Ronald Egalka does naked writing.

Egalka's careful "writing" (i.e. selling) of "naked" (uncovered by offsetting positions) put options, along with other sophisticated risk-management strategies , have produced steady, positive returns for the closed-end Eaton Vance Risk-Managed Diversified Equity Fund ( ETJ) while investors in other funds have been losing their shirts.

While the Standard & Poor's 500 total-return index fell 12.7% during the first seven months of 2008, ETJ's investors enjoyed a market return of 9.5%. Over the most recent three months, the fund marched 3.3% higher, while the S&P sagged 8%.

Because ETJ was initially offered at a premium over its net asset value per share, its NAV return for the past year stands at 8.1%, ahead of its market gain of 4.6%. Both returns are impressive when contrasted with the S&P's fall of 11.1% for the same period.

Egalka, chief executive of option strategy firm Rampart Investment Management, co-manages ETJ along with Eaton Vance veterans Walter Row and Michael Allison. The trio navigates the fund using disciplined risk-management techniques that have kept it on an uphill track during the market turmoil that has prevailed since the fund's debut on July 31, 2007.

The fund's overall stated primary investment objective "is to provide current income and gains, with a secondary objective of capital appreciation." Its largest holdings include mainstays such as Exxon Mobil ( XOM), General Electric ( GE), Microsoft ( MSFT) and International Business Machines ( IBM). The research-savvy Eaton Vance analysts and portfolio managers have kept the fund underweighted in the financial sector, which has helped the fund keep its returns from being tarnished by that group's woes.

What primarily sets ETJ apart from the typical long fund is that it has been writing index call options on roughly 67% of its holdings. The premiums received from the sales of the calls provide a steady income stream for the fund. This is a conservative strategy that augments returns but runs a risk of "opportunity losses" during periods of rapidly expanding values -- which haven't been characteristic of the market for some time.

Turmoil in securities markets over the past year has tended to boost the premiums that buyers have been willing to pay for options. This has helped amplify the benefits of ETJ's basic risk-management strategy.

"The fund will emphasize writing put options on individual stocks that the adviser believes are attractive for purchase at prices at or above the exercise price of the put options written," continues ETJ's statement of objectives. Often considered a risky strategy, this "writing of naked puts" is implemented in such a way by the fund's managers as to meld with its objective of conservative risk management. They identify put options of stocks they determine are priced at attractive valuations and write puts at prices averaging 8% out of the money.

Here is a hypothetical example of how such a strategy might work: Suppose a stock's current price of $10 represents a valuation that would make it an attractive addition to a fund's portfolio, and a put option with a strike price of $9.20 can be sold for, say, 20 cents. By writing the put, the fund immediately receives income of 20 cents. If the buyer of the option should eventually "put" the shares to the fund, the fund would then be acquiring the stock it determined represented reasonable value at a price of $10 at an effective cost of $9 (the $9.20 striking price minus the 20 cents it already received as the option's premium).

All else being equal, one risk to this put option writing program is a possibility of "opportunity loss," or by not writing a put the fund might be able eventually to acquire the stock for less than $9.

ETJ acquires index puts as a precaution against extreme price fluctuations in stocks whose shares it has written put options.

A number of "covered-call" option-income funds use call options strategies similar to those used by ETJ. But a text search of stated objectives of all open-end, closed-end and exchange-traded funds tracked by Ratings didn't find a fund other than ETJ that extended its return-enhancement, risk-management strategy to the use of put options.

ETJ has been achieving its positive risk managed returns at a total expense to holders of 1.08%, which is below the average of 1.48% for all closed-end funds.

Arguably the most telling data in the accompanying statistical profile of ETJ are its slender risk statistics. Its 12-month annualized standard deviation -- a measurement of the annualized range within which 68% of its monthly deviations from trend have fallen -- indicate a level of volatility of returns less than a third that of the S&P.

Perhaps of even more significance is ETJ's positive "Sharpe ratio." The gauge, named after Nobel laureate and portfolio theory pioneer William Sharpe, indicates the fund has achieved a positive return of 1.37% "per unit of risk" over the past year, with risk defined as standard deviation. This contrasts with a negative Sharpe ratio of 0.97% for the S&P.

ETJ's "beta coefficient" is a statistical gauge that indicates that the fund's movements have tended to be of significantly lower magnitude than "the market."

It now seems that everything, everywhere in the investment universe moves in unison with the U.S. stock market. But ETJ's "R-squared" measurement of near zero indicates the fund has achieved true diversification by not being totally uncorrelated with the rest of the market. Normally, only "long/short" hedge fund lookalikes are able to achieve that level of independence from the influence of the overall market, and they typically expose holders to higher levels of overall volatility than ETJ.

Eaton Vance has accommodated investors who would prefer an open-end version of ETJ. The Eaton Vance Risk-Managed Fund ( EROAX) debuted in February. This fund isn't tracked by Ratings.

Eaton Vance Risk-Managed Diversified Equity Income Fund S&P 500 Total Return Index
MANAGERS Walter A. Rowe, Michael Allison, Ronald Egalka -
INCEPTION DATE July 31, 2007 -
YIELD (%) * 9.48 2.26
3-MO. TOTAL RETURN (%) * 3.27 -8.02
YR.-TO-DATE RETURN (%) * 9.04 -12.66
12-MO. TOTAL RET'N (%) * 4.59 -11.09
12-MO. ANNUALIZED STD. DEVIATION (%) * 4.16 13.58
12-MO. BETA COEFFICIENT * 0.14 1.00
12-MO. R-SQUARED * 0.02 1.00
12-MO. SHARPE RATIO * 1.37 -0.97
TOTAL ASSETS ($MIL.) 1,404.1 -
* Data based on market returns.
Source: Ratings - Data as of 7/31/2008.
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Richard Widows is a senior financial analyst for Ratings. Prior to joining, Widows was senior product manager for quantitative analytics at Thomson Financial. After receiving an M.B.A. from Santa Clara University in California, his career included development of investment information systems at data firms, including the Lipper division of Reuters. His international experience includes assignments in the U.K. and East Asia.