October 6, 2022 | 6 Minute Read
Equity Strategist, Public Capital Markets
For equity investors, there are reasons to believe the next decade may look very different from the previous one. The 2012-2021 period was extraordinarily friendly to investors, thanks to ultra-low interest rates and the rise of the so-called FANGMAN stocks---Facebook, Apple, NVIDIA, Google, Microsoft, Amazon and Netflix. Together, this cohort powered the S&P 500 to a 17% annualized return over 10 years through 2021, well above long-term trend. On top of that, some suspect the returns that might have come over the next decade were “pulled forward” as unprecedented monetary and fiscal stimulus helped economies rebound from the COVID-19 pandemic.
It may be prudent to lower forward expectations at this point. We expect returns for the S&P 500 to mark a significant step down from what recent history might suggest. To add insult to injury, stocks are expected to exhibit more volatility in the future (Exhibit 1) as markets grapple with multiple headwinds, including hawkish global central banks, supply chain realignment, geopolitical unrest, deglobalization and energy insecurity.
Source: Morningstar Direct, December 31, 2021; *Historical 10-Yr Period = 01/01/2012–12/31/2022. Goldman Sachs Multi-Asset Solutions Group June 30, 2022. Strategic long-term assumptions are subject to high levels of uncertainty regarding future economic and market factors that may affect future performance. They are hypothetical indications of a broad range of possible returns. Please see additional disclosures. Past performance does not guarantee future results, which may vary. The economic and market forecasts presented herein have been generated by Goldman Sachs Asset Management for informational purposes as of the date of this publication. They are based on proprietary models and there can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this publication. Volatility is measured by standard deviation.
We are still constructive with regard to equities and firmly believe they have a significant role to play in a portfolio, especially when inflation is eroding purchasing power. Still, in the new market regime, market stressors may be more frequent and more extreme.
What might investors consider to help them navigate this more challenging market terrain? We think equity Buy-Write strategies may deserve a look. No two Buy-Write strategies are the same, but they tend to have some strong commonalities. A Buy-Write strategy will typically hold (“Buy”) a diversified basket of stocks to mimic a particular index—the S&P 500, for instance—and sell (“Write”) related call options seeking to generate additional income from the premium. In short, a Buy-Write strategy forfeits potential equity upside in exchange for enhanced income above and beyond equity dividends.
Buy-Write strategies do things differently from long-only equity portfolios, and usually produce different outcomes. For one thing, Buy-Write strategies can alter the mix of total return. Looking forward, it may be more palatable to accept lower return potential in exchange for a greater proportion of income relative to less reliable stock price appreciation.
Secondly, it is in more muted return environments that Buy-Write strategies have tended to outperform. In negative or flat-to-single-digit markets, selling call options provides incremental returns that are beyond the reach of long-only strategies. With its option premium “cushion,” a typical Buy-Write strategy may demonstrate a higher frequency of outperformance in these markets relative to the benchmark.
For instance, considering rolling one-year returns (measured quarterly, over 20 years), the CBOE S&P 500 2% OTM Buy-Write Index—a reasonable proxy for the Buy-Write strategy universe in aggregate—has outperformed the S&P 500 more than 50% of the time in flat markets, but nearly three quarters of the time in negative return periods. In negative return markets, the CBOE S&P 500 2% OTM Buy-Write Index outperformed the S&P 500 by an average 370 bps. Often, playing good defense can be a solid foundation for long-term outperformance (Exhibit 2).
Source: Morningstar Direct, Goldman Sachs Asset Management as of June 30, 2022. Time periods represent rolling 4 quarter window rolled each quarter. Time frame shown is 3Q 2002 – 2Q 2022. Past performance does not guarantee future results, which may vary.. The S&P 500 represents the overall market in the example above. Negative Market is defined as returns less than zero, Flat to Single Markets is defined as returns from 0-9.99%. Exuberant Market is defined as returns greater than 10%.
In the more challenging equity return environment we anticipate, a Buy-Write strategy may improve investor experience via a more defensive, muted-volatility return profile.
Source: Goldman Sachs Asset Management. For illustrative purposes only.
In the new market regime, it may be more sustainable to accept lower highs but higher lows (Exhibit 3). A smoother glide path may be more likely to keep investors engaged with their investment programs—and with equities—to the benefit of their long-term financial health. In an era of rising costs and eroding purchasing power, we think that’s engagement worth having.
Committed to providing you with the insights you need to build your practice.