The inventor’s corner: Cboe Vest on outcome defined investing

SRP spoke with the chief executive officer of Cboe Vest Karan Sood (pictured) to discuss the advent of outcome defined structures, market highlights, and  his outlook for 2021.

In 2016, we launched the first-ever defined outcome buffer fund, as a mutual fund

How did CBOE Vest come to live? Why the focus on buffered ETFs?

Sood: We invented defined outcome investing in 2012. At the time, we were motivated to find a way to offer the benefits of structured notes (ie targeted payoffs) without their liquidity issues and credit risk, delivered to investors in a registered fund wrapper while using exchange-listed derivatives. No one had ever done this before the way we intended to do. We invented the way to do this using exchange-listed FLEX options, and applied for a patent in 2012. Subsequently, we built the index methodology, industry partnerships and infrastructure to bring this concept to life.

In 2016, we launched the first-ever defined outcome buffer fund, as a mutual fund. We have been busy since, following up with offerings in managed accounts, unit investment trusts, collective investment trusts and mutual funds – launched in partnership with select asset managers. Unit investment trusts are unmanaged vehicles, which like structured notes have an inception and termination date. Mutual funds and ETFs are managed vehicles that provide persistently rolling exposure. Collective investment trusts are specialised vehicles for retirement. And in our managed account offerings, we give institutional investors the ability to access target outcomes customised to their specific needs. The buffer strategy is the most topical strategy currently, but we also offer access to other payoffs, such as the enhanced upside participation payoff.

How would you describe the competitive landscape in the outcome defined space?

Sood: As you know, since our inaugural filings and launches, we have attracted competitive interest in this space. Today there are competitors offering defined outcome investments in unit investment trusts and exchange-traded funds that utilize the same FLEX options-based investment strategies as us.

We have not always been the first in particular product categories, but we have been the most deliberate. As an example, we waited for the passage of a specific exchange rule that allowed options-based ETFs to utilise the same in-kind redemption process that provides tax-efficiency to all other ETFs, while competitors rushed to launch their versions. This deliberation has been rewarding – today we manage the largest buffer ETF.

How are you growing CBOE Vest’s offering?

Sood: We have played a pioneering role in establishing this product category, and continue to lead the industry in terms of the breadth and scope of the applications. From our initial launch in 2016, we have made defined outcome investments available in additional delivery vehicles each successive year. This includes customised managed accounts in 2017, followed by unit investment trusts and collective investment trusts in 2018-19, and ETFs more recently.

We are not about predicting or timing the market – we are about building strategies and products

As we have increased the scope of the offerings, the business has increased each year since 2016.

Interestingly though, when we started in 2012, we didn’t plan to get into the product business. Initially, our goal was to offer the concept as software, so that investors could just click and get their own defined outcome directly in their account.

What is CBOE Vest’s edge in the market?

Sood: The highlight for me is that we are the creators of this burgeoning space. This is our sole focus, and we are trailblazing the path to building it out. We are deliberate about what we do, and I believe we will continue to consolidate our leadership in the space. We are committed to broadening the access to this innovative and novel style of investing by making more payoffs available in more delivery vehicles.  

Our original premise was based on utilising the higher governance standards of the registered fund and investor-friendly aspects of the Investment Company Act and marrying those with the high integrity of the exchange-listed options (as opposed to over-the-counter options). Our culture, and that of our asset management partners, is to continue in that tradition of building products to high standards and not cutting any corners in a rush to get to market. This will be appreciated over time and will be a competitive strength.

What is the appeal of defined outcome products in the context of near-zero rates and market uncertainty?

Sood: The role of bonds as a counterbalance to equities from a risk mitigation perspective is rather challenged in the current environment. There is a limit to how much bonds can produce in terms of returns due to there being a lower bound to interest rates. So, the diversification potential of bonds is compromised.

Defined outcome investments do not suffer from that limitation since they rely on a defined level of downside protection to provide risk mitigation. Defined outcome investments offer a risk management complement to the traditional asset allocation approach and are a welcome addition in most portfolios.

Are there any pitfalls with buffered ETFs such as market timing, tracking error, liquidity etc?

Sood: We are not about predicting or timing the market – we are about building strategies and products with defined payoffs that enable investors to achieve their investment objectives regardless or in spite of the market. So, whether the market is up, down, erratic or sideways in 2021 and beyond, we will be helping investors seeking enhanced income, protection, volatility control or enhanced growth. 

We're in the first inning when it concerns defined outcome investing, and we have a long way to go. The notion that these products were being delivered on the back of banks’ balance sheets, or an insurance companies’ general accounts led them to have some degree of success. It also constrained them from going to places with higher governance standards around credit, liquidity and transparency. For example, it would not be prudent to put investments such as structured notes with concentrated credit risk in retirement accounts.

Over the long term, I believe that the market for defined outcome investments has the potential to be bigger than bank-issued products.