Investors looking to the equity markets can consider Defined Outcome ETFs that seek better-than-market upside, to a cap, without taking on additional downside risk. Knowing potential outcomes prior to investing can help advisors re-think portfolio construction, especially in the face of lower future returns.
In the recent webcast, New Developments in Defined Outcome ETFs, Bruce Bond, Co-Founder and CEO, Innovator ETFs, and Graham Day, Vice President of Product and Research, Innovator ETFs, presented a new suite of U.S. Equity Accelerated ETFs that will be listed on April 1. The new Accelerated ETF suite includes: Innovator U.S. Equity Accelerated ETF – April (XDAP), Innovator U.S. Equity Accelerated 9 Buffer ETF – April (XBAP), Innovator U.S. Equity Accelerated ETF – Quarterly (XDSQ), and Innovator Growth-100 Accelerated ETF – Quarterly (XDQQ).
The Innovator U.S. Equity Accelerated ETF – April will seek to provide investors with double the upside performance of SPY, to a cap, with approximately single exposure to SPY on the downside, over a one-year outcome period. The average cap ratio is about 19.55%.
The Innovator U.S. Equity Accelerated 9 Buffer ETF – April will seek to provide investors with double the upside performance of SPY, to a cap, with approximately single exposure to SPY on the downside and a buffer against the first 9% of losses in SPY, over a one-year outcome period. The average cap ratio is about 11.46%.
The Innovator U.S. Equity Accelerated ETF – Quarterly will seek to provide investors with double the upside performance of SPY, to a cap, with approximately single exposure to SPY on the downside, over a three-month, or quarterly, period. The average cap ratio is about 8.12%.
Lastly, the Innovator Growth-100 Accelerated ETF – Quarterly will seek to provide investors with double the upside performance of QQQ, to a cap, with approximately single exposure to QQQ on the downside, over a three-month, or quarterly, period. The average cap ratio is about 11.33%.
Additionally, Innovator is working on the Innovator Upside: 3x SPY to a Cap (XTAP) and Innovator Upside: 3x QQQ to a Cap (QTAP), which Innovator says will be “coming soon.”
The Innovator Upside: 3x SPY to a Cap will seek to provide investors with tripe the upside performance of SPY, to a cap, with approximately single exposure to SPY on the downside, over a one-year outcome period. The average cap ratio is about 17.06%.
The Innovator Upside: 3x QQQ to a Cap will seek to provide investors with triple the upside performance of QQQ, to a cap, with approximately single exposure to QQQ on the downside, over a one-year outcome period. The average cap ratio is about 22.23%.
Big Gains, No Leverage
It should be noted that these strategies are not leveraged.
The Accelerated ETFs seek outperformance and prepare investors for low-to-moderate future returns. The first Accelerated ETFs seek approximately 2x the S&P 500 ETF, to a cap, with a one-to-one downside. They try to provide the outperformance of a benchmark, to a cap, without increased downside risk and provide a defined outcome for investors.
For financial advisors, these Accelerated ETFs allow for known outcome potentials prior to investing, don’t take on added risk to chase returns, help clients achieve target returns, and offer long-term solutions.
The Innovator strategists highlighted the challenges that investors face in the equity markets today. The amount that investors are paying for forward earnings is near a 25-year high. This is true even when accounting for the current low-yield environment. Specifically, the S&P 500 shows a current valuation level of 27x price-to-earnings. To put this in perspective, the S&P 500 showed an average of 16.1x P/E when the yields on U.S. Treasury bonds were hovering between 1% to 3%.
Meanwhile, investors are faced with increased risks in the fixed income market, especially in a record low-rate environment with expected rising rates on the horizon. As interest rates have risen bond prices have fallen by almost 4%. Despite the loss, bond yields have only risen 40 bps and investors may be exposed to more downside risk if rates continue to grow. Currently, bond investors are only being compensated with yields of 1.48% to take on the credit and rate risk of these bonds.
Furthermore, duration risk is near an all-time high. Interest rates and bond prices move in opposite directions. As the risk for interest rates to rise increases, the potential for bond prices to fall is that much greater. Yields are at all-time lows, and because investors have little yield to offset the potential interest rate risk that they face, bond investors have never been paid so little to take on so much risk.
“The importance of maximizing equity returns today in light of potential low bond returns is heightened today,” the strategists said.
“A low bond and equity return environment would prove challenging for advisors to meet required returns of their clients.”
An ETF Solution
The guests pointed to Accelerated ETFs in preparation of a lower equity and bond return environment moving forward.
“Accelerated upside can serve a variety of purposes in a portfolio. If you’re growing your portfolio via income, part of your growth will be taxable, upon receipt of income. As a result utilizing a strategy like the Accelerated ETFs, for growth, due to its expected tax-efficiency, can create a situation where an investor can defer any gains until they chose to sell. Traditional long equity exposure often has a portion of its total return derived from income which is taxable. As uncertainty in the market grows, being able to communicate a range of potential outcomes prior to investing can be of increased value to client,” the strategists added.
Financial advisors who are interested in learning more about defined outcome strategies can watch the webcast here on demand.