Are you looking for a relatively safe mutual fund haven amid current market carnage? Check out $124.2 million Madison Covered Call & Equity Income Fund (MENYX).
Going into last Friday, the fund was roughly breaking even for the year while the S&P 500 was down more than 20%. Even now, after market declines in three of the past four trading days, the fund is down 3.58%, far less than the broad market's 23.26% plunge going into Tuesday, according to Morningstar Direct.
And you may be equally enticed by the fund's generous trailing 12-month yield, which is 4.82%.
In contrast, a popular S&P 500 tracking mutual fund like $3 billion Vanguard 500 Index Investor (VFINX) sports a trailing 12-month yield of 1.63%.
Mutual Fund Defensive Strategy
Madison Covered Call & Equity Income Fund is built for markets like the current one, says lead manager Ray Di Bernardo.
Di Bernardo and manager Andrew Justman aim for price appreciation on large- and midcap stocks. And as the fund's name indicates, they sell call options on many holdings to generate income for shareholders. ("Covered" refers to the fact that the fund owns the stocks in which it is selling call options.)
How This Mutual Fund Works
Their strategy tends to fare best in indecisive and weak markets like today's, says Di Bernardo. "Essentially we presell potential share-price gains for a specified price to a certain market," Di Bernardo said. "In a sideways or down market like this year, we would expect to significantly outperform."
Basically, investors who buy the fund's call options are looking into the future. They're anticipating the inevitable next market rally. And they want to turbocharge their own gains in that future and now, when possible. They're betting that call options the Madison fund sells to them are on quality stocks that will in fact appreciate in value, even beyond the threshold price that can trigger the option. That threshold price is known as the strike price.
Those gains beyond the strike price pad advances notched by option buyers on other stocks they invest in.
For the right to obtain potential gains on stocks optioned by the Madison fund, option buyers pay more than the strike price. That extra amount is known as a premium.
The Madison fund relays those premiums to its shareholders in the form of yield. It does the same with any dividends it collects. Those income flows are why the fund's yield is higher than the broad market's.
More Upside To Energy Stocks
Energy stocks have provided price appreciation and income. And Di Bernardo thinks the sector still has room to run despite its gains this year. "We're still bullish on the price of oil and gas despite the big increase," Di Bernardo said. "There's more upside despite the rise."
The Madison mutual fund owns EOG Resources. Earnings per share growth has slowed for four straight quarters. Di Bernardo says the EPS growth slowdown does not concern him. Cash flow is still very strong, he says.
Also, EOG is more integrated than many rivals, Di Bernardo says. They own sources of fracking sand, drilling mud and other key services and supplies. That helps keep their costs down, Di Bernardo says.
He called EOG "the premier energy producer in the U.S. shale industry. They have more wells than most other companies, even exploration and production majors. They're efficient. They get more additional production out of their wells in a quicker amount of time, so they're more profitable."
EOG is up 46.63% this year. Its trailing 12-month yield is 2.15%.
Madison's Inflation Play
Because of inflation, the Madison mutual fund has fished for more opportunities among stocks with exposure to commodities.
"Commodity input costs are rising, whether they are fuel, labor, materials," Di Bernardo said. "So we look for a company with a pricing advantage or that's less affected by inflation. Archer Daniels Midland is one."
Inflation raises prices on agricultural products that Archer Daniels Midland processes. But it is able to pass those price hikes along to its customers, Di Bernardo says.
ADM also benefits from the shortage of products caused by the Ukraine war. "That helps keep prices high," Di Bernardo said.
ADM earnings per share growth has accelerated. They grew 9%, 24%, 37% and 62% the past four quarters. Its share price is up about 30% this year.
ADM's trailing 12-month yield is 1.81%.
Elective Surgeries Rebound
Health-care stocks that Di Bernardo likes for his mutual fund include Stryker and Medtronic. Stryker develops medical devices like orthopedic implants and surgical instruments. Medtronic makes medical gizmos like implantable cardiac devices and insulin pumps.
Stryker is down 21.44% this year. Its trailing 12-month yield is 1.34%.
Medtronic is down 18.97%. Its trailing 12-month yield is 3.2%.
"Patients put off many elective surgeries during the Covid pandemic," Di Bernardo said. "Now elective surgeries are coming back. Stryker makes devices for knee, hip and shoulder reconstruction. Medtronic has heart valves and diagnostic equipment. We're seeing much more demand for their products."
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