November 5, 2024 • 32 mins
Buffer ETFs, which use options to limit losses and offer upside potential, have taken in around $10 billion in new flows this year as their popularity grows. On this episode of Inside Active, host David Cohne, mutual fund and active-management analyst with Bloomberg Intelligence, along with co-host James Seyffart, a BI ETF analyst, spoke with Burke Ashenden, director of capital markets at Innovator ETFs, about the rise of defined-outcome ETFs. They examine the unique features that set them apart from traditional investment funds, and how they provide risk-managed exposure. They also discussed how the underlying management of these products works.
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Speaker 1 (00:14):
Welcome to Inside Active, a podcast about active managers that
goes beyond sound bites and headlines and looks deeper into
their processes, challenges, and philosophies and security selection. I'm David Cohne,
I lead mutual fund and active Research at Bloomberg Intelligence.
Today my co host is James Seyffert, ETF, analyst at
Bloomberg Intelligence. James, thank you for joining me today.
Speaker 2 (00:37):
Yeah, happy to be back, David, thank you for having me.
Speaker 1 (00:39):
So, James, we've talked about Buffer ETFs in the past,
but how are they doing in terms of flows this year?
Speaker 2 (00:47):
Yeah?
Speaker 3 (00:47):
So, I mean I think of Buffer's ETFs in this
like broader category of like these you know a lot
of derivative based products that are either like seeking some
sort of income or some sort of protection or some
sort of accelerated ye. But within Buffer specifically, that's probably
the most successful within that deridit of landscape. And I
think they've taken in a little over ten billion this year.
(01:09):
I mean, if you look at the category, I mean,
it didn't exist a few years ago and now we're
looking I consider it like a fifty billion dollar category
for buffers overall. So no matter how you slice it
like this has been a smashing success and honestly like
this is something that our team has been looking at
and covering for a long time now. But yeah, this
(01:29):
this is finding its home in the ETF industry and
it's doing really well.
Speaker 1 (01:33):
Nice well. I think it'd be a great time to
bring on our guests. We'd like to welcome Burke Ashington
to the podcast. Burke is director of Capital Markets at
Innovator ETFs. Burke, thanks for joining us today.
Speaker 4 (01:45):
Great to be here, guys, James David, it's pleasure.
Speaker 1 (01:47):
So Burt, can you tell us a little bit about
your career and how you got started in the ETF industry.
Speaker 4 (01:52):
Yeah, happy to I've known James and the ETF team
at Bloomberg for a few years here. Before my tenure
at Innovator, started on a trade desk, so it was
CASEG Holdings. It then became Virtuo Financial, an ETF market
making firm, so cut my teeth on the trading desk.
I love that fast paced environment, competitive atmosphere. And you know,
(02:16):
Virtuo Financial specializes in ETF trading, so our desk did
a lot of arbitrage ETF trading, ETF block trading, so
more of a technical start, I would say, on the
ETF side, and it kind of gave me a background
grounded in ETF pricing, how the ETFs are structured, but
also got a little bit of a glimpse into how
to launch an ETF because you're the l m M
or lead market maker and typically provided c capital for
(02:40):
a lot of ETFs that were brought to market. So
after Virtuo Financial, I kind of went over to the
dark side, as we like to say, the ETF issuer side,
and went to Direction ETFs and that's where I got
my first taste of derivatives within the ETF rapper. Direction
specializes in the leveraged and inverse funds, a really interesting firm.
(03:01):
I'm on the forefront of innovation there, but focus more
on the tactical trading crowd. But you know, I saw
there kind of the writing on the wall that derivatives
in the ETF rapper were still in the early stages.
You could use them to leverage returns accelerate your upside,
but you could also use them to insert protection in
the ETF rapper. So you know, from there I got
(03:24):
put in touch with more of a startup ETF firm
innovator Capital Management was the name. They were based in Wheaton, Illinois.
I was looking for an earlier stage ETF firm and
got put in touch with them and ended up being
sort of the first product hire undergrad Day are now
CIO and we can talk more about Innovator in a second.
(03:44):
But we're doing some pretty disruptive stuff over here.
Speaker 1 (03:48):
Great. Well, actually, let's you know, as you talked, you
mentioned Innovator. What's the innovator story?
Speaker 4 (03:54):
Yeah, Innovator has a really interesting story. You know, Bruce
Bond and John Southard are found So Bruce Bond and
John Southard, we're the original founders of Power Shares ETF
ETF's trail breke blazers in the ETF market. They really
pioneered the segments like smart, Beta, the matic, even household
names like the cues, so they were first to market
(04:17):
with a lot of those names. They sold that business
to Investo around two thousand and six and they retired.
They went into retirement pseudo retirements, and one of them
was pitched a structured note in retirements, and that's where
the story gets really interesting. The light bulb sort of
went off and they said, you know what, there may
be a better way to package this risk managed exposure
(04:40):
that we see in structured notes ryla's annuities, that type
of risk managed exposure that's typically only existed facing a
single counterparty like a bank or an insurance company. How
can we deliver that kind of exposure in the ETF wrapper?
And we know you know, you guys know this better
than anyone. The ETF rapper delivers liquidity, tax efficiency, transparency,
(05:02):
lower costs. So really Innovator's mission is to disrupt the
structured product annuity hedge fund industries by trying to provide
superior outcomes in the ETF rapper for those reasons that
we mentioned before. So our entire business is built around
delivering risk managed payoffs in a very easy to digest, inexpensive,
(05:23):
transparent rapper.
Speaker 3 (05:26):
I want to add real quick something that brick kind
of glossed over there. We in Illinois as like a
small Midwest town, and it's probably got on a per
capita basis the most amount of dollars in the asset
management industry of any place in the world. It's an
ETF capital. I mean, like, as you mentioned, power Shares
are now owned by Invesco, is based there first trust
(05:46):
based there. Innovator now twenty plus billion dollar firm based there.
Amplify ETFs, which also bought another ETF firm, is based there.
So there's a lot of people from coming out of
Wheaton College and Illinois that are based in the ETF industry.
Speaker 2 (06:02):
It's a powerhouse. So people probably heard wheat in Illinois
and don't know, but it really is.
Speaker 3 (06:06):
There's a lot of people that are based out there
in this industry.
Speaker 1 (06:10):
Well, you talked about, you know, just aid Innovator. I'd
really love to learn how defined outcome ETFs work at Innovator.
Speaker 4 (06:19):
Yeah, yeah, happy to so defind out come ETFs. Like
I mentioned before, we pioneered this category, so we launched
the first ETF in twenty eighteen. It was our fifteen
percent buffer. To this day, it remains one of the
most popular ETFs in our suite. So I'll use a
fifteen buffer as the example as we go through this.
But just how do they work and what is their function?
(06:40):
So defined out COMEDTF isn't really anything new, right, Like,
these types of payoffs have existed in the structured note
rapper for many years, but we simply kind of shepherded
that exposure over into the ETF rapper. So there's three
things that you need to know when you're talking about
a defined out COMEDTF. The first this is BTF has
(07:01):
an outcome period, so that's a specific set of time.
It could be three months or a quarter. It could
be one year, it could be two years. That is
the time over which the defined outcome exists. Then you
have your protection that could be a buffer or a
barrier against losses, which we'll talk about more in a
moment that cushions you against losses, protects you in the
fifteen percent buffer example I gave that buffers you from
(07:24):
zero to negative fifteen percent. So over a one year
outcome period in the ETF, a tick orrell I'll throw
out is poct. That's our fifteen percent buffer on the
S and P five hundred that ETF is designed to
deliver you point to point exposure to the S and
P five hundred its price return over one year with
a fifteen percent buffer against losses. And then the third
(07:45):
component that I'll mention is there's an upside cap, so
there's no free lunch with the product. Even though you
have a buffer against losses, you're going to have a
cap on the upside So if the market finishes down
twenty percent at the end of that one year, you're
going to be down five percent in the fifteen percent
buffer ETF. If the market is down ten percent, you're buffered.
You're completely covered. The buffer did what it was supposed
(08:07):
to do, and you were flat. Now on the upside,
you're going to track one to one with the price
return of SPY. So let's say you have a twelve
percent upside cap in that ETF. If the market's skyrockets
and is up thirty percent over that one year, you're
going to hit your cap. You're going to be capped out,
as we like to say an innovator, and your return
is going to be twelve percent. But if the market
(08:29):
finishes up five you're going to be up five. You're
going to track one to one with that ETF over
that outcome period. So again, outcome period, protection level, and
upside cap or those three core components.
Speaker 3 (08:43):
Yeah, so let's let's get into this little bit the
buffer version of the defined outcome products.
Speaker 2 (08:48):
Those are the first ones that really.
Speaker 3 (08:49):
Caught fire, But you have a bunch of other defined
outcome type products that are focused on income, accelerated returns,
full protection on the downside, different floors. Can you just
go into like the differences between how they're structured and
what those different things are trying to do your your
other products, I guess besides just the buffer.
Speaker 4 (09:07):
Yeah, yeah, definitely. So defined out come ETFs is kind
of the umbrella, right, like everything lives under the defined
out com ETF umbrella. You're launching different segments under that umbrella.
So buffers, for instance, provide you a buffer against losses.
We mentioned this before. Once you move below the buffer level,
you start to take on those losses one to one,
but if you finish anywhere in that buffer, you're covered.
(09:30):
A barrier is a little bit different, So we offer
barrier income ETFs. That's a very popular type of structured notes,
and again we're bringing that to the ETF rapper. Now
that type of solution offers a set amount of income
on the upside, so we sell options you have a
set income level on the upside, so you're not going
to track the price return of the index. You're just
(09:51):
going to have that set income level. But your protection
is a barrier. So a barrier is a little bit
different than a buffer in that the barrier is protection
in place, but if you fall below the barrier, you've
now assumed all losses, including up until the barrier and
beyond the barrier. So just put some numbers to it.
A fifteen barrier, if the market finished down twenty, you're
(10:13):
going to be down in twenty because you kind of
locked into that barrier. You're taking on all the losses
once you went through the barrier level Versus with a
fifteen buffer, if the market was down twenty, you're just
going to be down five. So you can imagine since
there's more risk with the barrier, you're compensated a little
bit more on the upside. But to be honest with you, James,
you know most of the assets are in the buffers,
(10:34):
most of the interest is in the buffer space right now.
But we are beginning to see interest in barriers and accelerated.
Speaker 2 (10:42):
Awesome, So can you talk a little bit.
Speaker 3 (10:43):
You mentioned like these outcome periods, and like everything I
see for the most part right now, seems to be
following these one year outcome periods. Right, what is the
rebalance frequency? So on those obviously it's one year, Like
what are you seeing are you seeing interest in? Like
we're interested in one month outcome period three month out comperiods,
multi year. I mean you talk about direction, those leverage
(11:04):
ETFs right now, we see some issuers toying with doing
things longer than leverage on a daily basis. So those
direction products that offer you three times a return of
something or inverse return, it only tracks it for a day.
You guys are going the opposite where like you're kind
of only offering this thing over year. Like, are you
seeing interest in other areas of those outcomeperiods?
Speaker 4 (11:23):
We are, Yeah. So we started with annual outcome periods,
and again our strategies are more defensive in nature, is
totally separate from a direction or appro shares. That being said,
we started with one year. We've seen a lot of
interesting quarterly outcome periods and the reason for that is
there's a more frequent reset. So advisors, for instance, if
they buy a one year outcomperiod and let's say the
(11:44):
market moves up three months in the market's up ten
or fifteen percent, that ETF that is a one year
out comperiod has now moved up and has experienced some
of its cap into that one year out comperiod. So
if you were to buy into that ETF three months
into the one year out comperiod, you actually now have
a little bit of downside right and you have a
little bit less cap. So that's why we typically see
(12:05):
volume cluster around the beginning or the end of the
outcome period, at least for our annual products. The reason
we've seen quarterly outcome periods explode in popularity these are
tickers like balt b alt zalt zlt is because of
that more frequent reset, James, And that's that's really useful
because advisors have money coming in throughout the year, so
(12:26):
they don't necessarily always want to worry about do I
buy this specific annual outcome period that's resetting in March.
Do I need to buy a different annual outcome period
resetting in August. Instead of lattering those they say, you
know what, I'm just going to use a quarterly outcome
period product, and when that money comes in throughout the year,
I know that in the next month, two or three months,
it's going to be resetting and getting a fresh downside
(12:47):
buffer and a fresh upside cap.
Speaker 1 (12:51):
We're talking about the different kinds of buffer ETFs and
the different options, but I'd love to hear, and I
know our listeners would love to hear how these ETFs
are actually managed. You know, what are the steps that
the pms take to implement these strategies.
Speaker 4 (13:06):
Yeah, so we innovator is the advisor. Our subadvisor is
Milliman Financial Risk Management, so we partner with them to
bring these ETFs to market. They manage the day to
day trading of these funds, and they have significant experience
working with the largest bank and insurance balance sheets and derivatives.
So the process is actually really simple, David. So the
(13:27):
benefit of the ETF for APPER, as we mentioned before,
the liquidity, the tax efficiency, the reset. So I'm going
to double click on the reset here because it's really cool.
We talked about outcome periods. What separates these ETFs from
a traditional structured note. So at the end or xpery
of a structured note, let's say it's one year, two years,
or five years or six months at xpery, that is
(13:51):
a taxable event that note comes due. That is a
taxable event for the investor or the advisor and their
client with the ETF at the end of the outcome period,
at the end of that one year or three month
out comperiod, it resets within the wrapper. So what that
means is we're going to roll the exposure at the
end of one year, and we're going to move into
(14:11):
a new basket of options with a one year xpree.
That process of either selling we're letting those options expire
if they're in a lass position. In rolling into a
new options basket is not a taxable event that occurs
within the ETF wrapper. So it's not tax avoidance, it's
tax deferral. We're deferring those gains to the future. But
(14:32):
the benefit for you is the investor, is when you
buy that ETF at the end of that outcome period,
there's nothing that you need to do, absolutely nothing. You're
going to get a fresh buffer and a fresh upside
cap and you can hold the ETF in perpetuity and
you decide when you want to experience that taxable event
when you sell the ETF. So what actually happens behind
the scenes on that reset day To answer your question,
(14:56):
we move in and is that ETF approaches the end
of its outcome period. On the final trading day of
that outcome period, we close out that basket of options
typically four options, which we can get into in a moment,
and we roll into a new basket of options with
a new one year expery and then even though these
are classified as active ETFs, there's really no active management
(15:17):
that's occurring. It's all systematic in nature. So once we
strike those options at the beginning of the outcome period,
that set of options with that xpery and those strikes
are not going to change. Those will going to be
the exact same options for the entirety of the outcome period.
The only thing that's going to change is the quantity
of the options in the basket when we see creations
or redemptions in the ETF.
Speaker 3 (15:40):
So we've talked a lot of high level about like
what these things offer in the outcome periods and the
caps and the floors, but like, can you get into
a little more detail you kind of hinted at there,
and like what exactly is in these portfolios, like what
is being held and how are you generating these you know,
defined outcomes for these funds.
Speaker 4 (16:00):
So the magic really occurs in the flex options. So
if you look under the hood, you peel back the
onion of a defined out com ETF. We talked about
a fifteen percent buffer earlier. We're going to stick on that.
You'll see four options. The first is it deep in
the money call that's going to act like you're one
to one exposure to spy. You're going to have your protection,
which is a put spread, typically an at the money
(16:22):
put and then another puts sold about fifteen percent lower,
and then we have a call on the upside that
we sell, and we sell that call on the upside
and that's what sets our cap for the outcome period.
We're going to sell that call at the highest level
that we can to set the cap that will perfectly
finance the protection or the buffer that we have in
(16:42):
place with those puts. So typically four options in that basket.
They are exchange traded in their flex options, So flex
is easy for your listeners. Flex is flexible. What that
means is that we can customize the tenor we can
customize the strike price. And the reason that we do
that is we want to be able to communicate a
(17:04):
perfect fifteen percent a perfect thirty percent buffer for our clients.
And you know, putting on my market making have for
a second. You know, these these ETFs and these options
trade very similarly to like a listed option, So a
flex option is really eased to hedge those market makers
that are out there they've told me. It's kind of
like a Swiss army knife. Of ways that you can
(17:24):
hedge our ETFs. You can use spy, you can use
spy options, you can use index options. The critical takeaway
for your listeners is that the basket is hyper liquid.
If you look under the hood of these ETFs, you'll
see a basket of flex options tracking the most liquid
equity benchmarks in the world. So spy iwm q's efa
(17:45):
ee M, we're tapping into all of those liquid benchmarks
with our flex options. So don't be to turn if
you look into the basket and you see options. Remember
they're tracking the most liquid benchmarks. They're very simple to hedge,
and the proof's kind of in the pudding because if
you look at the ds on screen, James, you'll see
they're like fifteen to twenty basis points, which is super
tight across the ETF landscape for ETFs.
Speaker 1 (18:09):
So how much of this is automated?
Speaker 4 (18:13):
Good question, Almost all of it, I would say systematic.
So kind of an anecdote is when I was on
the desk at Virtue, RFQs were just kind of getting
their start. That's a Bloomberg turmoil. They're out there but
it stands for requests for quote. And one of the
things that we did when I was a trader on
that desk is we were getting quotes from people all
(18:35):
day long, people paying us saying I need to buy
fifty thousand shares of this ETF eighty thousand shares of
this ETF, and those quotes would hit the market making
desks and they typically would put market makers in competition
when an advisor or an institution wants to purchase a
big block of an ETF, So our job as a
market maker was we have to give them a competitive quote.
(18:55):
The problem was is that ETF became really popular and
everybody wanted a quote all the time. So what we
did was we found a way to automate the response
to RFQs a request for quotes. And now if you
look across the ETF marketplace, if we have advisors on
the call, if they custody at Schwab or the custody
at Fidelity, that entire process is automated. They go to
(19:16):
their block desk at one of those custodial firms, or
if you're an institution, you go to a custodian or
a market maker and you can get a nearly instantaneous
quote back on an ETF block trade, and that's because
of the automation of the request for quote process. So options,
it's a relatively similar process in what we're doing. We
go out there whenever we reset the funds, and we
(19:38):
use an auction, and we go out to five or
six different option market makers and we request a quote
on the options package. And this is a cool caveat.
We actually trade the options as a package. Instead of
going out there and trading each individual options, leg Innovator
goes out and gets a quote on that entire options package.
And the thing I like to say is that we
(20:00):
have economies of scale and we actually have the attention
of these big options market makers like Susquehanna, Old Mission, Goldman, Sachs,
Jane Street. So what we found is that we're actually
able to get a significantly higher cap for our investors
than if they tried to do this on their own.
And that's what I talked to about with institutions, pensions, endowments.
(20:21):
We say, you know what, you can try to mimic
this yourself, but you'll typically get a lower cap than
you would get if you use the innovative product because
of our economies of scale. And to top of that,
David and James, nobody wants to manage options. That's the
feedback that we've gotten. It's Harry. It creates operational difficulties.
So if you can get that risk managed exposure in
the etf rapper, it's a win.
Speaker 3 (20:42):
Yeah, if I find that, Like when I talk with
people about these, they're like, oh, I can just do
this myself, And I'm like, go ahead.
Speaker 2 (20:48):
If you can figure out how to do it, go ahead.
Speaker 3 (20:50):
But I guess my next question is something you just
hit to a real quick, Like can you talk about
like how the cap is determined? Like, obviously options pricing
are determined by you know, a whole host of different things,
applied volatility, interest rates, time to expirey, you name it,
the underlying asset. So like, how is the cap actually determined?
(21:11):
You said you can get a higher cap, but like,
can you go into like the math of why you
can get a higher cap than most individuals and like
what goes into calculating that?
Speaker 4 (21:19):
Yeah? Yeah, without going to in the weeds, I think
there are a couple things that go into it. So,
first of all, are size, right, So when you hit
a certain critical size. We are now rebalancing billions of
dollars in options each month. I mentioned spread costs before,
So James, if you were to go and buy options
on screen right now, you could see what that spread
(21:41):
cost would be, and you'd have to calculate the spread
of the listed options for each individual leg We typically
are going to pay around twenty to thirty percent of
that spread cost, which means that we have more options
budget to spend on that specific package, so we're paying
less and spread cost that's going to contribute to a
higher cap. On top of that, we typically get superior
(22:02):
pricing on a fifteen percent buffer. We recently modeled that
we get between one and two percent, so around one
and a half percent. We'll call it higher cap than
if you tried to do this exact same payoff yourself
using listed options, So a significantly higher cap that not
only is larger than the management fee that we charge,
but also just gives you additional upside for your investors.
(22:24):
So I would say spread cost is a main determinant.
Economies of scale is another determinants in generally those market
maker relationships that we built over the course of the
past six seven years of doing this are a large contributor.
Speaker 3 (22:38):
So this is like we've talked about like the pros
almost exclusively here, right. Obviously there are some cons in
the fact if you go through the buffer, particularly with
the buyer ETF. But like one con that I know of.
You mentioned price return multiple times, So these things aren't
total return. So can you go into one why you're
using price return and not total return? So incomes aren't
(22:59):
accounted for here? And like what other cons are you
like seeing most people worried about.
Speaker 4 (23:05):
Yeah, so you know from our perspective there are cons.
I guess the con that would come to my mind
is you know your captain the upside. But in my
mind that's not a true con. The mistake that I
see James across the industry, and I see articles all
the time, and I think there's a little bit of
a misconception here. People compare the buffer ETF to the
reference asset. So they'll compare a fifteen percent buffer to spy.
(23:28):
They'll pull up a chart of twenty years and they'll
say this ETF underperforms. But I think there's kind of
just a fundamental misunderstanding of what the investment objective is
of the ETF. It's designed to deliver risk managed exposure.
It's designed to deliver that defined outcome. If you move
below the buffer, James, yes, you're going to take on
one to one downside, but you're still going to outperform
(23:49):
if you had just held unheadged equities. So you know,
from my perspective, the risk managed, the risk managed exposure
is built into the structure, and I think folks that
have usedtructured product, they get that, they're familiar with it.
Another thing that's come up, James, is what if we
buy the ETF in the middle of the outcome period.
What if we buy it at the wrong time, what
(24:10):
if we buy it in the markets up, I buy
it six months into the twelve month outcome period and
I have downside. And we, as kind of the pioneer
in the space, have put a ton of effort into
our website and our tools. So if you go to
our website, I would encourage folks to go to innovator
ETFs dot com. We've designed five different tools, a potential
outcome analyzer, a previous outcome analyzer, a personal outcome analyzer
(24:34):
to help you make sure that you're getting in at
the right point the outcome is exactly what you would
expect it to be and avoid any of those situations.
So those are the potential pitfalls that we've heard raised,
but those are easily addressable if you use some of
our tools.
Speaker 3 (24:50):
So I guess my next question would be, like when
rates were really low, when these things launched, the main
thing I saw people thinking about doing was if you
had a sixty to forty portfolio taken like a small
slug of their fix income and putting into these because
the risk was not nearly as high as just going
full equity, and they were trying to juice their returns
because they didn't have any income from their fix income.
Right now, rates are high, people have no problem getting income,
(25:13):
but you guys are still pulling in assets. I guess, like,
what are you seeing people actually doing in the allocation
side of this, Like where are they taking it from?
Are they taking it from an alts bucket? Are they
take it from the equity bucket fixed income? Like what
what are you seeing happening? And what type of allocations
are we seeing? Because I would say like people should
not be substituting their core equity exposure with these things,
But it makes sense in some regard like to take
(25:34):
maybe some of it if you're worried about risk over
the next year term or something like that.
Speaker 2 (25:37):
But how are you seeing people actually use these things?
Speaker 4 (25:41):
Yeah? Great, great question. So sixty twenty twenty is a
phrase that we've thrown around recently. We just published a
white paper on it. So, if you go back to
COVID rates went to zero, we saw a ton of
people move a lot of their bond exposure into buffers
to get more upside. They had squeezed all the juice
out of their bond allocation. They said, okay, we're going
to take some of that bond exposure and we're going
(26:03):
to put it into a buffer. Then we saw rates
go up, right, and something really interesting happened, James, and
this is why our product suite really can stand the
test of time in volatility and rates. When rates went up,
certain segments of our suite became very appealing. So, for instance,
we launched the first one hundred percent buffer ETFs last year,
(26:24):
which is basically a principally protected note equivalent in the
ETF wrapper, and rates were a key determinants of the
upside cap in that ETF, so you were able to
get around a nine to ten percent upside cap to
the s and P five hundred with full principal protection,
which was around two times what you were getting in
treasuries at the time. So the rate environment actually helped
(26:47):
products like that, and we saw one hundred percent buffer
ETFs used as sort of a cash substitute, cash compliment,
get that cash off the sidelines, but in sort of
a core allocation. Where does it fit We view these
ETFs for conservative investors, pre retirees, retirees. We see folks
pulling our thirty percent buffer or our bolts, our quarterly
(27:09):
twenty percent buffer, taking some of their bond exposure and
putting it in that highly defensive buffer ETF to get
more upside. The key thing to James Is and David
is taxes. This is something that keeps coming up. There
are ETFs now in the marketplace that it will not
be named, that are almost designed for that purpose to
deliver you just the price return and avoid that. It's
(27:30):
a nice consequence of the buffer ETFs that we are
not paying the dividends. We actually use that dividend to
finance a higher upside cap for our investors, So we
don't ever intend to pay out any sort of capital
gains distribution in the fund. These funds are designed to
deliver that price return, and that's intentional because clients don't
want to pay taxes. They want to insulate that they
(27:51):
want to defer taxes in the fund until the future
points and that's the benefit of the buffers. So James
I would say hadged equity conservative equity bond replacement. We
kind of see it run the gamut depending on the
buffal level.
Speaker 3 (28:04):
Alsome one last quick question before I hand it over
to Dave. You you talked about like there's other indices.
From the most part of what I'm seeing, all the
assets are for the most part in like S and
P five hundred of these products. So when we're talking
about the index of the underline track is the SMP
five hundred. But you mentioned flex options are available on
a bunch of other underlying indices. I know you guys
(28:25):
have tried with other different assets. Are you where are
you seeing demand? You're seeing demand anywhere other than the
S and P five hundred. Are you going to hopefully
are you looking to launch other products at some point
tracking underlying different underlying indices?
Speaker 2 (28:35):
Where else are you looking to do these.
Speaker 4 (28:38):
We are Yeah, that's spot on. So the majority of
the assets now live I think it's over eighty percent
live in the S and P five hundred complex. That
being said, we are far and away the largest provider
when it comes to the other indices, and by other
I mean Developed Markets EFA, Emerging Markets EEM, small Caps IWM, TLT,
(28:59):
as well as Deck one hundred, the cues. We have
monthly offerings on all of those ETFs, so fifteen percent
buffers on all of those ETFs with one year outcome periods.
We recently launched quarterly outcome periods with a ten percent
buffer on all of those. And to be honest with
you guys, the growth there is accelerating even faster than
(29:21):
the S and P five hundred complex. Over the past
two years, each of those reference assets, just to put
it in perspective, is approaching around a billion dollars, so
a lot smaller than the big pie, which is fifty billion.
But the reason that people are buffering those indices is
that they've typically underperformed like the small caps. Like people have.
People have been trying to time small caps for a
(29:41):
long time. Advisors have been in institutions, have been a
little bit tenuous when it comes to investing in those.
So we say, if you're considering it, use a buffer
avoid market timing, and if you're incorrect, you have that
built in protection in place.
Speaker 2 (29:55):
Awesome.
Speaker 3 (29:55):
You mentioned TLT, but we talked about a bunch of
equityts that's a long duration treasury ETF for those that
aren't sure what TLT is. So they're doing this on
fixed income too.
Speaker 1 (30:05):
So I was going to say before we let you go,
I actually have a question, and you know, it kind
of relates to what we were just talking about, and
so you mentioned all these other indexes and so you know,
my question is, really, do you have any predictions for
the future of buffer ETFs? And you know, part of
that is, you know, could there be a situation where
there are flex options on other types of indexes, even
(30:28):
you know, maybe smart beta you know, to try to
you know, do a buffer on a smart beta index,
or you know, just general predictions for the future.
Speaker 4 (30:37):
Yeah, this is this is really exciting. You know, when
we think about the total addressable market at Innovator, we
really look at structured products is our north star. When
we think about new products, we look at what's selling
in the structured node space. We think about what it
makes sense in the ETF wrapper, do advisors actually want it?
We speak to advisors a lot here, and advisor demand
(30:58):
drives the majority of our product. Looking at the numbers, David,
So around three hundred and eighty billion, I think was
the number last year in annuity sales across growth and
protection hedge funds. Don't even get me started. I think
there's like three trillion across the hedge fund space. Rylas,
which are more of an index linked annuity type product,
(31:21):
those sold about fifty billion last year and they're growing too.
This year. I think the expectations are that those numbers
are going to be twenty to thirty percent higher than
they were in twenty twenty three. So what does that
tell me? That tells me that if the structured note
world is still selling like hotcakes, we think we have
a better mouse trap that's more transparent, scalable, better for
(31:42):
advisors and institutional practices at Innovator. So you know, the
space is at fifty billion right now. I can you
could add a zero, I think to that AUM in
the next five to ten years. If we get to
the place that we want to be in terms of
investor education and delivering on what we're supposed to.
Speaker 1 (31:58):
Well, this is great. Burke, thank you so much for
joining us today.
Speaker 4 (32:01):
It was a pleasure. Guys, thanks for having me and James.
Speaker 1 (32:04):
Thank you for being my co host.
Speaker 2 (32:06):
Yeah, happy to do it. This is fun. I love
talking about this.
Speaker 1 (32:08):
Stuff until our next episode. This is David Cohne with
Inside Active
Welcome to Inside Active, a podcast about active managers that
goes beyond sound bites and headlines and looks deeper into
their processes, challenges, and philosophies and security selection. I'm David Cohne,
I lead mutual fund and active Research at Bloomberg Intelligence.
Today my co host is James Seyffert, ETF, analyst at
Bloomberg Intelligence. James, thank you for joining me today.
Speaker 2 (00:37):
Yeah, happy to be back, David, thank you for having me.
Speaker 1 (00:39):
So, James, we've talked about Buffer ETFs in the past,
but how are they doing in terms of flows this year?
Speaker 2 (00:47):
Yeah?
Speaker 3 (00:47):
So, I mean I think of Buffer's ETFs in this
like broader category of like these you know a lot
of derivative based products that are either like seeking some
sort of income or some sort of protection or some
sort of accelerated ye. But within Buffer specifically, that's probably
the most successful within that deridit of landscape. And I
think they've taken in a little over ten billion this year.
(01:09):
I mean, if you look at the category, I mean,
it didn't exist a few years ago and now we're
looking I consider it like a fifty billion dollar category
for buffers overall. So no matter how you slice it
like this has been a smashing success and honestly like
this is something that our team has been looking at
and covering for a long time now. But yeah, this
(01:29):
this is finding its home in the ETF industry and
it's doing really well.
Speaker 1 (01:33):
Nice well. I think it'd be a great time to
bring on our guests. We'd like to welcome Burke Ashington
to the podcast. Burke is director of Capital Markets at
Innovator ETFs. Burke, thanks for joining us today.
Speaker 4 (01:45):
Great to be here, guys, James David, it's pleasure.
Speaker 1 (01:47):
So Burt, can you tell us a little bit about
your career and how you got started in the ETF industry.
Speaker 4 (01:52):
Yeah, happy to I've known James and the ETF team
at Bloomberg for a few years here. Before my tenure
at Innovator, started on a trade desk, so it was
CASEG Holdings. It then became Virtuo Financial, an ETF market
making firm, so cut my teeth on the trading desk.
I love that fast paced environment, competitive atmosphere. And you know,
(02:16):
Virtuo Financial specializes in ETF trading, so our desk did
a lot of arbitrage ETF trading, ETF block trading, so
more of a technical start, I would say, on the
ETF side, and it kind of gave me a background
grounded in ETF pricing, how the ETFs are structured, but
also got a little bit of a glimpse into how
to launch an ETF because you're the l m M
or lead market maker and typically provided c capital for
(02:40):
a lot of ETFs that were brought to market. So
after Virtuo Financial, I kind of went over to the
dark side, as we like to say, the ETF issuer side,
and went to Direction ETFs and that's where I got
my first taste of derivatives within the ETF rapper. Direction
specializes in the leveraged and inverse funds, a really interesting firm.
(03:01):
I'm on the forefront of innovation there, but focus more
on the tactical trading crowd. But you know, I saw
there kind of the writing on the wall that derivatives
in the ETF rapper were still in the early stages.
You could use them to leverage returns accelerate your upside,
but you could also use them to insert protection in
the ETF rapper. So you know, from there I got
(03:24):
put in touch with more of a startup ETF firm
innovator Capital Management was the name. They were based in Wheaton, Illinois.
I was looking for an earlier stage ETF firm and
got put in touch with them and ended up being
sort of the first product hire undergrad Day are now
CIO and we can talk more about Innovator in a second.
(03:44):
But we're doing some pretty disruptive stuff over here.
Speaker 1 (03:48):
Great. Well, actually, let's you know, as you talked, you
mentioned Innovator. What's the innovator story?
Speaker 4 (03:54):
Yeah, Innovator has a really interesting story. You know, Bruce
Bond and John Southard are found So Bruce Bond and
John Southard, we're the original founders of Power Shares ETF
ETF's trail breke blazers in the ETF market. They really
pioneered the segments like smart, Beta, the matic, even household
names like the cues, so they were first to market
(04:17):
with a lot of those names. They sold that business
to Investo around two thousand and six and they retired.
They went into retirement pseudo retirements, and one of them
was pitched a structured note in retirements, and that's where
the story gets really interesting. The light bulb sort of
went off and they said, you know what, there may
be a better way to package this risk managed exposure
(04:40):
that we see in structured notes ryla's annuities, that type
of risk managed exposure that's typically only existed facing a
single counterparty like a bank or an insurance company. How
can we deliver that kind of exposure in the ETF wrapper?
And we know you know, you guys know this better
than anyone. The ETF rapper delivers liquidity, tax efficiency, transparency,
(05:02):
lower costs. So really Innovator's mission is to disrupt the
structured product annuity hedge fund industries by trying to provide
superior outcomes in the ETF rapper for those reasons that
we mentioned before. So our entire business is built around
delivering risk managed payoffs in a very easy to digest, inexpensive,
(05:23):
transparent rapper.
Speaker 3 (05:26):
I want to add real quick something that brick kind
of glossed over there. We in Illinois as like a
small Midwest town, and it's probably got on a per
capita basis the most amount of dollars in the asset
management industry of any place in the world. It's an
ETF capital. I mean, like, as you mentioned, power Shares
are now owned by Invesco, is based there first trust
(05:46):
based there. Innovator now twenty plus billion dollar firm based there.
Amplify ETFs, which also bought another ETF firm, is based there.
So there's a lot of people from coming out of
Wheaton College and Illinois that are based in the ETF industry.
Speaker 2 (06:02):
It's a powerhouse. So people probably heard wheat in Illinois
and don't know, but it really is.
Speaker 3 (06:06):
There's a lot of people that are based out there
in this industry.
Speaker 1 (06:10):
Well, you talked about, you know, just aid Innovator. I'd
really love to learn how defined outcome ETFs work at Innovator.
Speaker 4 (06:19):
Yeah, yeah, happy to so defind out come ETFs. Like
I mentioned before, we pioneered this category, so we launched
the first ETF in twenty eighteen. It was our fifteen
percent buffer. To this day, it remains one of the
most popular ETFs in our suite. So I'll use a
fifteen buffer as the example as we go through this.
But just how do they work and what is their function?
(06:40):
So defined out COMEDTF isn't really anything new, right, Like,
these types of payoffs have existed in the structured note
rapper for many years, but we simply kind of shepherded
that exposure over into the ETF rapper. So there's three
things that you need to know when you're talking about
a defined out COMEDTF. The first this is BTF has
(07:01):
an outcome period, so that's a specific set of time.
It could be three months or a quarter. It could
be one year, it could be two years. That is
the time over which the defined outcome exists. Then you
have your protection that could be a buffer or a
barrier against losses, which we'll talk about more in a
moment that cushions you against losses, protects you in the
fifteen percent buffer example I gave that buffers you from
(07:24):
zero to negative fifteen percent. So over a one year
outcome period in the ETF, a tick orrell I'll throw
out is poct. That's our fifteen percent buffer on the
S and P five hundred that ETF is designed to
deliver you point to point exposure to the S and
P five hundred its price return over one year with
a fifteen percent buffer against losses. And then the third
(07:45):
component that I'll mention is there's an upside cap, so
there's no free lunch with the product. Even though you
have a buffer against losses, you're going to have a
cap on the upside So if the market finishes down
twenty percent at the end of that one year, you're
going to be down five percent in the fifteen percent
buffer ETF. If the market is down ten percent, you're buffered.
You're completely covered. The buffer did what it was supposed
(08:07):
to do, and you were flat. Now on the upside,
you're going to track one to one with the price
return of SPY. So let's say you have a twelve
percent upside cap in that ETF. If the market's skyrockets
and is up thirty percent over that one year, you're
going to hit your cap. You're going to be capped out,
as we like to say an innovator, and your return
is going to be twelve percent. But if the market
(08:29):
finishes up five you're going to be up five. You're
going to track one to one with that ETF over
that outcome period. So again, outcome period, protection level, and
upside cap or those three core components.
Speaker 3 (08:43):
Yeah, so let's let's get into this little bit the
buffer version of the defined outcome products.
Speaker 2 (08:48):
Those are the first ones that really.
Speaker 3 (08:49):
Caught fire, But you have a bunch of other defined
outcome type products that are focused on income, accelerated returns,
full protection on the downside, different floors. Can you just
go into like the differences between how they're structured and
what those different things are trying to do your your
other products, I guess besides just the buffer.
Speaker 4 (09:07):
Yeah, yeah, definitely. So defined out come ETFs is kind
of the umbrella, right, like everything lives under the defined
out com ETF umbrella. You're launching different segments under that umbrella.
So buffers, for instance, provide you a buffer against losses.
We mentioned this before. Once you move below the buffer level,
you start to take on those losses one to one,
but if you finish anywhere in that buffer, you're covered.
(09:30):
A barrier is a little bit different, So we offer
barrier income ETFs. That's a very popular type of structured notes,
and again we're bringing that to the ETF rapper. Now
that type of solution offers a set amount of income
on the upside, so we sell options you have a
set income level on the upside, so you're not going
to track the price return of the index. You're just
(09:51):
going to have that set income level. But your protection
is a barrier. So a barrier is a little bit
different than a buffer in that the barrier is protection
in place, but if you fall below the barrier, you've
now assumed all losses, including up until the barrier and
beyond the barrier. So just put some numbers to it.
A fifteen barrier, if the market finished down twenty, you're
(10:13):
going to be down in twenty because you kind of
locked into that barrier. You're taking on all the losses
once you went through the barrier level Versus with a
fifteen buffer, if the market was down twenty, you're just
going to be down five. So you can imagine since
there's more risk with the barrier, you're compensated a little
bit more on the upside. But to be honest with you, James,
you know most of the assets are in the buffers,
(10:34):
most of the interest is in the buffer space right now.
But we are beginning to see interest in barriers and accelerated.
Speaker 2 (10:42):
Awesome, So can you talk a little bit.
Speaker 3 (10:43):
You mentioned like these outcome periods, and like everything I
see for the most part right now, seems to be
following these one year outcome periods. Right, what is the
rebalance frequency? So on those obviously it's one year, Like
what are you seeing are you seeing interest in? Like
we're interested in one month outcome period three month out comperiods,
multi year. I mean you talk about direction, those leverage
(11:04):
ETFs right now, we see some issuers toying with doing
things longer than leverage on a daily basis. So those
direction products that offer you three times a return of
something or inverse return, it only tracks it for a day.
You guys are going the opposite where like you're kind
of only offering this thing over year. Like, are you
seeing interest in other areas of those outcomeperiods?
Speaker 4 (11:23):
We are, Yeah. So we started with annual outcome periods,
and again our strategies are more defensive in nature, is
totally separate from a direction or appro shares. That being said,
we started with one year. We've seen a lot of
interesting quarterly outcome periods and the reason for that is
there's a more frequent reset. So advisors, for instance, if
they buy a one year outcomperiod and let's say the
(11:44):
market moves up three months in the market's up ten
or fifteen percent, that ETF that is a one year
out comperiod has now moved up and has experienced some
of its cap into that one year out comperiod. So
if you were to buy into that ETF three months
into the one year out comperiod, you actually now have
a little bit of downside right and you have a
little bit less cap. So that's why we typically see
(12:05):
volume cluster around the beginning or the end of the
outcome period, at least for our annual products. The reason
we've seen quarterly outcome periods explode in popularity these are
tickers like balt b alt zalt zlt is because of
that more frequent reset, James, And that's that's really useful
because advisors have money coming in throughout the year, so
(12:26):
they don't necessarily always want to worry about do I
buy this specific annual outcome period that's resetting in March.
Do I need to buy a different annual outcome period
resetting in August. Instead of lattering those they say, you
know what, I'm just going to use a quarterly outcome
period product, and when that money comes in throughout the year,
I know that in the next month, two or three months,
it's going to be resetting and getting a fresh downside
(12:47):
buffer and a fresh upside cap.
Speaker 1 (12:51):
We're talking about the different kinds of buffer ETFs and
the different options, but I'd love to hear, and I
know our listeners would love to hear how these ETFs
are actually managed. You know, what are the steps that
the pms take to implement these strategies.
Speaker 4 (13:06):
Yeah, so we innovator is the advisor. Our subadvisor is
Milliman Financial Risk Management, so we partner with them to
bring these ETFs to market. They manage the day to
day trading of these funds, and they have significant experience
working with the largest bank and insurance balance sheets and derivatives.
So the process is actually really simple, David. So the
(13:27):
benefit of the ETF for APPER, as we mentioned before,
the liquidity, the tax efficiency, the reset. So I'm going
to double click on the reset here because it's really cool.
We talked about outcome periods. What separates these ETFs from
a traditional structured note. So at the end or xpery
of a structured note, let's say it's one year, two years,
or five years or six months at xpery, that is
(13:51):
a taxable event that note comes due. That is a
taxable event for the investor or the advisor and their
client with the ETF at the end of the outcome period,
at the end of that one year or three month
out comperiod, it resets within the wrapper. So what that
means is we're going to roll the exposure at the
end of one year, and we're going to move into
(14:11):
a new basket of options with a one year xpree.
That process of either selling we're letting those options expire
if they're in a lass position. In rolling into a
new options basket is not a taxable event that occurs
within the ETF wrapper. So it's not tax avoidance, it's
tax deferral. We're deferring those gains to the future. But
(14:32):
the benefit for you is the investor, is when you
buy that ETF at the end of that outcome period,
there's nothing that you need to do, absolutely nothing. You're
going to get a fresh buffer and a fresh upside
cap and you can hold the ETF in perpetuity and
you decide when you want to experience that taxable event
when you sell the ETF. So what actually happens behind
the scenes on that reset day To answer your question,
(14:56):
we move in and is that ETF approaches the end
of its outcome period. On the final trading day of
that outcome period, we close out that basket of options
typically four options, which we can get into in a moment,
and we roll into a new basket of options with
a new one year expery and then even though these
are classified as active ETFs, there's really no active management
(15:17):
that's occurring. It's all systematic in nature. So once we
strike those options at the beginning of the outcome period,
that set of options with that xpery and those strikes
are not going to change. Those will going to be
the exact same options for the entirety of the outcome period.
The only thing that's going to change is the quantity
of the options in the basket when we see creations
or redemptions in the ETF.
Speaker 3 (15:40):
So we've talked a lot of high level about like
what these things offer in the outcome periods and the
caps and the floors, but like, can you get into
a little more detail you kind of hinted at there,
and like what exactly is in these portfolios, like what
is being held and how are you generating these you know,
defined outcomes for these funds.
Speaker 4 (16:00):
So the magic really occurs in the flex options. So
if you look under the hood, you peel back the
onion of a defined out com ETF. We talked about
a fifteen percent buffer earlier. We're going to stick on that.
You'll see four options. The first is it deep in
the money call that's going to act like you're one
to one exposure to spy. You're going to have your protection,
which is a put spread, typically an at the money
(16:22):
put and then another puts sold about fifteen percent lower,
and then we have a call on the upside that
we sell, and we sell that call on the upside
and that's what sets our cap for the outcome period.
We're going to sell that call at the highest level
that we can to set the cap that will perfectly
finance the protection or the buffer that we have in
(16:42):
place with those puts. So typically four options in that basket.
They are exchange traded in their flex options, So flex
is easy for your listeners. Flex is flexible. What that
means is that we can customize the tenor we can
customize the strike price. And the reason that we do
that is we want to be able to communicate a
(17:04):
perfect fifteen percent a perfect thirty percent buffer for our clients.
And you know, putting on my market making have for
a second. You know, these these ETFs and these options
trade very similarly to like a listed option, So a
flex option is really eased to hedge those market makers
that are out there they've told me. It's kind of
like a Swiss army knife. Of ways that you can
(17:24):
hedge our ETFs. You can use spy, you can use
spy options, you can use index options. The critical takeaway
for your listeners is that the basket is hyper liquid.
If you look under the hood of these ETFs, you'll
see a basket of flex options tracking the most liquid
equity benchmarks in the world. So spy iwm q's efa
(17:45):
ee M, we're tapping into all of those liquid benchmarks
with our flex options. So don't be to turn if
you look into the basket and you see options. Remember
they're tracking the most liquid benchmarks. They're very simple to hedge,
and the proof's kind of in the pudding because if
you look at the ds on screen, James, you'll see
they're like fifteen to twenty basis points, which is super
tight across the ETF landscape for ETFs.
Speaker 1 (18:09):
So how much of this is automated?
Speaker 4 (18:13):
Good question, Almost all of it, I would say systematic.
So kind of an anecdote is when I was on
the desk at Virtue, RFQs were just kind of getting
their start. That's a Bloomberg turmoil. They're out there but
it stands for requests for quote. And one of the
things that we did when I was a trader on
that desk is we were getting quotes from people all
(18:35):
day long, people paying us saying I need to buy
fifty thousand shares of this ETF eighty thousand shares of
this ETF, and those quotes would hit the market making
desks and they typically would put market makers in competition
when an advisor or an institution wants to purchase a
big block of an ETF, So our job as a
market maker was we have to give them a competitive quote.
(18:55):
The problem was is that ETF became really popular and
everybody wanted a quote all the time. So what we
did was we found a way to automate the response
to RFQs a request for quotes. And now if you
look across the ETF marketplace, if we have advisors on
the call, if they custody at Schwab or the custody
at Fidelity, that entire process is automated. They go to
(19:16):
their block desk at one of those custodial firms, or
if you're an institution, you go to a custodian or
a market maker and you can get a nearly instantaneous
quote back on an ETF block trade, and that's because
of the automation of the request for quote process. So options,
it's a relatively similar process in what we're doing. We
go out there whenever we reset the funds, and we
(19:38):
use an auction, and we go out to five or
six different option market makers and we request a quote
on the options package. And this is a cool caveat.
We actually trade the options as a package. Instead of
going out there and trading each individual options, leg Innovator
goes out and gets a quote on that entire options package.
And the thing I like to say is that we
(20:00):
have economies of scale and we actually have the attention
of these big options market makers like Susquehanna, Old Mission, Goldman, Sachs,
Jane Street. So what we found is that we're actually
able to get a significantly higher cap for our investors
than if they tried to do this on their own.
And that's what I talked to about with institutions, pensions, endowments.
(20:21):
We say, you know what, you can try to mimic
this yourself, but you'll typically get a lower cap than
you would get if you use the innovative product because
of our economies of scale. And to top of that,
David and James, nobody wants to manage options. That's the
feedback that we've gotten. It's Harry. It creates operational difficulties.
So if you can get that risk managed exposure in
the etf rapper, it's a win.
Speaker 3 (20:42):
Yeah, if I find that, Like when I talk with
people about these, they're like, oh, I can just do
this myself, And I'm like, go ahead.
Speaker 2 (20:48):
If you can figure out how to do it, go ahead.
Speaker 3 (20:50):
But I guess my next question is something you just
hit to a real quick, Like can you talk about
like how the cap is determined? Like, obviously options pricing
are determined by you know, a whole host of different things,
applied volatility, interest rates, time to expirey, you name it,
the underlying asset. So like, how is the cap actually determined?
(21:11):
You said you can get a higher cap, but like,
can you go into like the math of why you
can get a higher cap than most individuals and like
what goes into calculating that?
Speaker 4 (21:19):
Yeah? Yeah, without going to in the weeds, I think
there are a couple things that go into it. So,
first of all, are size, right, So when you hit
a certain critical size. We are now rebalancing billions of
dollars in options each month. I mentioned spread costs before,
So James, if you were to go and buy options
on screen right now, you could see what that spread
(21:41):
cost would be, and you'd have to calculate the spread
of the listed options for each individual leg We typically
are going to pay around twenty to thirty percent of
that spread cost, which means that we have more options
budget to spend on that specific package, so we're paying
less and spread cost that's going to contribute to a
higher cap. On top of that, we typically get superior
(22:02):
pricing on a fifteen percent buffer. We recently modeled that
we get between one and two percent, so around one
and a half percent. We'll call it higher cap than
if you tried to do this exact same payoff yourself
using listed options, So a significantly higher cap that not
only is larger than the management fee that we charge,
but also just gives you additional upside for your investors.
(22:24):
So I would say spread cost is a main determinant.
Economies of scale is another determinants in generally those market
maker relationships that we built over the course of the
past six seven years of doing this are a large contributor.
Speaker 3 (22:38):
So this is like we've talked about like the pros
almost exclusively here, right. Obviously there are some cons in
the fact if you go through the buffer, particularly with
the buyer ETF. But like one con that I know of.
You mentioned price return multiple times, So these things aren't
total return. So can you go into one why you're
using price return and not total return? So incomes aren't
(22:59):
accounted for here? And like what other cons are you
like seeing most people worried about.
Speaker 4 (23:05):
Yeah, so you know from our perspective there are cons.
I guess the con that would come to my mind
is you know your captain the upside. But in my
mind that's not a true con. The mistake that I
see James across the industry, and I see articles all
the time, and I think there's a little bit of
a misconception here. People compare the buffer ETF to the
reference asset. So they'll compare a fifteen percent buffer to spy.
(23:28):
They'll pull up a chart of twenty years and they'll
say this ETF underperforms. But I think there's kind of
just a fundamental misunderstanding of what the investment objective is
of the ETF. It's designed to deliver risk managed exposure.
It's designed to deliver that defined outcome. If you move
below the buffer, James, yes, you're going to take on
one to one downside, but you're still going to outperform
(23:49):
if you had just held unheadged equities. So you know,
from my perspective, the risk managed, the risk managed exposure
is built into the structure, and I think folks that
have usedtructured product, they get that, they're familiar with it.
Another thing that's come up, James, is what if we
buy the ETF in the middle of the outcome period.
What if we buy it at the wrong time, what
(24:10):
if we buy it in the markets up, I buy
it six months into the twelve month outcome period and
I have downside. And we, as kind of the pioneer
in the space, have put a ton of effort into
our website and our tools. So if you go to
our website, I would encourage folks to go to innovator
ETFs dot com. We've designed five different tools, a potential
outcome analyzer, a previous outcome analyzer, a personal outcome analyzer
(24:34):
to help you make sure that you're getting in at
the right point the outcome is exactly what you would
expect it to be and avoid any of those situations.
So those are the potential pitfalls that we've heard raised,
but those are easily addressable if you use some of
our tools.
Speaker 3 (24:50):
So I guess my next question would be, like when
rates were really low, when these things launched, the main
thing I saw people thinking about doing was if you
had a sixty to forty portfolio taken like a small
slug of their fix income and putting into these because
the risk was not nearly as high as just going
full equity, and they were trying to juice their returns
because they didn't have any income from their fix income.
Right now, rates are high, people have no problem getting income,
(25:13):
but you guys are still pulling in assets. I guess, like,
what are you seeing people actually doing in the allocation
side of this, Like where are they taking it from?
Are they taking it from an alts bucket? Are they
take it from the equity bucket fixed income? Like what
what are you seeing happening? And what type of allocations
are we seeing? Because I would say like people should
not be substituting their core equity exposure with these things,
But it makes sense in some regard like to take
(25:34):
maybe some of it if you're worried about risk over
the next year term or something like that.
Speaker 2 (25:37):
But how are you seeing people actually use these things?
Speaker 4 (25:41):
Yeah? Great, great question. So sixty twenty twenty is a
phrase that we've thrown around recently. We just published a
white paper on it. So, if you go back to
COVID rates went to zero, we saw a ton of
people move a lot of their bond exposure into buffers
to get more upside. They had squeezed all the juice
out of their bond allocation. They said, okay, we're going
to take some of that bond exposure and we're going
(26:03):
to put it into a buffer. Then we saw rates
go up, right, and something really interesting happened, James, and
this is why our product suite really can stand the
test of time in volatility and rates. When rates went up,
certain segments of our suite became very appealing. So, for instance,
we launched the first one hundred percent buffer ETFs last year,
(26:24):
which is basically a principally protected note equivalent in the
ETF wrapper, and rates were a key determinants of the
upside cap in that ETF, so you were able to
get around a nine to ten percent upside cap to
the s and P five hundred with full principal protection,
which was around two times what you were getting in
treasuries at the time. So the rate environment actually helped
(26:47):
products like that, and we saw one hundred percent buffer
ETFs used as sort of a cash substitute, cash compliment,
get that cash off the sidelines, but in sort of
a core allocation. Where does it fit We view these
ETFs for conservative investors, pre retirees, retirees. We see folks
pulling our thirty percent buffer or our bolts, our quarterly
(27:09):
twenty percent buffer, taking some of their bond exposure and
putting it in that highly defensive buffer ETF to get
more upside. The key thing to James Is and David
is taxes. This is something that keeps coming up. There
are ETFs now in the marketplace that it will not
be named, that are almost designed for that purpose to
deliver you just the price return and avoid that. It's
(27:30):
a nice consequence of the buffer ETFs that we are
not paying the dividends. We actually use that dividend to
finance a higher upside cap for our investors, So we
don't ever intend to pay out any sort of capital
gains distribution in the fund. These funds are designed to
deliver that price return, and that's intentional because clients don't
want to pay taxes. They want to insulate that they
(27:51):
want to defer taxes in the fund until the future
points and that's the benefit of the buffers. So James
I would say hadged equity conservative equity bond replacement. We
kind of see it run the gamut depending on the
buffal level.
Speaker 3 (28:04):
Alsome one last quick question before I hand it over
to Dave. You you talked about like there's other indices.
From the most part of what I'm seeing, all the
assets are for the most part in like S and
P five hundred of these products. So when we're talking
about the index of the underline track is the SMP
five hundred. But you mentioned flex options are available on
a bunch of other underlying indices. I know you guys
(28:25):
have tried with other different assets. Are you where are
you seeing demand? You're seeing demand anywhere other than the
S and P five hundred. Are you going to hopefully
are you looking to launch other products at some point
tracking underlying different underlying indices?
Speaker 2 (28:35):
Where else are you looking to do these.
Speaker 4 (28:38):
We are Yeah, that's spot on. So the majority of
the assets now live I think it's over eighty percent
live in the S and P five hundred complex. That
being said, we are far and away the largest provider
when it comes to the other indices, and by other
I mean Developed Markets EFA, Emerging Markets EEM, small Caps IWM, TLT,
(28:59):
as well as Deck one hundred, the cues. We have
monthly offerings on all of those ETFs, so fifteen percent
buffers on all of those ETFs with one year outcome periods.
We recently launched quarterly outcome periods with a ten percent
buffer on all of those. And to be honest with
you guys, the growth there is accelerating even faster than
(29:21):
the S and P five hundred complex. Over the past
two years, each of those reference assets, just to put
it in perspective, is approaching around a billion dollars, so
a lot smaller than the big pie, which is fifty billion.
But the reason that people are buffering those indices is
that they've typically underperformed like the small caps. Like people have.
People have been trying to time small caps for a
(29:41):
long time. Advisors have been in institutions, have been a
little bit tenuous when it comes to investing in those.
So we say, if you're considering it, use a buffer
avoid market timing, and if you're incorrect, you have that
built in protection in place.
Speaker 2 (29:55):
Awesome.
Speaker 3 (29:55):
You mentioned TLT, but we talked about a bunch of
equityts that's a long duration treasury ETF for those that
aren't sure what TLT is. So they're doing this on
fixed income too.
Speaker 1 (30:05):
So I was going to say before we let you go,
I actually have a question, and you know, it kind
of relates to what we were just talking about, and
so you mentioned all these other indexes and so you know,
my question is, really, do you have any predictions for
the future of buffer ETFs? And you know, part of
that is, you know, could there be a situation where
there are flex options on other types of indexes, even
(30:28):
you know, maybe smart beta you know, to try to
you know, do a buffer on a smart beta index,
or you know, just general predictions for the future.
Speaker 4 (30:37):
Yeah, this is this is really exciting. You know, when
we think about the total addressable market at Innovator, we
really look at structured products is our north star. When
we think about new products, we look at what's selling
in the structured node space. We think about what it
makes sense in the ETF wrapper, do advisors actually want it?
We speak to advisors a lot here, and advisor demand
(30:58):
drives the majority of our product. Looking at the numbers, David,
So around three hundred and eighty billion, I think was
the number last year in annuity sales across growth and
protection hedge funds. Don't even get me started. I think
there's like three trillion across the hedge fund space. Rylas,
which are more of an index linked annuity type product,
(31:21):
those sold about fifty billion last year and they're growing too.
This year. I think the expectations are that those numbers
are going to be twenty to thirty percent higher than
they were in twenty twenty three. So what does that
tell me? That tells me that if the structured note
world is still selling like hotcakes, we think we have
a better mouse trap that's more transparent, scalable, better for
(31:42):
advisors and institutional practices at Innovator. So you know, the
space is at fifty billion right now. I can you
could add a zero, I think to that AUM in
the next five to ten years. If we get to
the place that we want to be in terms of
investor education and delivering on what we're supposed to.
Speaker 1 (31:58):
Well, this is great. Burke, thank you so much for
joining us today.
Speaker 4 (32:01):
It was a pleasure. Guys, thanks for having me and James.
Speaker 1 (32:04):
Thank you for being my co host.
Speaker 2 (32:06):
Yeah, happy to do it. This is fun. I love
talking about this.
Speaker 1 (32:08):
Stuff until our next episode. This is David Cohne with
Inside Active
Host
Gina Martin Adams
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