When Textbook Asset Allocation Falls Short, CIHEX Uses Higher Rates to Earn Extra Credit

Eli Pars, CFA

Summary

• We manage CIHEX with the goal of dampening equity portfolio volatility and managing drawdowns.
• As a rise in long-term Treasury rates roiled both stocks and bonds during the quarter, CIHEX demonstrated relative resilience, declining less than both the stock and bond market.
• Whereas higher interest rates cause headwinds for bonds and stocks, our hedged equity strategy can benefit because higher rates give us the opportunity to earn more from selling calls.

CIHEX for enhanced equity diversification

The sell-off that began a few months ago in the long end of the Treasury market accelerated in September, ultimately igniting a pullback in the equity market. And once again, the textbook asset allocation of 60% stocks and 40% bonds failed investors, with both the S&P 500 Index and the Bloomberg US Aggregate Bond Index declining more than 3.0%. The lack of diversification benefits between stocks and bonds seems to be a recurring theme in our post-zero-percent interest-rate world.

Given this backdrop, we believe the case for Calamos Hedged Equity Fund remains as strong as ever. Calamos Hedged Equity Fund (CIHEX) is an equity alternative designed to help investors dampen the impact of equity market volatility and drawdowns. During the quarter, the fund performed in line with this goal, mitigating the market drawdown.

Tailwinds for hedged equity

We continue to like the opportunity set in hedged equity. The rise in overnight interest rates coupled with relatively low volatility has led to some interesting trades becoming available in the options market. For example, we have positioned the option book with a trade that is structured to pursue 65% of the market's upside and 35% of the market's downside at its expiration in 15 months. In a higher interest environment, we can earn more from selling calls, which highlights part of the attraction we see in the hedged equity strategy with overnight money at 5%. (For more on the impact on interest rates on option pricing, see Co-Portfolio Manager Dave O’Donohue’s video blog, “Higher Rates are an Opportunity for Hedged Equity Strategies.”)

Our investment approach is designed to take advantage of market opportunities by being favorably positioned for as many outcomes as possible. Consistent with this, we continually seek ways to enhance our process while maintaining our intended risk/reward parameters. Since CIHEX’s launch almost nine years ago, having at least a 40% notional value of net long puts aligned with the market environment and has served the fund well. The fund is currently above the floor, and we anticipate this positioning will continue over the short to medium term. However, the environment calls for us to allocate capital in a more efficient manner due to current tail risk pricing. This environment makes put spreads more attractive (bidding up the put we are selling in a put spread). Given our expectation that this dynamic will persist, we believe there will likely be periods when a more flexible approach (without a hard minimum) will allow us to maintain comfortable levels of downside risk mitigation more efficiently.

Average Annualized Total Returns, as of 9/30/2023

Performance data quoted represents past performance, which is no guarantee of future results. Current performance may be lower or higher than the performance quoted. Please refer to Important Risk Information. The principal value and return of an investment will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost. Performance reflected at NAV does not include the Fund's maximum front-end sales load of 4.75%. Had it been included, the Fund's return would have been lower.

The fund’s gross expense ratio as of the prospectus dated 3/1/2023 is 0.92% for Class I shares.

Average annual total return measures net investment income and capital gain or loss from portfolio investments as an annualized average. All performance shown assumes reinvestment of dividends and capital gains distributions.