Protection plays offering a cushion against downturns were a prominent strategy last year, but the market rally during the first half of 2023 is prompting more exchange-traded fund investors to rethink the growth trade.
"When you're selling calls, you're capping your upside," Kim Arthur, CEO of Main Management, told Bob Pisani on CNBC's "ETF Edge" on Monday. "When you have an up-16% first half of the year, these types of strategies are going to underperform."
Arthur explained call writing strategies do typically benefit from a down or flat market but struggle to perform in a rebounding environment. And as the Cboe Volatility Index continues its decline this year and yields smaller premiums for investors, he said, strategies betting on markets to remain range-bound or lower become unsustainable.
"You need to have something that is a level," he said. "[Something] that you can do repeatedly in all environments."
The built-in income-generating options strategies of the JPMorgan Equity Premium Income ETF (JEPI) helped fuel the fund's popularity in 2022. It remains the largest actively managed ETF on the market with nearly $28 billion in assets, but the rebound in growth this year has left the product lagging the broader market.
Arthur's firm manages the Main BuyWrite ETF (BUYW), which acts as a competitor to JEPI. Both funds apply a covered call selling strategy to help ease volatility and provide more income.
"For a specific set of investors that's looking for a particular outcome, these tools work really well," Mike Akins, founding partner at ETF Action, told Pisani in the same interview Monday.
But Akins warned that protection plays often get spun off as alpha generators during the transition out of a bear market.
"And that's just not the case," he said. "In almost all bull market cycles, these types of strategies are going to have a much lower up capture ratio, and oftentimes a similar downside capture ratio."
"As we know, the markets over time go up," Akins said. "So, you're not going to keep up with the market with these types of strategies."
While investors sticking with protection strategies might not be compensated for market upswings, Arthur said that he still sees the funds holding a key place within a portfolio.
"It's kind of the glue between the wall," he said, defining the "wall" as fixed income and risk-on equities as the "wallpaper."
"If you look over an extended period of time, they do deliver in that bucket," Arthur added. "It should be 6% type of returns. Not equity returns but better than fixed income."
