As we look for ways to navigate a more volatile market better, investors may consider a Defined Outcome exchange traded fund strategy with a built-in buffer to help better diversify an investment portfolio.
In the recent webcast, A Defined Outcome Strategy Amidst Market Uncertainty, Bruce Bond, Co-Founder and CEO, Innovator ETFs, outlined the current market we are in today, highlighting the coronavirus pandemic that has infected close to 3 million worldwide. If the COVID-19 pandemic and containment peaks in the second quarter for most countries in the world and recedes in the second half of the year, the International Monetary Fund projected global growth in 2020 to contract -3% year-over-year or 6.3 percentage points lower from its prior January 2020 projections.
“This makes the Great Lockdown the worst recession since the Great Depression, and far worse than the Global Financial Crisis,” Bond said. “All hope is not lost though. Assuming the pandemic fades in the second half of 2020 and that policy actions are taken around the world are effective in preventing widespread firm bankruptcies, extended job losses, and system-wide financial strains, we project global growth in 2021 to rebound to 5.8%.”
Bond also warned of other potential risks ahead, namely political risks associated with the U.S. Presidential Elections.
“We don’t know who will win, and looking at the poll numbers, it is a fairly tight race at this time. What we do know is that the added uncertainty is unlikely to put the markets at ease anytime soon,” Bond added.
Despite the ongoing volatility and potential risks, Graham Day, Vice President of Product and Research, Innovator ETFs, argued that investors can still maintain market exposure, but one should consider an alternative solution that is better equipped to handle the potential swings ahead.
Specifically, Innovator ETFs has come out with a suite of Defined Outcome ETF strategies with a built-in buffer to help investors hedge against risks ahead, depending on one’s level of risk aversion.
For example, its April series includes the Innovator S&P 500 BUFFER ETF (BAPR), Innovator S&P 500 POWER BUFFER ETF (PAPR), and Innovator S&P 500 ULTRA BUFFER ETF (UAPR), which have a 9%, 15%, and 30% buffer, respectively.
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.
While the quarterly Defined Outcome ETF series is set up with an annual target, investors can still invest in a series of intra-period.
So far, these buffer ETF strategies are doing precisely what they promised to do: limit drawdowns during periods of heightened volatility. For example, over its first outcome period ended March 31, BAPR returned -0.70% with a volatility of 20.7% and a max draw of 24.6%. In comparison, the S&P 500 Index returned -8.8% with a volatility of 30.0% and a max drawdown of 33.9% over the same period. Additionally, PAPR showed a return of -0.7% with a volatility of 15.1% and max drawdown of 15.9%, while UAPR had a -5.8% return with a volatility of 11.8% and a max drawdown of 14.2%.
Day argued that 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.
Ben Ostrove, Senior Vice President Financial Planning, Personal CFO Solutions, believed that Defined Outcome ETFs are a better alternative to 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.
Financial advisors who are interested in learning more about defined outcome strategies can watch the webcast here on demand.