Defined outcome ETFs like those from pioneer Innovator Capital Management have performed extremely well during recent market volatility, helping investors “smooth their ride” on a bumpy road. ETF Trends Director of Research Dave Nadig sat down with co-founder, CEO and industry legend Bruce Bond to chat about how these funds have worked, and why.
Dave Nadig: So Bruce, why now? Is it too early, too late, to be considering these kinds of hedges?
Bruce Bond: I think they’re well-suited for this type of an environment. Everyone believes that the coronavirus is going to move through our system, just like it has in China, just like it’s doing in Italy. And we’re going to get to the other side of this, but it is very difficult to tell when that will actually occur, and a lot of people want to be invested because they want to be ready for the market when it does turn back up. But they also want to be prepared if there are some additional movements down. Using a defined outcome product right now lets you get invested and be involved. It’s a particularly key time to be able to ride the market if it goes up, but also to have a buffer on the downside if there is a little bit of downside left. That’s why I think they are key.
Dave Nadig: Is there any one Buffer ETF in particular you like today?
I like the April Series. It encapsulates two uncertainties. First, the coronavirus period. I think a year from now … optimism will have returned to the economy and we’ll have a better understanding of where we stand (and what actually happened). I think Covid-19 is going to move through the system, and things are going to eventually return to normal. We’re already seeing this in China, where they’re up to 90% production again. My hope is it doesn’t take too long to get this situation under control, and not too many people will become infected. All that said, I think that we could see some additional downside pressure as the virus moves throughout the world, and more tests are distributed, resulting in more data to hit the tape. The data itself will also be interesting. Personally, I’m witnessing Covid-19 tests being administered to those potentially most severely impacted by this virus. If that is the case around the U.S., it will undoubtedly skew the statistics.
In ’08 – ’09, there were good days peppered in, and a lot of people hype when the market jumped up. A lot of people were faked out, and got back in too early. The point is, it’s nearly impossible to time the market. But what you can do is buffer against it. The Buffer ETFs allows you to get in; to know that you have this clearly defined downside buffer built-in; but when the market turns around, you’ll be invested, and poised to participate on the upside.
Dave Nadig: OK, so that’s where the April buffer funds come in – they cover this whole period we’re heading into.
Bruce Bond: Well, the April-to-April period not only covers specific levels of downside risk related to Covid-19, but it also encapsulates the upcoming election, and whatever happens after the election. We were initially thinking November would be the next wave of volatility to hit the markets. We were wrong. It was Covid-19. But the nice thing is it doesn’t matter when the volatility hits. These ETFs provide downside buffers through all markets, over the stated outcome period. So both of these market events are “covered” within this April series. So for example, if you believe there will be more optimism in the market by next April, but want some downside risk management just in case things aren’t that optimistic…I think it’s an attractive opportunity to be invested for the turnaround, but at the same time have a built-in buffer.
Dave Nadig: Let’s look back a few weeks: How have these ETFs held up during the crisis?
Bruce Bond: They’ve done exactly what they’re designed to do—buffer a specific level of downside risk and participate in upside gains (to cap), over an outcome period. But it’s not only that they buffer you across their one year outcome periods, but in the interim, they also exhibit much less volatility, lower beta, and lower drawdowns. Risk has been reduced for investors in every defined outcome product. People don’t have to wait until the end to realize some of those benefits.
Dave Nadig: What makes the risk management process behind Defined Outcome ETFs different from other hedge or so-called “black swan” approaches?
Bruce Bond: Dave, I can’t stress the importance of this question enough…if you look at most risk management strategies in existence today, they too have “done what they are supposed to do.” My issue with them is that doesn’t always equate to good outcome for people. Many risk management strategies de-risk during volatile markets, moving to cash. This takes them out of the market. Look at 3/24-25. Those folks missed 18% gains because they were sitting on the sidelines!
Defined outcome ETFs don’t operate this way. They are invested in the market, all the time, with a hedge that is always in place. The cost of that hedge is a capped upside participation. But the beauty of it is the upside cap is typically higher when markets are volatile, which allows people to actually participate more fully in market upside exactly when they need it most.
With our Buffered products, the day you buy it, you’re able to evaluate what you’re buying, and understand what your outcome will be at the end of the outcome period (e.g., one year). There are no moving parts, there’s no switching back and forth. There’s no moving to cash. You own the same securities throughout the entire period, and you know that you have a certain amount of buffer and a certain amount of upside available to you.
Now if you start to get “capped out,” if the market runs up well beyond the cap level, you can always roll into a new month, and you can make tactical adjustments. The ability to actually know what your potential outcome is provides a lot of comfort for people. It eliminates emotion, because fear is what typically drives selling behavior, and Buffer ETFs help take fear out of the equation. They cast light on your future outcome potential.
With other, more active approaches, they basically work until they don’t. It’s the same thing for correlation within a diversified portfolio. At some point most asset classes become highly correlated and fall together. We’ve seen this happen a couple times historically. So that is the big difference between these particular styles of investing.
Defined outcome investing stands in such stark contrast to other risk management approaches that I wanted to spend some time pointing out the differences.
Dave Nadig: You now have a full suite of 36 S&P 500 funds, what about the other indexes your products target?
Bruce Bond: To put it simply, we’ve built the largest suite of Defined Outcome ETFs in the world. We started issuing quarterly series of three buffer levels on the S&P 500, and we had a few projections out there in terms of potential assets we might raise. I said, “When we hit a certain asset level, then we’ll start issuing these ETFs monthly.” And now we’re there—monthly issues of 9%, 15% and 30% buffers on the S&P 500. We’ve taken the same approach on several other indexes as well: MSCI EAFE, MSCI Emerging Markets, Russell 2000, and NASDAQ 100. We are issuing quarterly series of these indexes, allowing awareness and interest to grow, and our plan is to move to monthly as assets grow in these products.
Dave Nadig: Are you seeing any interesting use cases among advisors?
Bruce Bond: We’ve seen our Defined Outcome ETFs used in three specific ways. One, for risk-managed equity exposure. We’ve seen people late last year (and early this year) just swap out of equity exposure into a buffered ETF. They felt like the market was getting overvalued. Several of those advisors are calling us today and thanking us for bringing these products to market. It shows the value these products can bring to advisors’ books, and to people’s lives.
Recently, we’ve also had people who have made a lot of money in fixed income, and decided there wasn’t much upside left in that space; so they moved out of fixed income and bought a Power Buffer ETF (15% downside buffer) in order to get exposure to the upside of this market when it turns around and goes back up.
And then obviously a lot of people just use it for their alts exposure. A lot of people are not happy with their alternatives options, and they’ve just switched out of them, into defined outcome products.
Dave Nadig: Well Bruce, obviously the right product for the right time.
Bruce Bond: I agree. We’re excited for the opportunity to show advisors how these products can help. Thanks for the conversation.
The Defined Outcome ETFs seek to generate returns that match the Price Index, up to the Cap, while buffering against losses, before fees and expenses, over the course of a 1 year period. The Defined Outcome Series Funds have characteristics unlike many other traditional investment products and may not be suitable for all investors. For more information regarding whether an investment in the Fund is right for you, please see “Investor Suitability” in the prospectus. There is no guarantee the fund will achieve its investment objective.
Investors who purchases in the middle of an outcome period will achieve a different defined outcome than those who entered on day one. Alternatively, if you sell shares prior to its conclusion, you will not achieve the full buffer or cap participation. After an outcome periods the fund will reset it’s buffer and receive a new cap.
The Funds are designed to provide point-to-point exposure to the price return of an index via a basket of Flex Options. As a result, the ETFs are not expected to move directly in line with the index during the interim period. Additionally, FLEX Options may be less liquid than standard options. In a less liquid market for the FLEX Options, the Fund may have difficulty closing out certain FLEX Options positions at desired times and prices.
Fund shareholders are subject to an upside return cap (the Cap) that represents the maximum percentage return an investor can achieve from an investment in the funds’ for the Outcome Period, before fees and expenses. If the Outcome Period has begun and the Fund has increased in value to a level near to the Cap, an investor purchasing at that price has little or no ability to achieve gains but remains vulnerable to downside risks. Additionally, the Cap may rise or fall from one Outcome Period to the next. The Cap, and the Fund’s position relative to it, should be considered before investing in the Fund. The Funds’ website, www.innovatoretfs.com, provides important Fund information as well information relating to the potential outcomes of an investment in a Fund on a daily basis.
The Funds only seek to provide shareholders that hold shares for the entire Outcome Period with their respective buffer level against index losses during the Outcome Period. You will bear all index losses exceeding 9, 15 or 30%. Depending upon market conditions at the time of purchase, a shareholder that purchases shares after the Outcome Period has begun may also lose their entire investment. For instance, if the Outcome Period has begun and the Fund has decreased in value beyond the pre-determined buffer, an investor purchasing shares at that price may not benefit from the buffer. Similarly, if the Outcome Period has begun and the Fund has increased in value, an investor purchasing shares at that price may not benefit from the buffer until the Fund’s value has decreased to its value at the commencement of the Outcome Period.
The Funds’ investment objectives, risks, charges and expenses should be considered carefully before investing. The prospectus contains this and other important information, and it may be obtained at innovatoretfs.com. Read it carefully before investing.
Innovator ETFs are distributed by Foreside Fund Services, LLC