Structured Outcome ETFs to Capture Upside Potential, Limit Risks

As we consider ways to better navigate more tumultuous waters, exchange traded fund investors can consider a new sophisticated strategy that can provide uncapped upside and still help hedge against drawdowns.

In the recent webcast, Is There a Cure for Portfolio Stress? Exploring Structured Outcome Strategies, Michael Loukas, Principal and Chief Executive Officer, TrueMark Investments; Eric Metz, CIO and Portfolio Manager, SpiderRock Advisors; and Jason Weaver, Co-Founder, Weaver Consulting Group, looked at the rebounding markets that are now hovering around all-time highs but remarked upon lingering volatility. The economic forecast remains uncertain as the shadow of the coronavirus still hangs over the globe, and ongoing shutdown to quarantine Covid-19 hot spots are still making themselves known. Consequently, anxious investors may consider a so-called defined or structured outcome strategy that basically pursues more predictable results.

The strategists highlighted the importance of volatility management. Long-term returns aren’t sequential as they will experience periods of heightened oscillations, which would produce “lumpy” results. It is also equally important to put cash to work and capture long-term returns. However, investors can do so through a rules-based strategy that can keep emotions in check.

As a rules-based strategy, a structured outcome investment product has a long history of providing improved risk-adjusted returns for long-term investors. At TrueShares, they have started to roll out a suite of structured outcome ETFs with uncapped upside potential. Instead of placing a “hard cap” on the upside participation, TrueShares choose to pursue an “uncapped” approach that allows for a percentage of upside participation without a limit. This approach not only helps an investor create some downside protection, but it also preserves the long-term compounding effect of market returns.

The uncapped strategy is designed to improve “right tail” participation. Looking at the S&P 500 index rolling 1-year returns from January 1988 through June 2019, we see that the S&P 500 has produced positive returns 83% of the time, with a 0% to 17% return 47% of the time and over 17% returns 36% of the time. From 1988 through 2019, the S&P 500’s average return for the 5 best years was 33.3%.

The strategists argued that if investors were to follow a structured outcome strategy with a capped upside potential, investors would miss out on those outsized upside years, which can potentially create significant drag on long-term returns.

TrueMark Investments currently provides a provider two actively managed ETFs under its TrueShares brand, including the TrueShares Structured Outcome July ETF (JULZ) and the more recently launched TrueShares Structured Outcome August ETF (AUGZ).

Both of the ETFs’ structure allows for the potential of an asymmetric return profile. The funds utilize a “buffer protection” options strategy that seeks to provide investors with returns (before fees and expenses) that track the S&P 500 Price Index. As part of the strategy, the ETFs will provide a buffer of 8-12% on that index’s losses over the fund’s one-year investment period. In practice, the fund adviser will target the buffer at 10% of index declines over the investment period following the first day of trading while also allowing for uncapped upside participation.

The strategy is implemented through the purchase and sale of options on the S&P 500 Price Index or an ETF that tracks the S&P 500 Price Return Index. While there is no guarantee the Fund will be successful in providing these outcomes in any period, the intent of the ETFs in the series is to provide uncapped equity market upside participation with a measure of downside risk mitigation, according to TrueShares.

Financial advisors who are interested in learning more about structured outcome strategies can watch the webcast here on demand.