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