prices. Additionally, the cost to buy a Put option on the S&P 500 is substantially above the theoretical value of those options, suggesting that near-term sentiment remains extremely bearish on the part of traders. While the timing of any change in direction is very difficult to forecast, we think all of the ingredients are present to lead to a reversal in trend.
Senior Portfolio Manager
Note: By selling covered call options, the Fund limits its opportunity to profit from an increase in the price of the underlying stock above the exercise price, but continues to bear the risk of a decline in the stock. A liquid market may not exist for options held by the Fund. If the Fund is not able to close out an options transaction, it will not be able to sell the underlying security until the option expires or is exercised. While the Fund receives premiums for writing the call options, the price it realizes from the exercise of an option could be substantially below a stock’s current market price. Premiums from the Fund’s sale of call options typically will result in short-term capital gain taxes, making it ill suited for investors seeking a tax efficient investment.
Past performance does not guarantee future results. Investment return and principal value of mutual funds will vary with market conditions, so that shares, when redeemed, may be worth more or less than their original cost.
Before investing, carefully consider the fund’s investment objectives, risks, charges and expenses. Contact 800 992-8151 for a prospectus containing this and other information. Read it carefully. Aston Funds are distributed by BNY Mellon Distributors Inc.