Performance figures for each account are calculated using time weighted rate of returns on a daily basis. The Composite returns are calculated based on the asset-weighted monthly composite constituents based on beginning of month asset mix and include the reinvestment of all earnings as of the payment date. Composite returns are as follows:

Buying Defensively Using Options

MEDA-2013-04-17 - Buying Defensively Using Options (header)


By Jonathan Ratner



Manager: John Nicola, Nicola Wealth Management
Fund: NWM Tactical High Income Fund (USD)
Description: Concentrated portfolio of dividend-paying stocks and high-yield bonds, using options strategies for some or all equity positions
AUM: US$30-million (fund); $2.1-billion (firm)
Performance: 1-year: 7%; since Sept. 30, 2010, inception: 11.3% (as of Feb. 28, 2013)
MER: Between 1.01% and 2.11% (for clients)

John Nicola and the investment team at Vancouver-based Nicola Wealth Management aren’t convinced the sideways trend for equity markets is over.

As a result, Nicola and portfolio manager Sean Oye continue to use options strategies for much of the NWM Tactical High Income Fund.

“We buy companies we want to own for the long term, then use calls and puts to be more defensive about how we own them,” Nicola said.

For example, if the managers wanted to increase their position in Microsoft Corp., they could buy the stock at roughly US$28.50 today. By employing a covered-call strategy, whereby someone pays them $1 for the right to buy those Microsoft shares in six months at US$30 each, they can get a return of about 3.3%.

The managers would also collect Microsoft’s 3%-plus dividend yield, as well as a capital gain of US$1.50, for a total return of about 10% over six months.

“We’re being more conservative when we do that: We give up some upside and protect some of the downside,” Nicola said. “This is a way to participate without having the same naked exposure to the volatility in the marketplace.”

He added that while a put-and-call-writing strategy for the S&P 500 may underperform in bull markets, it has historically outperformed in sideways and bear markets.

In addition to the mid- and large-cap names that make up the majority of the fund’s equity exposure, more than half of the portfolio is in high-yield bonds and cash.


Brookfield Office Properties Inc. (BPO/NYSE)

The position: Added in past 12 months.

Why do you like it? Nicola noted BPO is currently trading roughly 20% below its net asset value, despite owning a very high-quality position in difficult-to-enter central business district markets around the world.
“Whenever you can buy something at less than its intrinsic value, you usually make money,” he said.

He adds the market has also completely ignored BPO’s development opportunities. “As the U.S. economy picks up and business confidence improves, we’d expect leasing announcements to be a big catalyst for the stock.”

Biggest risk: Lower demand for office leasing.

Costco Wholesale Corp. (COST/Nasdaq)

The position: Added in past 12 months.

Why do you like it? In addition to praising the warehouse retailer’s management team, Nicola highlighted Costco’s operational execution.
“You’re starting to hear rhetoric about Democrats wanting to raise the minimum wage,” he said. “While this will have an impact on the Walmarts of the world, Costco employees are paid much more, resulting in turnover that is far below the industry average.”
Nicola also highlighted the resilience of the company’s business model due to its nearly 70 million member base.
“Even though this name trades at a higher P/E multiple than its peers, it is warranted due to their long runway of growth, superior operating metrics, solid balance sheet and shareholder focus.”

Biggest risk: A contraction in the multiple due to a slow-down in same-store-sales.
JPMorgan Alerian MLP ETN (AMJ/NYSE Arca)

The position: Added to existing position in past six months.

Why do you like it? This exchange-traded note provides exposure to midstream energy master limited partnerships (MLPs) and pays a variable quarterly coupon linked to their cash distributions.
“The boom in unconventional oil and gas production in the U.S. has created a need for energy infrastructure, and master limited partnerships are a way to play this theme with solid cash flow,” Nicola said. “In the past, we invested in a number of individual MLPs, but found the tax requirements burdensome.”
He added this security has handily beat the S&P 500 over the past three, five and 10 years with a lower correlation to the broad market, and it pays a dividend yield of roughly 4.5%.

Biggest risk: Higher interest rates could hurt MLP funding and provide investors with other yield options.


Linn Energy LLC (LINE/Nasdaq)

The position: Sold early in 2013.

Why don’t you like it? Nicola exited this energy producer due to accounting concerns related to its natural gas hedging strategies.
“We had also owned a position for a number of years and done well with it, so we saw a better opportunity in the broader Alerian MLP Index,” he said.

Potential positive: A further shift to natural gas away from coal and oil.