Benjamin Franklin once wrote, “In this world, nothing is certain except death and taxes.” While the quote was referring to his hope that our country’s Constitution would endure, the words are applicable to investing as well particularly following end of year when investment professionals utilize tax selling to reduce capital gains. Hedged equity and option-based funds are often considered more appropriate for non-taxable accounts for fear of elevated capital gains distributions. Our hedged equity strategy differs from more income-oriented approaches by focusing on total return rather than attempting to maximize income by automatically allowing in-the-money options to be called away. This gives us the flexibility to roll options up (to a higher strike) and out (to a later expiration) to participate in additional potential upside in the underlying equity as well as provides a tax loss on the option that was repurchased. This also allows us to maintain the cost basis of the stock, thereby reducing near-term taxes on capital gains.

With this in mind, we thought it might be instructive to analyze the 10-year returns of the market as represented by the S&P 500® without distributions versus the returns of the S&P 500® with 8% annualized monthly distributions, as shown in the chart below. Over the ten-year period, the growth of a $1M portfolio without distributions is significantly higher as expected growing to over $3.5 million, while the portfolio with monthly distributions grows to $2.5M or nearly $1M less. On an annualized return basis, the portfolio without distributions returned 13.4% per year over ten years, while the portfolio with monthly distributions returned 9.7% per year. While the returns are lower, the benefit of monthly distributions comes from income and lower standard deviation (11.0% vs. 15.2% without distributions), as shown in the table below, as cashflows, once received, are no longer subject to market volatility. That said, our biggest takeaway is that investors can receive the benefits of compounding by only taking distributions as needed. In addition, while we did not address taxation directly in the accompanying chart and table, the portfolio without monthly distributions can be more tax efficient if distributions are only taken as needed versus taken out every month. This is particularly true with option-based strategies where call options written against positions can create sizeable taxable gains if the focus is on creating income via options versus a total return strategy where options can be rolled when it makes sense, thereby participating in additional potential upside while preserving the cost basis of the underlying positions. This not only avoids taxes in the near term but also provides capital losses from the options, which can later be used to offset gains.

In conclusion, while Benjamin Franklin’s quote that there are only two certainties in life: death and taxes may still hold true, strategies such as our hedged equity approach that focus on total return can allow for potentially greater market participation in up markets and better tax efficiency by allowing the investor to create their own distributions as needed thus receiving greater benefit from the power of compounding over time and reducing taxable capital gains. In addition, by allowing investors to create their own distributions by withdrawing cash as needed, portfolio managers have the flexibility to raise cash by selling securities with lower gains or selling specific tax lots, thus further minimizing taxable capital gains compared to monthly income distributions.

Important Disclosure Information

Please remember that past performance is no guarantee of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Connors Investor Services, Inc. [“Connors]), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from Connors. No amount of prior experience or success should be construed as a certain level of results or satisfaction if Connors is engaged, or continues to be engaged, to provide investment advisory services. Connors is neither a law firm nor a certified public accounting firm, and no portion of the commentary content should be construed as legal or accounting advice.

Historical performance results for investment indices, benchmarks, and/or categories have been provided for general informational/comparison purposes only and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results.  It should not be assumed that your Connors account holdings correspond directly to any comparative indices or categories. Please Also Note: (1) performance results do not reflect the impact of taxes; (2) comparative benchmarks/indices may be more or less volatile than your Connors accounts; and (3) a description of each comparative benchmark/index is available upon request.

Investments in options involve risks different from, or possibly greater than, the risks associated with investing directly in the underlying securities. The S&P 500® Index is a capitalization-weighted unmanaged index of 500 widely traded stocks created by Standard & Poor’s. The index is considered to represent the stock market's performance in general. Indexes do not incur fees, and it is not possible to invest directly in an index.

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This commentary is not intended for the giving of investment recommendations to any single investor or group of investors, and no investor should rely upon or make any investment decisions based solely on its contents. All returns are shown net of fees. The indices shown are for informational purposes only and are not reflective of any investment. As it is not possible to invest in the indices, the data shown does not reflect or compare features of an actual investment, such as its objectives, costs and expenses, liquidity, safety, guarantees or insurance, fluctuation of principal or return, or tax features. As it is not possible to invest in an index, the information shown does not reflect the features of an actual investment, such as objective, cost and expenses, liquidity, safety, guarantees or insurance, fluctuation of principal or return, or tax features. The Strategy involves risk, including the possible loss of principal. There is no assurance that the Strategy will achieve its investment objectives. The use of leverage embedded in written options will limit the Strategy's gains because the Strategy may lose more than the option premium received. Selling covered call options will limit the Strategy's gain, if any, on its underlying securities, and the Strategy continues to bear the risk of a decline in the value of its underlying stocks. The S&P 500® Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value-weighted index (stock price times the number of shares outstanding), with each stock's weight in the Index proportionate to its market value. It is widely used as a benchmark of U.S. equity performance. Standard deviation is a statistical measurement of volatility risk based on historical returns.