The Defined Outcome exchange traded fund strategy with a built-in buffer may help financial advisors better diversify client portfolios during these more troubled times.
In the recent webcast, Finding Certainty Amid the Global Pandemic – Where can you turn in Today’s Markets?, Bruce Bond, Co-Founder and CEO, Innovator ETFs, outlined the current market environment that has been propped up by central banks, but he also warned investors about the sustainability of such aggressive actions may be in the short-term. The massive stimulus measures have helped equities rebound, with the S&P 500 forward price-to-earnings hovering around 24.9% and the Shiller P/E ratio at 29.8, or near their highest levels since the tech bubble burst.
Along with pricier market valuations, Bond also underscored the brewing political risk ahead as presidential elections are right around the corner. Projections are showing an easy win for Joe Biden and the Democrats, with an expected 90% chance the Biden ticket will come out on top.
In a year where markets have taken investors for a wild ride, traditional defensive equity strategies have more or less failed in 2020. Bond pointed out that for the year-to-date through the end of July, the minimum volatility strategy returned -2.3% with a max drawdown of -33.1%, low-volatility strategy fell -7.1% with a max drowdown of -36.1%, dividend aristocrats dropped -5.0% with a -35.5% max drawdown, and defensive equity declined 1.8% with a -35.7% max drawdown, compared to the S&P 500’s positive +1.2% return and -33.9% max drawdown.
On the other hand, Graham Day, Vice President of Product and Research, Innovator ETFs, pointed out that the Defined Outcome ETFs have helped investors hold up in this more volatile year. For example, the Innovator S&P 500 Buffer ETF (BJAN) returned +1.6% with a max drawdown of -26.3% over the same period.
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 Innovators August Defined Outcome series includes the Innovator S&P 500 Buffer ETF (BAUG), Innovator S&P 500 Power Buffer ETF (PAUG) and Innovator S&P 500 Ultra Buffer ETF (UAUG), 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.
So far, Innovator ETFs have completed their first outcome period for seven series, including August, July, October, January, April and June.
Over the first outcome period ended July 31, BAUG generated a 9.08% return with a 23.49% volatility, PAUG generated a 8.14% return with a 18.01% volatility and UAUG generated a 8.33% return with a 14.29% volatility. In comparison, the S&P 500 Index rose 9.76% with a 33.76% 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.
Innovator ETFs has also expanded its Defined Outcome suite of ETFs, including the recently launched Innovator Laddered Fund of S&P 500 Power Buffer ETFs (BUFF), which provides exposure to the investment results of the Refinitiv Laddered Power Buffer Strategy Index. The Index is comprised of an equal-weight allocation to each of the 12 Innovator S&P 500 Power Buffer ETFs which provide the upside of U.S. equities, subject to caps, while buffering against the first 15% of U.S. equity losses.
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).
Financial advisors who are interested in learning more about Defined Outcome strategies can watch the webcast here on demand.