Innovator bets on tracker funds with downside protection and defined outcomes to make structured products accessible.
Following the launch of the Innovator S&P 500 Defined Outcome ETFs - July Series on Cboe on August 8, 2018, SRP spoke to Bruce Bond (pictured), co-founder & CEO at Innovator Capital Management, and Matt Kaufman (below), principal and senior director, product development and marketing at Milliman Financial Risk Management - the fund sub-advisor.
The Innovator Defined Outcome ETFs will track the performance of the S&P 500 Price Return Index (S&P 500) to a cap, with downside protection levels of 9%, 15%, or 30% over an outcome period of approximately one year, at which point each ETF will reset. Innovator believes that the exchange-traded fund (ETF) wrapper can make structured products more accessible while avoiding many of the downfalls associated with structured notes.
What would you highlight about the new products? What is the appeal for retail investors?
Bond: This is the first time investors will be able to access structured outcomes through an ETF vehicle that offers defined downside protection levels; exposures to S&P 500 upside performance; a low cost, flexible, liquid, and transparent product with no credit risk, which resets annually and can be held indefinitely, according to Bond.
These are the first of their kind in the ETF market, [and] we don't know of any other firm offering defined outcome products so there are no direct competitors in this space. However, there are a number of ETFs designed to protect investors from sustained loss during market downturns, whether through asset allocation, tactical movements, market timing, or hedging strategies, many of which tend to break down as assets become highly correlated (as is often the case when markets are falling).
We believe that investors will be attracted to these downside protection ETFs for two reasons. [Firstly, they will know] investment outcomes before they invest and, [secondly the] downside buffer. Both advisers and retail investors can appreciate having more certainty in their investments as opposed to having uncertain exposures (and outcomes) in the market, as is the case with traditional approaches.
Are these new tracker funds competition or complement to structured notes?
Bond: From our experience in the financial product markets, we are very familiar with structured products and ETFs. We do recognise that structured products can add value to an investor's portfolio. The problem we see with structured products in the US is that a significant number of advisers do not have access to them, and others do not use them because of issues they see with the structured product wrapper (e.g., relatively low liquidity, lack of transparency, high fees, counterparty risk). By offering a similar strategy via the ETF wrapper, we are making them much more accessible, and avoiding or eliminating many of the downfalls often associated with structured products. The other focus for us is to provide an easy-to-understand product based on a simple strategy. In our view, all of this makes for a very interesting proposition.
We were surprised no one introduced these before. We saw an opportunity to be creative with Cboe's Flex options and provide an ETF with a defined outcome. This is very different to ETFs simply providing market participation, and opens up new opportunities for investing via the ETF vehicle, which we think is superior to the other alternatives.
How did the decision to provide downside protection on an ETF came about?
Kaufman: "We researched the structured note marketplace, as well as the potential upside growth potential that could be offered based on various protection (or "buffer") levels, and believe that these protection levels (9%, 15%, and 30%) have unique risk/return characteristics that may benefit a wide range of investors.
By offering these protection levels we can provide a more defined risk tolerance for people. They will no longer have to assume a risk tolerance level based on a 20 or 30-year history of the stock market. Investors can now know (prior to investing) what amount of their investment is truly at risk, and obtain those outcome parameters over a set timeframe. The defined outcome strategies obtain each protection level by layering multiple Flex options positions, which have different strike prices but the same expiration date.
This layering approach allows the fund to establish exposure to a market (i.e. S&P 500), a buffer level, and an upside maximum growth limit (the cap), all over an outcome period (the roll date of the options). The market exposure, buffer level and outcome period do not change, but the cap will vary at the beginning of each outcome period based on market conditions at that time. Because these are exchange traded, we are effectively bringing liquidity into the structured outcome space. We think investors will appreciate having an intraday price at which they can buy or sell a defined outcome product."
Why the S&P 500 index as the underlying for this new series? Are you planning to offer exposure to other underlying assets?
Bond: There are a number of considerations when choosing an index you want to obtain exposure to. We chose the S&P 500 because it has the most liquid options market tied to it, and because investors are aware of this index; they are comfortable investing in it as a core asset. We think it's the right place to start, but there are other potential broad indexes we will consider as we look forward.
Why do you think these products will resonate with advisers and retail investors?
Bond: The industry is moving away from products loaded with high fees and sales charges, especially within larger accounts. This means that a significant amount of advisers providing retirement planning and asset allocation are seeking alternative investment approaches that offer true downside protection, while also offering upside market exposure. Our goal right now is to educate the advisers about the value of such products within a portfolio and provide them with a regular offering aimed at different risk profiles. We expect other firms to follow if the products gain traction (and assets). We are doing the missionary work. We think this will become a core product in the advisory market.
In 2017, the US market saw the revival of unit investment trusts (UITs) with a number of market players developing structured target outcome funds. This included Olden Lane Securities' distribution agreement with JVB Financial Group; the launch of Alaia Capital's Market-Linked Trust platform and a distribution partnership with Incapital; as well as a number of products launched by Cboe Vest following its initial Cboe S&P 500 Buffer Protect Index Balanced Series.
"We have seen a number of firms such as Alaia Capital, JVB Financial, and Cboe Vest doing similar strategies using the UIT wrapper," said a senior market source. "The UIT is similar to a structured product as it's traded on a desk, and is not as liquid as an ETF. It will be interesting to see if these products get traction. If they're successful others will follow."
Related stories:
Olden Lane enters structured funds distribution partnership
US investment firm sues exchange in trade secrets structured notes case
CBOE Vest adds leverage to S&P 500 range
Incapital and Alaia enter distribution partnership to deliver market-linked UITs to advisors
US fund manager acquires 'next generation' of structured notes