Defined Outcome ETFs Could Help Investors Face Bull Run Challenges

Buffer exchange traded fund strategies can help investors remain fully invested in the markets up to a cap, with built-in buffers to help manage downside risks.

In the recent webcast, How to Stay Invested While Seeking to Buffer Against Risk In 2022, Innovator ETFs’ co-founder and CEO, Bruce Bond, warned that there are no shortage of problems and issues that financial advisors face in today’s extended record-setting bull run with a rising interest outlook ahead. Looking at the U.S. markets, the S&P 500 is trading at elevated valuations and is very expensive based on the current Shiller P/E of 39.

“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. According to State Street research, when the Shiller P/E is greater than 30, there has never been a subsequent 10-year return environment greater than 10%,” Bond said.

Specifically, Bond pointed out that when the starting P/E was greater than 38, the average subsequent 12-month return was -2.4%, and the average subsequent 36-month return was -10.1%. If we take historical data as a guide, the elevated prices today could contribute to greater risk of loss with a lower probability of big gains.

Meanwhile, after a multi-decade bond rally with interest rates pushing toward zero, we are finally looking at rising interest rates ahead. Bonds are currently very expensive when compared to historical levels. Furthermore, the elevated inflationary pressures challenge real yields.

“We believe that the risk facing both equities and bonds is all-time highs. This poses a challenge for how advisors are allocating clients’ money today,” Bond added.

In this type of environment, vice president of product and research, Graham Day, highlighted the Innovator Defined Outcome ETFs, which offer defined return and risk parameters, easy access, ample liquidity, low cost, transparency, and tax efficiency.

Day also highlighted Innovator’s Accelerated ETF suite as a means for investors to enhance their market exposure in today’s more challenging market environment. The Accelerated ETFs seek outperformance and prepare investors for low-to-moderate future returns. They come with a capped upside, 2x to 3x upside potential but a 1x downside risk.

For financial advisors, the 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.

For example, investors can look to the Innovator US Equity Accelerated ETF – April (XDAP), the Innovator US Equity Accelerated 9 Buffer ETF – April (XBAP), the Innovator US Equity Accelerated ETF – Quarterly (XDSQ), and the Innovator Growth-100 Accelerated ETF – Quarterly (XDQQ).

XDAP will seek to provide investors with double the upside performance of the SPDR S&P 500 ETF Trust (SPY), to a cap, with approximately single exposure to SPY on the downside, over a one-year outcome period.

XBAP 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.

XDSQ 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.

XDQQ will seek to provide investors with triple the upside performance of SPY, to a cap, with approximately single exposure to SPY on the downside, over a one-year outcome period.

The latest January series to come out includes the Innovator U.S. Equity Accelerated ETF (XDJA), the Innovator U.S. Equity Accelerated 9 Buffer ETF (XBJA), the Innovator U.S. Equity Accelerated Plus ETF (XTJA) , and the Innovator Growth Accelerated Plus ETF (QTJA).

Looking at how these strategies perform in various market conditions, investors should expect Accelerated ETFs to hit performance cap finishes below the reference asset during strong up markets, or they can hit performance caps above the reference asset in normal up-market conditions. During down-market conditions, the strategy matches the performance of the reference asset.

According to the strategists, an 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 their expected tax efficiency, can create a situation where an investor can defer any gains until they choose to sell. Traditional long equity exposure often has a portion of its total return derived from taxable income. As uncertainty in the market grows, communicating a range of potential outcomes before investing can increase clients’ value.

Financial advisors who are interested in learning more about the buffer strategy can watch the webcast here on demand.