Welcome to Trallians.
I'm Joel Webber and I'm Eric Valchunis Eric.
Every once in a while we come across the thing that feels like a big deal, maybe a good thing, really good thing for investors, and this one really piqued my interest.
Yeah, there's a new category that's getting big quickly and it's really we call them the buffer ETFs. Target out target outcome is another name for them, and there's been there's dozens of them. But there was a story written by Bloomberg News that had a headline that really just caught people's attention. This story got a lot of reads and it was basically along the lines of, hey, here's a new fund that offers one downside protection.
Downside protection.
That's what I like, Yeah, everybody does. I think there's also a too good to be true element to it as well, and so clearly you're going to click on that and say what's going on here? And I think it's just excuse to get into the buffer funds and what they do and the audience they serve. I just looked recently they've taken in over five billion this year. That's a twenty three percent organic growth rate. That's about triple the ETF industry as a whole. They're now up
to about thirty billion dollars. And this search I did isn't even catching them all. It's only the ones with buffer in the name. But anyway, it's a whole big category. Black Rocks jumped in and so I think it's a good time to revisit this, in particular this one that has one hundred percent downside protection.
Joining us on this episode. We're gonna have Bruce Bond, the CEO and founder of Innovator Capitol Management, as well as Graham Day, the chief investment officer, and we're going to talk about the Innovator equity defined protection ETF with the ticker t Jewel, this time on trillions no downside Bruce, Graham, Welcome to the Trillions.
Great to be here, guys, really happy to be here.
Thanks for having us guys.
Okay, Bruce, I'm gonna start with you. Do you prefer the term buffer ETF or defined outcome?
We prefer the term defined outcome to cover the whole category of these defined outcome type ETFs, which includes buffers, accelerated, income based and now you know the defined protection ETFs as well, so we look at defined outcome kind of as an umbrella, and buffers is a category within that.
Okay, so is this too good to be true? I mean I put money in and then a little bit later, like chaos unfolds. There's no downside. I only get upside. That seems like there's a catch.
Yeah, well there really is no catch. It is a great product. It took us a while to get it out, and I think to be able to tell people that you can now participate in the equity markets with no downside risk and with upside now you are giving a couple things up.
One of the Oh there's the catch, okay, yeah, what do I give up?
Yeah?
So I guess, yeah, I mean catch you're giving up the dividend, so you don't receive the dividend, and you're also giving up the upside over two years above sixteen point six percent, you know, so any performance over sixteen and a half percent, let's say you're giving that up. So you're giving up the dividend and that and so those are the gives up. So there's nothing free within
the investing world, as we all know. But to be able to understand you don't have downside, but you get that amount of upside is a huge benefit to many many people in the investing world.
Do you keep whatever's above sixteen percent.
No, we don't keep it. What happens is we take the dividend and we buy part of the options with the dividend. But then we don't quite have enough money just using the dividend to buy the options, and so we have to sell a call and we determine where the cap is by how much money we have to raise in order to finance this package. We want the options package to be a zero cost package for investors, and so we set the cap there. So where's really We're selling off the upside to get a little more
money to finance the package. And that's really what happens, and the way we're able to give you the downside protection and give you a certain amount of the upside.
Gram Let's come in here. That was a deep endo the swimming pool. Can you break that down a little bit before.
Me, guys, It's really simple. All we're doing is, as Bruce was saying, in giving up unlimited upside potential, you're exchanging that for the certainty of having a one hundred percent buffer and if you think about long term the ability to get some equity upside in today's market where it's at all time highs, where people are really scared
of what do I do. Do I just keep giving my money to the banks and letting them sit in the deposits, or do I invest in the markets but also have that one hundred percent protection and so to have a sixteen percent upside over two years, history suggests that's a better spot to be than if you were just sitting on the sidelines in cash.
Okay, there's a lot of questions on where this fits into portfolio, who it's for, But before we get there, just while we're on the product itself, just explain as best you can what you're doing in the portfolio. You talked about selling the upside. What kind of options are you using, how often are you changing the options, what kind of options are they?
It's really simple at the end of the day, these are three options positions that we're holding. And the beauty of the defined outcome ets is that once that basket of options is set, it is fixed for the entirety of the outcome period. There's no active management, there's no one pulling levers behind the curtain. That's what gives all
investors a defined outcome. And so we start with a deepend the money call on the S and P five hundred that gives you the long exposure to the S and P five hundred, and then, as Bruce mentioned, we use the implied dividend inside that deep in the money call to help fund the at the money put so and at the money put is what gives you that
one hundred percent downside protection. Now the dividend is not enough to cover that cost of that protection, and so that's where we go out and we put the market makers on the option side into competition and tell them, look, we need to finance this downside protection. At what level can we sell a call the highest level possible to finance the remainder of the cost of the protection. In this case, it was sixteen point six percent. We sell
that call. That's what gives the cap to investors, but it's also what helps finance that at the money put.
When these products come out they sometimes have dates around them. Is this is this one T jewel, which by the way, sounds like a like a rapper. It's a cool name, it's like a It just kind of rolls off the tongue. Whoever got that took your good job?
Do you?
These are designed to start on the day that they come out, kind of right. It's not a lot of other ETFs, including leveraged the leverage resets every day. This is a little different. Can you just explain how the timing works.
Yeah, and Eric, maybe even before we do that, we didn't really talk about, Okay, what is this product and how does it work a little bit, you know, just kind of the overview for everyone. Yeah, basically, t jewel It was listed on the first of July, and you have to hold this product for two years in order
to get the sixteen point six percent. So you buy that and then over a two year period, if the market is up twenty percent, you get sixteen point six If the market is up ten percent, you just get ten percent, So you get all the way up to sixteen point six percent. Now, the beauty of this product is that you can't lose money on the downside if you buy day one. So if the market's down five percent, you don't lose. If it's down ten percent, you don't lose.
If it's down twenty percent from July first, you don't lose any money, and I think that's what people are so excited about. So I just want to make sure everybody understands this. Although what Graham's talking about with the call bonds, and I mean with the calls and the options and all this stuff, it's not kind of confusing for some people. What they really need to do is look at this at face value. You buy it on the first of July, or you can really buy it anytime.
If you look at the website, you get the upside of the market up to sixteen and a half percent and you have no risk on the downside. But you have to stay in it for two years in order to receive that. And that's really what people are so excited about. So storry to interrupt. I just want to make sure everybody understood where we were.
Do people religiously buy on the first day and then nobody buys it? Or do you find some people come into these products after a couple months or a year. Is there a benefit to buying it a year in let's say the market is down or up, like, is there a trading crowd that gets into this even if they're not sort of maybe the older investor looking to protect their wealth and they go in day one, Is there any thing you can do with this after day one?
Eric? Yes. For the most part, though, we do find advisors like to buy at the very beginning of the outcome period. They like to understand that they have the full downside buffer, they have the full upside cap. And I think one of the things that we realized early on when we brought these products back in twenty eighteen was that what I alluded to before, when you look at the defined outcome, that package of options is fixed
for the entirety of the outcome period. That means it's someone who buys, say six months into an outcome period, they can still achieve a defined outcome. Now, their outcome may look a little different. The price of the underline and the options have moved, so the price of the ETF has moved. But now if they had a one year out from pater to start and they're six months in, now they have a unique six month defined outcome that
they can achieve. And so we've seen a growing number of advisors who have grown comfortable with using these ets. Maybe they started buying at the very beginning of the outcome period, but now they look and realize, well, this payoff is really intriguing to me and my clients for
this next six months. In terms of the trading community, I think there's definitely some and we've been talking with some institutions that have used options in sophisticated ways, but the ability to access a package of options via single ETF is far more efficient for them than it is to recreate the options package, trade those individual option legs tax full event every single time you're managing this portfolio options.
And so we're seeing the application of these ets extending from simply using day one the people using throughout the outcome period, to now getting some of these institutions involved as well.
One other thing I would add to you guys too, just to think about. So let's say you bought in day one and then at a at the year point, let's say the market's up ten or fifteen percent and the ETF's up eight percent. You know it's not going to be up as much as the EGF. Listeners need to understand that it's going to trail a little because there's a lot of time value in there. Only at the very end of the outcome period you're going to get one to one on the upside with the SMP.
And but just think about anytime you could use this if the market's up, and if the ETF is up, you can roll it into a new one at the reset time and you lock in whatever that gain is. You can't lose it after that, you know, so you just step up, you continue to lock your gains in. I can see a lot of people using it like that into the future if the market's up.
And so this to me, especially after last year, because sometimes I see a product like this and I'm like, why not just like diversify old school, have some treasuries, have some stocks. But after last year, treasuries and stocks both went down a lot, And so how big of an opening did that create? Because I get the appeal here, right, You've got older investors especially who have a lot of gains.
I was going to say, like a retiree.
This just seems like, yeah, what is the average age in these funds? Got to be like seventy? I mean I can't I mean, you wouldn't use this if you're thirty years old, right.
Yeah, it's hard to track. But you know one other thing, you know, because they're ETOs, we don't know everybody that owns them. But the thing to remember is that like seventy five percent of investable assets are in pre retirement and retirement accounts. That's where most of the money is located. And so those people that are getting ready are looking at retirement, are almost in retirement or saying I don't want to put my money at risk, and Eric, you're right.
Typically you would say, you know, let's say you get a windfall, you get a million blocks, and you're like, okay, well I need to buy a little bond. I got to buy a little You don't have to think about that anymore.
If you don't want to.
You can just buy this and say, Okay, I get all the upside up to sixteen percent over the next couple of years. I got no risk on the downside. Why, I think about what I want to do, and I think those are the options that this gives people that they didn't have access to before. One other thing, Eric, you can appreciate this. The SEC has never approved the name protection and the name of any other ETF until now. It's called defined protection ETFs that innovators bringing. That's a
big deal. It tells you a lot about how the SEC has seen them as well.
How were those conversations. Did it take a lot to convince them, because they are pretty conservative when it comes to putting certain words in the name.
Eric, you know, really know. In fact, what you'll find when you bring a lot of products to market is that the SEC has a significant amount of input when it comes to the final name, and so you are it's almost a collaboration with them. And so we were actually very surprised that this was one of the iterations
that they had come back to us with. And so I think to Bruce's point, that kind of reaffirms that they understand the value add proposition of this ETF and it being the first ETF that for this outcome period is going to provide investors what they have one hundred percent buffer on the downside.
Okay, so here's the question that I really want to know. What took so long?
Yeah?
Exactly. Well, you know, if good things take time, y'all, you know that, so it uh, yeah, it took a while. And you know, I think in our approach to the business, what we do is we look at the market and we say what do people need, what do they really want? What are they using today that we might be able to do better. And so if you look at the annuity business, this is why do people buy annuities for
the insurance. They want to know they're not going to lose that money, right, and so this provides that to them. Or even market link CDs that banks issue, why do people buy those because they want to know they can't lose money. Well, guess what's insurance companies? I mean, heaven forbid, we have a huge environmental calamity in these insurance companies. So of them go down or something, I mean, it's a real concern on people's minds these days. These do
not have credit risk. You don't have to wonder what they're invested in. You can see what's in there and it's not tax will when it resets, and so you don't have the credit risk, you don't have the tax risk. You just let it go into the future and you know when you sell it you have to pay the tax that's there, but you don't have to pay the tax until you sell it.
I remember looking through some teachers retirement plans with some of variable annuities, and the fees were ridiculous. I mean, these teachers were getting gouged in my opinion, Can you talk a little bit about that industry versus the fees on this and what the savings is.
Like, Eric, I think that's you kind of hit the nail on the head when you look at the way the ETF industry has evolved. It's been taking these exposures that have been less liquid, more expensive, less tax efficient, and making them accessible to all investors at the same price. And that price is often significantly lower than what you see in the insurance market. And so that's really no
different of what we've done here with Tjewel. We've taken a look at an area of the market where we were looking at the numbers twenty twenty two eighty billion dollars of fixed index annuity sales. So that's products in the insurance market that give you some of the equity upside, but give you that principle protection on the downside. The problem is the fees are high. They tend to be five six years in duration. Your money is locked up, you want to get out after a year, you're going
to have a hefty surrender charge. And that doesn't even take in consideration the tax implications of those structures. And again the ETF has shown the power of deferring taxes and what that can do for the end investor. You add that, uh, you know, you add that dynamic to this ETF, the tj U L there's a massive value added potential that investors can unlock because when you look at market link CDs, when you look at insurance products, market link CDs have what's called phantom income. Now that's
a fancy term for you. Essentially are going to be paying taxes along the way on gains that you have not yet received at an ordinary income rate. You look at fixed indextinuities. Once those policies come due in five or six years, you're going to be paying ordinary income taxes on gains the ETF you defer those gains. You choose if you want to sell after a year in a day, it's going to be long term cap gains.
And so you think about the tax alpha potential that the ETF wrapper delivers on top of the liquidity, on top of the fact that there's no credit risk, on top of the fact that there's no surrender charges. There's a huge benefit that we think we are giving to the end investor. And there's a huge market for this type of participation in the market. But having that known goffer.
In place, Okay, strong pitch, I think I understand the product a little bit better. Now, what could go wrong? What could make me not get the protection?
Yeah, of March twenty twenty, or like a black Swan event, or I don't know, what would make me.
There's there's none of Yeah, there's yeah, Joel, It's I mean, it's a great question. And again a lot of people will say this just sounds too good to be true. That the ETF owns options. Those options are exchange traded options. They are guaranteed for settlement by the OCC. The OCC has been identified by the US government as a too important to fail institution, and so that's your counterparty when it comes to the underlying options. The OCC has been
around since the seventies. They have never defaulted on any of their obligations. So that's your counterparty. Now obviously contrasts that to a bank or insurance company. We have found investors saying we would much rather prefer having our counter party be the OCC, as opposed to an insurance company or a bank.
So what can go wrong? Let me let me run at that real quick guys, I don't mean to jump in, but so really on the downside, you own to put one hundred percent put at the money, can't lose money if the market goes down. To remember, these are spy options, most liquid options in the world right, so unbelievably adopted a deep pool of options, so you really have no risk there. So the only risk someone really has if the market goes up significantly above the cap.
That's it.
That's your risk. And we find most people that are saying, Okay, I'm going to get one hundred percent downside protection. I'm good with sixteen. I can live with that. I'm happy with that, and I don't need more than that, and I'm willing to give up what is above that to know I can't lose going down. That's that's really your risk.
And that's sixty percent over two years, sixteen over two years. What's interesting is the S and P annually I think going back fifty one hundred years returns about eight point five nine percent, So it's almost the average return of the S and P. So I get it.
I mean it's actually to that end. You guys must have done a lot of back testing on this, like what did you learn from that process.
Yeah, I think you know what we found is and you look at today's market and you've got a JP Morgan in their second half outlook, they said that twenty five to thirty percent of their client's in bestible assets in cash. And I think that people have had this idea of gosh, cash is paying me four percent. Now, what a great place to be. But history shows that you do not want to overweight cash in your portfolio. Look what happened in twenty twenty three. People experience all
that downside. They moved to cash markets. The shots on nineteen percent, it's on a tear. And even you look at bonds, people were talking about bonds generational opportunities. Core bonds are up two percent, two and a half percent. That doesn't sound like a generational opportunity to be And so that's that's the beauty of these products is equity exposure is where where the where it happens in terms
of the portfolio. That's where you get the bulk of your returns, especially now that interest rates have normalized.
Well, that was what I was going to say, Like when I asked that question of like what took so long? It really was interest rates, right, we needed that to go up for strategy, right, yeah.
Yeah, yeah, you know, and Joel, that's a that's a fair point. And one of the reasons why it took a while. And again you look at the insurance market, the reason why they brought partially protected products is because it was too expensive to bring products that had one hundred percent downside protection. That was a function of interest rates. And so as interest rates have risen, that has really led to this new proliferation of insurance products that give
you equity upside with the full downside protection. And now we can offer that in the ef rapper. But in terms of back testing looking we have seen that this type of strategy significantly outperforms cash, which you would expect. Again, people think, well, gosh, I'm guaranteed to get four percent of my money market fund. Why would I give that up for potentially getting sixteen point six percent over two years?
And that's the hurdle that people can't get over. But that's why that these strategies actually do better than if you're just sitting in cash. And you, guys, Eric, you pointed out eight percent a year, eight nine percent a year over fifty years. That's the average an you'll return. You look over two year time frames, the SMP is positive ninety percent of those times, and the average return in positive markets is thirty two percent over two years.
So the math and the probability history tells you that this is a better spot to be in than simply sitting in bonds or on the side sidelines in cash. And by my dad, the money market funds are four percent. I'm not getting paid that at my JP Morgan Chase account. And that's where a lot of people have moved to. They've moved from these regional banks. They've moved they put their money in these big banks that are flush with cash, that are still paying ten twenty bases points on deposits.
And so again this is a tool to get that money off the sidelines and into the market.
Now, remember that's pre tax. I mean, I got to remind people that all the time they try to compare this to that, you know, I mean, if you did an after tax comparison, like buying a one year or to your T bill, you need really about eleven percent after you know, pre tax, So after tax you hit about eight percent. Where we're saying we're going.
To be.
All right, Let's talk a little bit about the size of this market. Because you guys were first I got to get you credit, and I've ember seeing these roll out and go. These are just probably too complex for advisors. I was wrong. I'm not wrong much, and I.
Really admit it when I am.
I was wrong on this. This was this category is ballooning. Then you had a bunch of copycats come after you. First Trust now Blackrock, now you know Blackrock. First Trust is really good at selling ETFs. Blackrock is Blackrock. What if this category goes to one hundred billion, two hundred billion, does that change the expensiveness of buying that insurance and or could the trade get too crowded? Is there any risk to the size of this.
I think one of the things we've done is we've tried to stay in or we are in, and I think most of the others as well, are in the most liquid pools. You know, we're really not looking to go into thinly traded areas. Like I said, you know the spy options ESPX options, that pool is the most liquid pool in the world. You know, we're talking in
the multiples of billions of dollars daily. So I don't think, really, we also have something you know, in the queues, in the small cap and EFA and emerging markets, you know, for the buffers, So we don't think so we you know, these options they trade an enormous size, so we don't think it's going to be an issue. And I think we have the flexibility to adjust, you know, where the trades occur. So we think we'll be fine for quite a while. Eric.
What I would say too, is you look at how much is traded in SPY and SPX options you're talking about. There's seven eight nine trillion dollars of open interest. There's almost eight hundred, nine hundred billion dollars traded every single day in these options. And so again to Bruce's point, we're bringing these exposures on the most liquid markets. Now. The beauty of what we've done, too, is we've diversified that liquidity across all of our series of products. We're
not rolling all the options at one time. That's we have monthly series with buffers of nine fifteen thirty percent. We have buffer here of one hundred percent on teedool, but we're not rolling all these at the same time, and that spreads out the liquidity risk. Now we will say, you know, we heard through the Grape find there was a there's a large mutual fund that's issued by JP Morgan.
It's a great fund. They were rolling twenty billion dollars of SMP options every single quarter, and we've noted that they closed that fund to new investors and opened up similar to what Innovator's done a few other series. And I think that was to diversify, you know, some liquidity if you want to call it risk, or that they saw that their calfs that they were getting were maybe lower because the amount of size and risk that they were putting on the market at a one time. But
that was at twenty billion dollars. We have almost one hundred to find out comyts and so that gives us a huge opportunity to continue to scale the business. I think our largest ETF is just knocking on the door of a billion dollars. So we feel like we have a long ways to go.
And just getting back to Blackrock, I know they came out there's are a little cheaper than the rest of the group their Blackrock. Do they worry you at all? What'd you think when you saw that filing?
I don't think we were surprised, you know, we we knew that they were very interested in the space. We are really pleased to see them talking about talking a lot like how we talk about investors and how much risk investors should be willing to take or want to take in the markets. And so really it's a real credibility booster for us, for you know, the largest asset manager in the world to come in and say, you know what, this makes a lot of sense for investors,
and we think they will continue to do this. But as you said, JP, Morgan and the like you know, have all come into the space saying yeah, Ali once know to do products along these lines because they really see the value.
All right, last question, Graham, what is your favorite ETF ticker other than any of your own?
That's a that's a good one. Oh, I can't think of one off the top of my head.
It's your next. But we'll let Graham kind of be quiet here for a second. Will he racks his brain?
Well, I'm a big tech investor. Uh so, uh, you know, I'm way overweighted into tech, and so probably something along the lines of a r KK.
I'll take arc from Bruce. I think that's an out of the box. I wasn't expecting it, Graham.
Would you come up.
With yeah, you know what, guys, I would probably have to say cows the fun from Pacer.
How did that go down with move head to head cows versus.
Move Cole's mood, Yeah, exactly, moves.
In all top par That's the first time someone pick cows.
But that is a good one, all right, Graham Bruce, thanks so much for joining us on Trillions.
Thanks for having us guys.
Thanks for listening to Trillions. Until next time. You can find us on the Bloomberg Terminal, Bloomberg dot com, Apple Podcasts, Spotify, or wherever else.
You'd like to listen. We'd love to hear from you. We're on Twitter, I'm at Joel Webber Show. He's at Eric Bauchuns. This episode of Trillions was produced by Magnus Hendrickson.
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