Sterling Capital Management launched the Sterling Capital Hedged Equity Premium Income ETF (SCEP) last year. The actively managed fund uses artificial intelligence for idea generation, and human intelligence for portfolio construction to deliver a best ideas U.S. equity allocation, while employing options strategies to generate income and protect against market drops, according to Whitney Stewart, executive director at Sterling Capital.
The fund, which began trading December 12 and currently manages $214.1 million in assets, charges a management fee of 0.65%. Stewart said the ETF structure was chosen over traditional mutual funds because clients are demanding the tax efficiency, intraday trading capability and lower costs that exchange-traded funds typically offer.
According to Stewart, SCEP aims to deliver three things simultaneously: tax efficient monthly income, better risk-adjusted returns through AI-driven stock selection, and reduced downside risk through protective options trading. The fund’s sub-adviser, Toronto-based Guardian Capital, has used AI in their equity strategies since 2018, and oversees more than $4 billion in assets using similar investment processes that combine AI and Human intelligence.
AI Stock Picking Engine Predicts Earnings Growth
Guardian’s AI models forecast key investment variables, such as earnings growth and the probability of an earnings miss, and dividend growth and the probability of a dividend cut, Stewart explained. The technology uses techniques such as machine learning, deep learning and large language models that integrate fundamental and alternative data, creating what Stewart describes as a symbiotic relationship between an innovative technology and human experience that strengthens our ability to deliver strong risk-adjusted returns.
The AI narrows the investment universe to a shortlist of best idea companies with a higher probability of delivering durable earnings and dividend growth, Stewart said.
“The AI only looks at the facts and the data and then narrows the universe down to a very short list of companies that, based on our data and analysis, we believe have a greater likelihood of durable earnings and dividend growth,” Stewart said during an interview. “Rather than looking at the entire market, we’re only looking at a small subset of high conviction investable opportunities.”
The fund focuses on two key characteristics: quality and growth. Stewart defines quality as the sustainability of cash flow, or the probability that a company’s cash flow continues to grow at expected levels. On the growth side, the AI specifically looks for companies that can consistently deliver high quality earnings and revenue growth — what Stewart calls the primary catalysts for stock movement.
The fund’s current top holdings (as of February 5) reflect this AI-driven approach: Alphabet Inc. (GOOGL) (6.37%), Apple Inc. (AAPL) (6.09%), NVIDIA Corp. (NVDA) (5.77%), Microsoft Corp. (MSFT) (5.07%) and Amazon.com, Inc. (AMZN) (4.58%). These companies share common traits the AI identifies as attractive — strong balance sheets, consistent cash flow, and growth potential, according to Stewart.
Options Strategy Delivers Income, Downside Protection
Beyond the AI-driven stock selection, SCEP employs a dynamic options overlay strategy to generate income and protect investors from losses. The fund writes covered call options on up to 100% of its portfolio to boost income while simultaneously buying protective put options to cushion downside moves.
Stewart said the protective puts are structured to guard against a 10% to 30% market decline. “Historically, on average, you should expect to get one correction per calendar year that’s kind of in that range, 10% to 30%, and we believe our strategy will help to cushion that downside,” he explained.
This protection strategy aims to help investors who rely on the fund for income and cannot afford large drawdowns in their portfolios. While the options overlay will limit participation in strong market rallies, Stewart said the trade-off is worthwhile for income-focused investors who have already built wealth and are now living off their assets.
The fund maintains exposure to midcap stocks at around 21% of the portfolio, slightly above many large-cap growth competitors, Stewart noted. This market cap flexibility may help the fund find higher-quality companies at better valuations than mega-cap alternatives.
A human options specialist manages the protective put and covered call strategies, while the AI focuses solely on selecting the underlying stocks. The fund can write options on individual stocks rather than broad indexes and has the ability to generate return of capital distributions, which Stewart believes provides more flexibility for tax management and total return potential.
Tax Structure Targets Higher After-Tax Income
SCEP’s structure aims to deliver more tax-efficient income than competing funds. Stewart said the fund seeks to find losses on individual securities and options to offset gains, potentially allowing a portion of distributions to receive a return of capital designation rather than being taxed as ordinary income.
While return of capital distributions are generally not taxable in the year received, they reduce the cost basis of the ETF and may result in a higher capital gain when shares are eventually sold, Stewart explained. This allows investors to defer taxes until they sell their position, potentially years into the future.
“We believe our premium income solution will generate more tax efficient income, because of the structure of the strategy and the ability to provide return of capital distributions,” Stewart said. The fund’s ability to write options on individual stocks rather than using structured notes gives it flexibility to manage gains and losses that many competitors lack.
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