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Investment management strategies can be created and fashioned to meet specific investor needs. An interesting example is how option income strategies can be tailored to High-Net-Worth (HNW) individuals and families. Working with HNW individuals can require a distinct discipline for your option strategy, stock selection, portfolio construction, and also a consideration on the structure of the investment vehicle that you employ to deliver those investment returns.
To understand the investment strategies at play here, we were introduced to Jeff McClean, Managing Partner of Solidarity Capital - a Lehi, Utah-based boutique investment management company committed to delivering consistent levels of monthly cash flow using a proprietary options investment strategy.
The Solidarity asset management firm was born from a multi-family office dedicated to High-Net-Worth families and their specific needs. They have over a decade of experience using option trading strategies and a hedge fund, Solidarity Capital Fund, designed to generate steady monthly income across bull and bear economic and market cycles.
We asked Mr. McClean questions to better understand how his firm’s focus on HNW families and individuals informs and propels their money management decisions.
Hortz: Many option income funds exist, but your fund has a unique perspective and structure. Can you walk us through some of your differentiations?
McClean: We serve a specific purpose for our High-Net-Worth family office clients, providing a unique perspective for our investment management activities. We hear directly from the end user about what they are trying to achieve. We are not just coming off a trading desk steps away from the end user of that investment. We are not part of a big bank or Wall Street firm. Our strategies are focused on our HNW clients’ need for consistent cash flow.
Much of their wealth is often tied up in their businesses, real estate, and other capital-intensive and illiquid investments. No matter how big their balance sheets are, these investors still need reliable cash flow they can count on to pay their monthly bills across their lifestyle needs without having to liquidate assets.
That kind of wealth is no different from a pension or retirement fund. They have their growth bucket and their cash flow bucket. Pensions must send checks out to their retirees every month, so they have to allocate to stable cash flow strategies and then, of course, a focus on growth.
We have developed a hedge fund investment strategy for a part of our HNW clients’ wealth that can generate the cash flow needed. This is one of the biggest principles we use on the wealth management side of what we do and that is where our investment strategies were born.
Hortz: How do you manage an investment income portfolio to drive steady cash flow for your specific HNW end-user clients?
McClean: We have a sophisticated and growing Limited Partner base in our chosen hedge fund vehicle with many of our clients having familiarity with options trading. Let me be clear that using options for income generation is not new but it is our investment process, discipline, nimbleness, and structure that allows us to thrive. It goes to the heart of answering the question we often get: “How are a bunch of guys in Utah doing this and why isn’t Wall Street eating their lunch?” There are three reasons for this:
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We are protected from the big guys (Goldman, JP Morgan, etc.) because if you move too much into our strategy of options trading on individual equities instead of on an index, you will move the market. We have the perspective to focus on strategies where we can do that and not have to scale to $10 billion and higher like the big players need to. This is why we ultimately have an AUM cap of likely $1.5-$2 billion under current market conditions.
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The sophistication of what we are doing, simultaneously underwriting both an individual company security and underwriting the options chain, crowds out everyone but the most sophisticated individual traders and investors.
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We stay disciplined to our clients’ needs. Traders get in trouble chasing the shiny object – or the most lucrative option writing opportunities – without properly considering the risk of WHY that trade is so lucrative. We stay disciplined in chasing singles and doubles and resist the temptation to chase triples and home runs, which rarely occur. It is easy to say but much harder to execute.
Our investment strategies combine different skill sets, including fundamental valuation, equity research and knowing what you own and why you own it. Then we layer options trading on top and underwrite both simultaneously.
We have a window we look to exploit—finding where others are not looking or where, from a big Wall Street perspective, it is not worth their time or resources. This is great for us. This niche makes sense for our HNW investors and gives them a differentiated alternative investment with steady monthly income they may not be getting elsewhere.
Hortz: How does this option-writing strategy work differently in a hedge fund structure than in other structures, like mutual funds, interval funds, ETFs?
McClean: Our strategy works best through a hedge fund structure because some of the power in steadily driving income while protecting assets is that we do not have to manage daily, monthly, or quarterly withdrawals. This strategy allows flexibility in the options we write and buy for strategic hedging to protect principal.
To explain further the differences in structure, one of the things you see a lot in ETFs is covered call-writing options. These strategies have become hot. Our advantage of being in a hedge structure is that we can think longer-term because we have a lock-up period with an extended notice provision. This allows us to work with market fluctuations. During market volatility, we do not know when and where a stock position is going to end up, but because of our due diligence process, we are comfortable that our portfolio company is going to come back. So, we have time to ride out those periods and think longer term. This is a definite advantage we have with our differentiated hedge fund structure.
Other investment structures may have daily, monthly, or quarterly liquidity. This leaves those structures potentially hamstrung. That is where our advantage comes into play against the bigger guys and other structures. When you look at other structures, many almost entirely focus on indices. Their returns are lower, which means you have more variability around the principal because you are trading day-to-day.
The trade-off is that it is much harder to distribute and market a hedge fund versus a mutual fund or interval fund. This is why most funds cannot mimic our approach. They are seeking size and as many investors as possible. For Solidarity, we know that this specific strategy in this specific structure has an ultimate cap on our Fund AUM. Our structure limits us as to how quickly we can grow, but also, over time, that is to our advantage and our investor’s advantage. You cannot scale this strategy forever. Goldman and JP Morgan cannot do this because they would move the market on individual equities if they came in with $10 billion or more.
We think we could probably scale this, under current market conditions, to about a billion and a half dollars to two billion dollars, before getting priced out of where we like to work.
Hortz: How does your strategy work on asset protection and risk management for your NHW clients?
McClean: The second aspect of our strategy, specifically for HNW clients, is that we stay away from the indices and some of the approaches of structured products based on a single high-volatility stock like Tesla. The Tesla stock may offer a high-yield option writing ability but it is incredibly volatile. But we see some financial products based around that process. You are less likely to find that on what we are doing, which is a basket of individual stocks that we are confident in from a long-term perspective, if we get stuck holding a stock, while acknowledging that we do not hit every pitch.
You have to simultaneously both underwrite the individual company and the option chain on that individual company. That is another one of our differentiators as well. It is a sophisticated strategy that is hard to copy because you have to have two unique skill sets. Most option traders have a day trader mentality. They are not fundamental valuation underwriters of an equity. We have both. We combine them into an options strategy with two different characteristics layered on top of each other.
We have been running a similar strategy as part of our wealth management business for close to 15 years. The strategy has performed as we said it would through the tail of the Great Financial Crisis, COVID, the post-COVID boom, and the pullback in 2022. It has held up in diverse market environments, and when you consider the income steadiness, there is a story to tell.
Hortz: Is there any interesting context to the 11% yield number your hedge fund offers?
McClean: The 11% net (12% gross) number comes from how we uniquely structured the fund. This is due to the fact that we have run the portfolio with a combination of two principles—the steadiness of income and the protection of principal. Because we have executed the strategy for so long, we know that we have steadily produced 1% per month on average. It is an average we know we can hit. Our investors value steadiness more so than an inconsistent higher-yield product.
Many investors get in a ton of trouble chasing bright, shiny object trades. It is a cardinal rule for HNW investors to keep their principal protected as much as possible. We have found that you have to give up some yield to protect principal. It is the balance of income steadiness and protecting assets that is essential, along with some prudent growth to protect against long-term inflation risk. So that is how we came to deliver our yield number.
Hortz: What else should we know about your firm and plans for the future?
McClean: We have generated income with asset growth over time with our wealth management services for our HNW client base. We are fairly young guys in our early forties with high aspirations and a long-term mindset to build our investment management services over the years. Our strength is in our differentiated experiences, backgrounds, and perspectives leading us to be independent-minded and nimble.
As we get closer to peak capacity on our first hedge fund, we can open up different strategies that we already do on our wealth management side with different variations for additional funds. We can continue to scale in a way that fits our investors, and that keeps us in our sweet spot. The hedge fund investment environment gives us the added flexibility and nimbleness to execute our HNW income strategies.
We endeavor to deliver the returns our investors need and create happy investors also because they are the best marketers we have. We have no external marketing firm or sales force per se. We have only been growing through client feedback and referrals. It has been all basically word of mouth at this point from the consistency of the returns we are delivering. We are proud and thankful for that support from our clients.
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