The Defined Outcome ETF strategy with a built-in buffer may help investors better diversify their investment portfolios as volatile conditions persist.
In the recent webcast, The Defined Outcome ETF Revolution, Bruce Bond, Co-Founder and CEO, Innovator ETFs; and Graham Day, Vice President of Product and Research, Innovator ETFs, commented on these times of uncertainty and provided alternative solutions to limit the negative effects of sudden spikes in volatility.
“The market ‘popped’ back up, making it seem, at least temporarily, that we were out of the woods and on our way to an upward trending market. We believe that we have not only experienced this in the past two months, but we would argue that there may be more of that in the coming months,” according to the strategists.
Specifically, Innovator pointed to ongoing risks, such as the upcoming presidential elections with economists now projecting a greater chance of a Joe Biden presidency and the potential uncertainty that would entail. Additionally, the so-called Great Lockdown has triggered the worst recession since the Great Depression, and it is not entirely certain when the economy will fully bounce back.
As a way to better diversify an investment portfolio, investors should consider the benefits of alternative strategies that incorporate an innate hedge to diminish downside risks but still maintain upside potential to capture market moves. Innovator ETFs has come out with a suite of Defined Outcome ETF strategies with a built-in buffer to help investors hedge against further swings ahead, depending on one’s level of risk aversion.
For example, the July series includes Innovator S&P 500 Buffer ETF (CBOE: BJUL), Innovator S&P 500 Power Buffer ETF (CBOE: PJUL), and Innovator S&P 500 Ultra Buffer ETF (CBOE: UJUL), which have a 9%, 15%, and 30% buffer, respectively. The Innovator MSCI Emerging Markets Power Buffer ETF (EJUL) and Innovator MSCI EAFE Power Buffer ETF (IJUL) provide exposure to international emerging and developed markets up to a cap with downside buffer levels of 15% over a one-year outcome period.
The Defined Outcome ETFs provide market exposure with a built-in downside buffer. The ETFs start with a synthetic 1 to 1 exposure to the target market. They would then include a put spread to provide targeted buffers of 9%, 15%, or 30% to their respective targets. Lastly, the upside is capped by selling an upside call to finance downside buffers.
The June series just successfully completed its first outcome period on May 29. The series includes the Innovator S&P 500 Buffer ETF (BJUN), Innovator S&P 500 Power Buffer ETF (PJUN), and Innovator S&P 500 Power Buffer ETF (UJUN), which have a 9%, 15%, and 30% buffer, respectively.
Over the first outcome period ended May 29, BJUN generated a 9.85% return with a 23.81% volatility, PJUN generated a 9.89% return with a 17.30% volatility and UJUN generated a 9.45% return with a 13.73% volatility. In comparison, the S&P 500 Index rose 10.62% with a 32.72% volatility over the same period. When comparing the performances, it can be seen that these Buffer ETFs did what they set out to do: they captured the upside while diminishing downside risks for an overall improved risk-adjusted return.
The Innovator Defined Outcome ETFs have numerous portfolio applications for financial advisors. The series comes with behavioral and asset allocation applications to help keep clients invested, build an advisory business, replace traditional equity/bonds, and include timely applications to hedge risks.
The Defined Outcome ETFs may also be a better alternative to traditional alternatives. Hedge funds are expensive, have spotty track records over the last market cycle, and come with high minimums. Shorting the market typically comes with high carry costs, limited upside exposure, and requires the ability to time the markets well. Additionally, the ability to access insurance and bank products typically is only available through agents or brokers. Alternatively, investors can look to Innovator’s Defined Outcome ETFs, which come with no credit risk, intra-day liquidity, no surrender fees, access on an exchange, no commissions, and lower fees.
Additionally, Innovator is working on the first-ever Defined Outcome bond ETF series, including the Innovator 20+ Year Treasury Bond 5% Floor ETF – July (TFJL) and the Innovator is also looking at an Innovator 20+ Year Treasury Bond 9% Buffer ETF – July (TBJL).
“The floor or buffer reduces the effect of rising rates more than the potential cap reduces the effect of falling interest rates. This means that these ETFs offer the ability to benefit when long-term rates are falling, while their floor or buffer mitigates the effects of price declines when long-term rates are rising,” according to the strategists.
Financial advisors who are interested in learning more about defined outcome strategies can watch the webcast here on demand.