Speaker 1: Welcome to Inside Active, a podcast about active managers that
Speaker 1: goes beyond sound bites and headlines and looks steeper 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. Today.
Speaker 1: My cost is James Seyffert, ETF analyst at Bloomberg Intelligence. James,
Speaker 1: thank you so much for joining me today.
Speaker 2: Yeah, thanks for having me, David, happy to be here.
Speaker 1: So in the ETF midyear Outlook, there was a section
Speaker 1: on ETF issuers flocking to vaneguard free zones to snag
Speaker 1: growth and revenue. One section is on buffer ETFs. Can
Speaker 1: you explain what a buffer ETF is and why they're
Speaker 1: called boomer candy?
Speaker 2: Yeah, I mean it's arguably one of, if not.
Speaker 3: The fastest growing areas of the ETF market in the US. Specifically, Really,
Speaker 3: anything that was providing income and with some sort of
Speaker 3: downside to volatility, decreasing volatility while capturing some sort of
Speaker 3: upside is doing really well.
Speaker 2: And buffers are a subset of that.
Speaker 3: Right, So within buffers, you what they use is they
Speaker 3: use derivatives to either completely diminish the downside over a
Speaker 3: specified time period, so over a year. So if you're
Speaker 3: investing the SMB of five hundred the queues you name it,
Speaker 3: essentially it's going to give you some sort of protection
Speaker 3: on the downside by selling derivatives or buying derivatives, and
Speaker 3: they're gonna sell derivatives on the upside, basically going to
Speaker 3: cap your exposure. So what they're doing is they're going
Speaker 3: to protect you at some to some level and downside
Speaker 3: in some cases to one hundred percent of your downside
Speaker 3: over a given time period. But in order to do that,
Speaker 3: you're going to have capped upside, so say nine percent
Speaker 3: right now in the current interest rate and environment. Well
Speaker 3: we can get into some of the more fine details there,
Speaker 3: but essentially what it's due if you're in an investor,
Speaker 3: you're protecting yourself a little bit and getting the upside.
Speaker 3: Maybe not the full upside, but it still looks pretty
Speaker 3: good and it's very defined. So this is very synonymous
Speaker 3: with like covered call products, where people are selling options
Speaker 3: on the overs on the upside in order to get
Speaker 3: income from selling those derivatives, and basically you're going to
Speaker 3: get decreased fall that income is going to protect you
Speaker 3: a little on the downside, but you don't know exactly
Speaker 3: how that's going to play out. With these buffer products,
Speaker 3: it's a lot more defined. And boomers, we say boomer
Speaker 3: candy because the people who are retired, that people are
Speaker 3: entering retirement, really care about that income piece and that
Speaker 3: downside protection and this is just like.
Speaker 2: It speaks to them very very well.
Speaker 3: And that's why things are selling very well, particularly for
Speaker 3: people who maybe are scared to go in the market
Speaker 3: fully don't want to take risk of full volatile of
Speaker 3: volatility of the stock market.
Speaker 2: This kind of speaks to them well.
Speaker 1: Speaking of buffer ETFs, we have Matt Kaufman, head of
Speaker 1: ETFs for Kalamos, and David o'donahue, co head of Alternative
Speaker 1: Strategies and head portfolio manager for the al the most
Speaker 1: structured protection ETFs with us. Matt Dave, thanks for coming
Speaker 1: on the podcast.
Speaker 4: Thanks for having us.
Speaker 2: Good to be here.
Speaker 5: Thanks, good to be here.
Speaker 1: Well let's start with Matt. Can you tell us how
Speaker 1: you got your start in ETFs and what it was
Speaker 1: like in the beginning years of the ETF.
Speaker 4: Sure, yeah, happy to I started my ETF career at
Speaker 4: power Shares in the early days. The interesting story there is.
Speaker 4: Your power Shares got its exemptive relief from a we'll
Speaker 4: say an unnamed Chicago based asset manager who had one
Speaker 4: of the only exemptive reliefs in the country.
Speaker 2: At the time.
Speaker 4: There were only a few out there that the SEC
Speaker 4: had granted. I think the statement that they had made
Speaker 4: was they thought all the good indexes were taken. You know,
Speaker 4: the S and P five hundred was taken, the NASDAQ
Speaker 4: one hundred was was an ETF, and so the diamonds
Speaker 4: was out there, and so they didn't think there was
Speaker 4: much more room for growth in the ETF space. You know,
Speaker 4: I say that kind of jokingly, but you know, the
Speaker 4: same is true here today. There's still a lot of
Speaker 4: innovation that can be had in the ETF world. But
Speaker 4: you know, when I was at power Shares there we
Speaker 4: launched well over one hundred ETFs building out the smart
Speaker 4: beta et F space. Most of the products were all
Speaker 4: market cap weighted back then, and so we were delivering
Speaker 4: smart beta type ETFs, delivering thematic ETFs, you know, bringing
Speaker 4: some of the first ETFs to market to bring access
Speaker 4: to spaces that investors just couldn't get get a hold of.
Speaker 4: But the ETF rapper really served to deliver that. So
Speaker 4: that's that's really where I cut my teeth, and ETFs
Speaker 4: learned a lot, you know about launching product, marketing products
Speaker 4: and working with financial advisors. It was a phenomenal opportunity.
Speaker 4: And then you know, power Shares sold to Investo, a
Speaker 4: lot of the partners retired, and I went over to
Speaker 4: an actual real consulting firm, which you know was you know,
Speaker 4: not in ETFs whatsoever. But you know, we learned a
Speaker 4: lot about risk management there, which we can touch on,
Speaker 4: but you' I'll stop there and pass it back over
Speaker 4: to you.
Speaker 1: Well that was great, now, David's your turn.
Speaker 5: Yeah. You know, I got started in the business and
Speaker 5: interested investing in college. I was a finance major, and
Speaker 5: like a lot of eighteen to twenty twenty two year olds,
Speaker 5: I had no idea what that actually meant and what
Speaker 5: to do with it. But I was lucky enough to
Speaker 5: get a job offer from a hedge fund that specialized
Speaker 5: in convert arb, which I think I had you know,
Speaker 5: one page and one book and one class about up
Speaker 5: until that point. But you know, it's interesting. It was
Speaker 5: you know, good hedge fund, good comp you know, it
Speaker 5: was actually local to where I grew up, so it
Speaker 5: was a great opportunity, so I jumped at it. And
Speaker 5: interesting side note to that, when I started, I accepted
Speaker 5: the offer and was still in college. They sent me
Speaker 5: two books to read to get up to speed, and
Speaker 5: one was McMillan's book and Options, which I think is still,
Speaker 5: you know, one of the go to option books. And
Speaker 5: the other was John Callamos's book on Convertibles, And so
Speaker 5: it was interesting. You know, it was exciting to join
Speaker 5: up with Calum most years later because you know, he
Speaker 5: legitimately wrote the book on convertible. But you know, convertibles
Speaker 5: is kind of a blend of bonds and options, and
Speaker 5: so everything that goes into valuing a bond, you know,
Speaker 5: interest rates, coupons, credit spreads, and everything that goes into
Speaker 5: valuing an option, you know, strike price, stock price, applied volatility,
Speaker 5: interest rates again, you know, all of that comes together
Speaker 5: and there's just so many moving parts, and when you
Speaker 5: add in hedging and shortening stock and CDs and bond hedges,
Speaker 5: there's just it's a big puzzle, you know, and trying
Speaker 5: to solve for the inefficiencies. And then you know, when
Speaker 5: you add in the cell side interaction and you know,
Speaker 5: I spotted this opportunity. Can I find somebody that actually
Speaker 5: has these bonds and while they sell them to me,
Speaker 5: and can I negotiate a better price. All of that
Speaker 5: was really right down the middle and kind of hooked
Speaker 5: from hooked early on. And you know, I've it's been
Speaker 5: the same ever since I've been I'm in my twenty
Speaker 5: fourth year now running convert and option related strategies and
Speaker 5: so you know, these buffer structured ETFs is kind of
Speaker 5: just another step that process of making something in the
Speaker 5: market I can use to move around to payoff and
Speaker 5: create a structure that makes sense for people.
Speaker 4: Cool.
Speaker 1: Well, you know James had mentioned, you know how buffer
Speaker 1: ETF's work in general, but Matt, you actually built the
Speaker 1: intellectual property for defined outcome ETFs. Can you kind of
Speaker 1: tell us how those work?
Speaker 4: Yeah, I had had an opportunity to have a role
Speaker 4: in that. So, you know, as I went over to
Speaker 4: Millman was the name of the firm, and they were
Speaker 4: a large actuarial consulting firm. As I went over there,
Speaker 4: it was around twenty ten, I believe, you know, interest
Speaker 4: rates were remarkably low, and so what we were doing
Speaker 4: was a lot of risk management strategies. We were building
Speaker 4: funds that were based off of the hedging strategies that
Speaker 4: we were running on the balance sheets of life insurance companies,
Speaker 4: and so we saw those risk management strategies work remarkably well.
Speaker 4: The interest rate environment that we were in, though, you know,
Speaker 4: really forced the insurance companies to move into this risk
Speaker 4: sharing model. You know, the cap rates that they could
Speaker 4: deliver on a fixed indexed annuity which gives you one
Speaker 4: hundred percent protection, were remarkably low. You know, that product
Speaker 4: set kind of went into the grave for a while.
Speaker 4: People weren't really buying fixed index annuities. The same was
Speaker 4: happening on the variable annuity. The guarantees that insurance companies
Speaker 4: could provide were very low because the interest rate environment
Speaker 4: was low, and we saw the same instructure products with
Speaker 4: the banks. You know, the cap rates were low on
Speaker 4: the principle protected strategies, and so what happened and it
Speaker 4: caused this move into what we would call partial principle
Speaker 4: protected world in that low rate environment where instead of
Speaker 4: one hundred percent protection, you know, an insurance company could
Speaker 4: afford to give you something less. We could give you
Speaker 4: a ten percent protection level or twenty percent protection level,
Speaker 4: or you could call it a buffer, you know, ten
Speaker 4: percent buffer on the S and P five hundred. Well,
Speaker 4: then you could give somebody a meaningful upside cap rate.
Speaker 4: And so we saw that moving through the insurance space
Speaker 4: and through the banking space and really looked back. This
Speaker 4: is around twenty fifteen, twenty sixteen, and we just were
Speaker 4: talking one day and said, you know, you can build
Speaker 4: that model very efficiently using options. We do not need
Speaker 4: a balance sheet from a bank or an insurance company
Speaker 4: to deliver a buffer on the S and P five hundred,
Speaker 4: and so we built some intellectual property that held a
Speaker 4: series of options positions that all expired on the same
Speaker 4: day and could deliver the upside to a cap relative
Speaker 4: to the S and P five hundred and a buffer
Speaker 4: level of what we determined. And you put all those
Speaker 4: in options positions, and then we developed that through a
Speaker 4: series of indexes, and then we built those within unit
Speaker 4: investment trusts. We built those types of strategies in annuity
Speaker 4: products through variable sub accounts, and then helped build the
Speaker 4: first defined outcome ETFs in the market as well. Those
Speaker 4: were launched in two thousand eighteen and really set the
Speaker 4: stage for the buffered ETF space. Remember we filed for
Speaker 4: those products in twenty seventeen. You know, normally it's a
Speaker 4: seventy five day SEC approval, you know period, and the
Speaker 4: SEC will take you know, roughly thirty forty five days
Speaker 4: to get back to you. They they called about two
Speaker 4: hours into the filing and said, what is this. We said, oh,
Speaker 4: we're replicating a structured outcome inside of an ETF And
Speaker 4: they said, okay, that's what we thought you were doing.
Speaker 4: We're gonna have to talk about this one, you know,
Speaker 4: And it took several months back and forth to get
Speaker 4: everybody comfortable with, you know, what was actually being delivered.
Speaker 4: But you know, fast forward, you know, seven eight years
Speaker 4: here and it's more than a fifty billion dollars space.
Speaker 4: Interest rates are obviously much higher, and so I came
Speaker 4: over to Calamos last year to build out the active
Speaker 4: ETF business. You know, there were some SEC rule changes
Speaker 4: that active ETF space is growing tremendously and so as
Speaker 4: I came over, you know, we're watching that rate environment.
Speaker 4: Interest rates are off of zero. You know, we're watching
Speaker 4: people buy fixed index annuities again. People are trying to
Speaker 4: you know, go after that five percent yield now that
Speaker 4: rates are higher and their CDs and money market funds,
Speaker 4: and so the space that we wanted to capture at Kalamos.
Speaker 4: We didn't want to be the tenth buffer ETF provider,
Speaker 4: but the capital protected ETF space, the one protection space,
Speaker 4: was ripe for the taking. And so that's what where
Speaker 4: we're operating in today. You know, I sat down with
Speaker 4: Dave o'donna. He was one of the first people I
Speaker 4: met at Calamos. I think I set up a two
Speaker 4: hour meeting with Dave to talk through these you know,
Speaker 4: quote buffer ETFs. He kind of super nice guy. He
Speaker 4: kind of put up his hand five minutes in He's like,
Speaker 4: I get it. He's like, we've been watching these. We
Speaker 4: really like what what you've done. Let's roll. And so,
Speaker 4: you know, it was a great match, you know, to
Speaker 4: come to Calamos, you know, who's been doing risk management
Speaker 4: for nearly fifty years. You think about John Calamos building
Speaker 4: and writing the book on convertibles, building one of the
Speaker 4: first convertible funds in the market, right around the same
Speaker 4: time that options actually opened on the CBO, you know,
Speaker 4: Chicago Board Options Exchange. And so you fast forward forty
Speaker 4: five years to today and we're still delivering risk management.
Speaker 4: We're still using options. The tools have evolved remarkably. The
Speaker 4: flex options which we can get into you didn't exist
Speaker 4: till nineteen ninety three. But all that said is, you know,
Speaker 4: Calamos was really well positioned to continue this trajectory of
Speaker 4: risk management for investors.
Speaker 1: So I guess this one's for Dave. How does the
Speaker 1: structured protection strategy work in an ETF such as CPSM
Speaker 1: or the Calamos S and P five hundred Structured at
Speaker 1: protection ETF?
Speaker 5: Yeah, it's you know, at its core, it's it's simply
Speaker 5: a product that uses a package package of options to
Speaker 5: create a payoff with no downside and some amount of upside.
Speaker 5: You know, people people talk a lot about rising rates
Speaker 5: and higher rates and the impact that has on fixed
Speaker 5: income and treasury yields, but they'd don't always think about
Speaker 5: the impact that has on option pricing. You know, as
Speaker 5: I mentioned earlier, interest rates are one of the factors
Speaker 5: that goes in to valuing options. And you know, twenty
Speaker 5: five basis point move here or there doesn't matter that much,
Speaker 5: but when you go from zero to five like we
Speaker 5: did recently, it does matter a lot. And so you know,
Speaker 5: as Matt said, it's kind of an extension of some
Speaker 5: of the other option related strategies and hedge equity strategies
Speaker 5: that you know we run and other people run. You know,
Speaker 5: if we have one of our flagship funds that I
Speaker 5: work on as our market neutral income fund, which is
Speaker 5: really a fixed income alternative, but it has a hedged
Speaker 5: equity sleeve. And so you think about the impact on
Speaker 5: rates have on option prices. When rates are higher, call
Speaker 5: prices are higher and put prices are lower. And so
Speaker 5: you know, setting up a hedge hedging out exposure. You
Speaker 5: can buy a put and sell a call, and that
Speaker 5: hatches out your exposure. When you have zero interest rates,
Speaker 5: that put costs you more than you get for selling
Speaker 5: a call. Specifically, you mentioned you know CPSM and one
Speaker 5: year SMP options. You know, you had to pay more
Speaker 5: for an at the money put than you'd get for
Speaker 5: that call. So you were paying to hedge. You know,
Speaker 5: fast forward to five percent risk free or five and
Speaker 5: a quarter risk free. Now you're getting paid to hatch.
Speaker 5: That put costs you less than you're taking in for
Speaker 5: the call. You can actually almost buy two puts for
Speaker 5: every call you sell, and so for our market neutral fund,
Speaker 5: which is more of the fixed income alternative. We're buying
Speaker 5: that put, selling that call, taking the extra money as income,
Speaker 5: and that kind of creates that steady, stable return that
Speaker 5: you expect out of bonds. If you move a step
Speaker 5: further to hedge equity, instead of taking that extra money,
Speaker 5: you can use that ratio to create a positive a symmetry.
Speaker 5: You know right now you can actually if you buy,
Speaker 5: you can buy point sixty five puts for every point
Speaker 5: three to five calls you sell. And if you own
Speaker 5: the underlying and do that, you set up a structure
Speaker 5: where you get sixty five percent of the upside and
Speaker 5: only thirty five percent of the downside. And you know
Speaker 5: that's attractive for people who want to have equity exposure,
Speaker 5: not capped upside, and are willing to take some risk.
Speaker 5: But then we took it another step further, and this
Speaker 5: is where you know Matt came in. You know, this
Speaker 5: is something we've been looking at already, is well, what
Speaker 5: if you want no downside? You know what can I
Speaker 5: do then? And so instead of having that thirty five
Speaker 5: percent downside, we took that to zero. You buy full
Speaker 5: put protection. You know what can I get you know
Speaker 5: I can. I don't have to sell you know, one
Speaker 5: call to pay for it. Or what what we do
Speaker 5: when a lot of people do is instead of selling
Speaker 5: a lower amount of at the money calls, we move
Speaker 5: that call strike up and it becomes you know, how
Speaker 5: high a call strike can I sell to pay for
Speaker 5: the cost of that put. And that's really how these work.
Speaker 5: You're taking advantage of that dynamic of option pricing where
Speaker 5: the you know, the put costs less than the call
Speaker 5: and using that to create that package where you have
Speaker 5: full put protection. You know, we own full at the
Speaker 5: money put protection. That's how you can protect people and
Speaker 5: give them one hundred percent downside protection and we don't
Speaker 5: have to sell and at the money call to pay
Speaker 5: for that. And you know we can sell a higher
Speaker 5: you know, farther out of the money call and give
Speaker 5: people some amount of upside. And you know that's really resonated.
Speaker 5: You know, each of those each of those structures is
Speaker 5: leaning in. Each of those funds is leaning on that
Speaker 5: same option dynamic, but it's doing it with a different
Speaker 5: end use for a different investor base. And I think
Speaker 5: you know, this has has been a natural fit, as
Speaker 5: James mentioned, for a lot of people you know. You know,
Speaker 5: my dad included who you know, wanted exposure to the markets,
Speaker 5: loved being in the markets, but just was so scared
Speaker 5: of a down forty percent, you know, and he couldn't
Speaker 5: take that. And so you know, it fits for a
Speaker 5: lot of people, this new structure.
Speaker 3: Sticking along the lines of what you were just talking about,
Speaker 3: can you get into a little bit more about the
Speaker 3: of the specifics of like how that cap is determined.
Speaker 3: You talk about you have to sell the put get
Speaker 3: the one hundred percent, but like what factors go into
Speaker 3: determining what that cap is going to be?
Speaker 5: Yeah, I mean, simplistically, as I mentioned, it's just what call,
Speaker 5: what how far up that strike is that we need
Speaker 5: that we can sell to fully fund the puts. Basically
Speaker 5: there's a little bit of extra things in there. You know,
Speaker 5: that zero strike doesn't trade exactly at intrinsic you know,
Speaker 5: and all of that. But but basically we want to
Speaker 5: make that that package cost zero so at the end
Speaker 5: of that one year outcome period, if the market is
Speaker 5: flattered down, you still have your your same investment.
Speaker 4: I would say. One of the ways that we explain
Speaker 4: this to our advisors who they use this analogy when
Speaker 4: they're talking to their clients. Just to make it really
Speaker 4: simple for them is just to pretend like I give
Speaker 4: you one hundred dollars and then we can recreate that exposure. So,
Speaker 4: you know, if we one hundred dollars, we're going to
Speaker 4: take about ninety eight of those dollars to buy our
Speaker 4: participation layer, which will give you the upside and downside
Speaker 4: exposure of the S and P five hundred and you know,
Speaker 4: the technically it's a deepen the money or a near
Speaker 4: zero strike call. Like Dave said, the next layer, we're
Speaker 4: going to spend four dollars on an at the money
Speaker 4: put and so that's going to be paying off all
Speaker 4: along the way, you know, as the market goes down.
Speaker 4: And so if you've been following along, we've spent ninety
Speaker 4: eight on your participation leg, four dollars on your put leg,
Speaker 4: so we've overspent. We've spent one oh two. And that's
Speaker 4: where the you know, no free lunch comes into play.
Speaker 4: So to bring that back to one hundred dollars, we're
Speaker 4: going to sell off enough upside to collect two dollars
Speaker 4: worth of premium and whatever the out of the money
Speaker 4: strike prices of that call that we have to sell
Speaker 4: is to collect two dollars, determines your upside cap and
Speaker 4: so that's where the cap comes from. So right now,
Speaker 4: that caps you know, around eight to nine percent, depending
Speaker 4: on the underlying re and saaset.
Speaker 5: That you use.
Speaker 3: So if we're at that eight to nine percent right now, like,
Speaker 3: how will I mean everyone's expecting rates to fall? First
Speaker 3: cuts are likely coming in September. How much of an
Speaker 3: impact will falling interest rates have on like how high
Speaker 3: that cap is going to be or how low that
Speaker 3: cap is going to be?
Speaker 4: For Yeah, Dave can check my math here, but you know,
Speaker 4: roughly you can expect that we'll deliver about twice the
Speaker 4: one year risk free rate. And so if rates settle
Speaker 4: let's say long term average one year risk free rate
Speaker 4: around three percent, you'll see a cap rate on the
Speaker 4: SMP of around six percent, maybe a little higher for Nasdaq.
Speaker 2: And then the.
Speaker 4: Russell has a little more volatility, but still a good
Speaker 4: a good dev yield, and so the Russell cap will
Speaker 4: be a little bit higher still, but comparing to like
Speaker 4: your alternative, let's compare to your CD or a bond.
Speaker 4: You know, if you bought a CD at the one
Speaker 4: year risk free rate of three percent. You're going to
Speaker 4: collect that guaranteed three percent, but then you're going to
Speaker 4: pay tax, you know, ordinary income tax on that three percent,
Speaker 4: so you're three will turn and into about two percent,
Speaker 4: depending on your tax bracket. So the opportunity would be
Speaker 4: to turn in that guaranteed two percent and own the upside.
Speaker 4: Tie your cash to the upside of an equity market.
Speaker 4: In this case, you get up to six percent in
Speaker 4: our example, but then that money grows and stays in
Speaker 4: the ETF. It can grow tax deferred, and then you
Speaker 4: pay long term capital gains rates at the end. So
Speaker 4: no matter how low rates go, you're still going to
Speaker 4: have something meaningful over the risk free rate. So if
Speaker 4: it's a bond alternative, you're going to be your opportunity
Speaker 4: is going to be a lot more significant than just
Speaker 4: owning that bond out right. And then if rates are
Speaker 4: you know that three to five percent range, which is
Speaker 4: where we're at today I think four fifties last time
Speaker 4: I checked, then you're going to have upside near the
Speaker 4: average historical return of the S and P five hundred.
Speaker 4: So it is a very good trade off there as well.
Speaker 4: But they feel free to correct anything I think we
Speaker 4: got it there.
Speaker 5: Yeah, No, I mean I think as you mentioned, I
Speaker 5: mean we you know, for our market neutral income fund,
Speaker 5: we raise a ton of money when rates were zero
Speaker 5: because people we were able to kind of consistently give
Speaker 5: a four to six percent return and you know, you forget,
Speaker 5: but that was really in the sweet spot for a
Speaker 5: lot of people. So I think it'll be interesting to see,
Speaker 5: you know, these products didn't exist really then, and so
Speaker 5: if we get not that anybody's expecting to get back
Speaker 5: down to you know, rates of zero. But you know,
Speaker 5: if we if we really have a pullback on rates,
Speaker 5: you're going to see those caps come down, as Matt mentioned,
Speaker 5: But I still think it is an interesting alternative for
Speaker 5: a lot of people. So we'll see, we'll see how
Speaker 5: they react to that. And as Matt said, it probably
Speaker 5: transitions a little bit from more of an equity alternative
Speaker 5: to a little bit of a fixed income alternative. But
Speaker 5: potentially when you see that come down, But but it'll
Speaker 5: be interesting to see how that that dynamic shifts.
Speaker 2: And and what what.
Speaker 3: So we just talked about rates, like is there anything
Speaker 3: else that's as impactful as rates and figuring out is.
Speaker 5: Implied volatility matters, and and really more specifically, skew matters,
Speaker 5: you know, because what the volatility of that call you're
Speaker 5: selling relative to the volatility that puts you're buying matters,
Speaker 5: and so that will change it in generally flat skew
Speaker 5: is a little bit better and lower ball is a
Speaker 5: little better so for creating that cap, so that that
Speaker 5: will matter a little bit, but rates is kind of
Speaker 5: the bigger driver of it.
Speaker 3: Great, And then how much of this is like you
Speaker 3: just talked like you're basically going to spend those two
Speaker 3: dollars no matter what you have to do to offset that,
Speaker 3: But like how much of that is automated? Like are
Speaker 3: you putting it out for people to bid on it?
Speaker 3: Like what is the actual process? How much of it
Speaker 3: is like passive in a way, and how much of
Speaker 3: it is like actually somebody out there actively trying to
Speaker 3: get the best deal you can to get the highest cap.
Speaker 4: Yeah. I think in terms of the active ETF space,
Speaker 4: we see a lot of buffer and capital protected ETFs
Speaker 4: filed is active, and so I think the important point
Speaker 4: to note here is that if ETF filed is active,
Speaker 4: simply means that it does not track an index, and
Speaker 4: so a lot of these ETFs are filed as active ETFs,
Speaker 4: but they don't track an index per se. They actually
Speaker 4: they track an underlying reference asset, and so there's a
Speaker 4: legal framework there as far as understanding goes. But you know,
Speaker 4: there's a lot of active ETFs that trade every single day.
Speaker 4: They're always moving around discretionarily. But for these types of ETFs,
Speaker 4: the goal is to deliver the upside to a cap
Speaker 4: with a built in protection level over that one year
Speaker 4: outcome period. And so the trading happens really once a
Speaker 4: year where we enter into these options positions, those positions
Speaker 4: are set and then they trade that package all throughout
Speaker 4: the whole next year. And so as people get in
Speaker 4: and out of those products, they can go to our
Speaker 4: website and you can see exactly what your outcome would
Speaker 4: be if you were to buy today. And so we're
Speaker 4: seeing a lot of active traders use these products. It's
Speaker 4: in a tactical or an active way to get in
Speaker 4: and out and finding opportunities there. But as far as
Speaker 4: the active management goes, you know, there's certainly a process
Speaker 4: on day one to bid out that that options package
Speaker 4: get the best cap rate possible. But then once that
Speaker 4: trade is set, it really is set for the life
Speaker 4: of the product.
Speaker 5: Yeah, there's a little bit of cash management and managing
Speaker 5: that cash drag versus you know, paying fees and a
Speaker 5: few things we kind of have to do along the
Speaker 5: way potentially, But the create redeemed process actually runs pretty smooth.
Speaker 1: You know.
Speaker 5: You think about the market makers out there making markets
Speaker 5: in it. Eventually he gets short enough that he goes
Speaker 5: to the AP authorized participant to create more. They come
Speaker 5: to us. It's cash creates. They give us cash, we
Speaker 5: farm out. That trade goes out to I think five
Speaker 5: different counterparties who bid on it, you know, best price
Speaker 5: gets it. The cool thing is that that trade prints
Speaker 5: at the close of the market and so those prices
Speaker 5: are used to set the NAV for that day, which
Speaker 5: is where how you know, what determines how much money
Speaker 5: comes in for that create. So it all works pretty
Speaker 5: pretty small than seamless, you know. So better prices or
Speaker 5: package on that option package isn't going to change your
Speaker 5: cap over the course. It's just going to change your
Speaker 5: NAV and your price. So the investor doesn't really have
Speaker 5: to worry about any of that. All they have to
Speaker 5: worry about is what price am I buying it at?
Speaker 5: And you know, if you're buying it a little bit
Speaker 5: above the starting price or below the starting price, that's
Speaker 5: going to change your cap and your downside protection levels.
Speaker 5: But you can make that determination for yourself, and as
Speaker 5: Matt said, you can go to our website and see
Speaker 5: exactly what you know. Here's the price and here's what
Speaker 5: the indexes and what does that mean for me today?
Speaker 3: Yeah, So, Matt, so we talked at the beginning like this,
Speaker 3: we refer to these types of strategies as boomer candy.
Speaker 3: People that are retired or near retirement tend to love these.
Speaker 3: But Matt also spoke about like people using these tactically
Speaker 3: in some ways. I guess who are the end clients? Like,
Speaker 3: what can you talk about like the buckets of your
Speaker 3: what you're seeing and how these things are being used
Speaker 3: from your point of view.
Speaker 4: Yeah, I think Eric made a great comment about boomer candy.
Speaker 4: I thought that was, you know, aptly put. We're seeing
Speaker 4: people use this for I would call safe money, you know,
Speaker 4: whether that's shorter term money that people might have a
Speaker 4: need for and you know, one two years out, but
Speaker 4: being able to tie their cash to the equity markets
Speaker 4: and get that upside potential with no downside risk over
Speaker 4: the outcome period, you know, opens up a lot of
Speaker 4: doors for folks. So people who might be looking at
Speaker 4: CDs or capital protected structured notes, fixed index ainuities are
Speaker 4: looking at these products as tax advantaged alternatives. And then
Speaker 4: we're also seeing people de risk their equity exposure today
Speaker 4: using these types of products. So if you were to
Speaker 4: move into one hundred percent protection ETF, you know, you
Speaker 4: would obtain that one hundred percent protection, But if you
Speaker 4: just moved a portion of your equities in, you can
Speaker 4: see how as an advisor, you can work with your
Speaker 4: client to determine exactly how much risk do you want
Speaker 4: to take over the next you know, six months, twelve months,
Speaker 4: whatever that is, and you can dial that in exactly.
Speaker 4: So let's say you want to take half your equity
Speaker 4: risk off the table. Well, now i can move half
Speaker 4: my equities into a structured protection ETF, and now I've
Speaker 4: got fifty percent downside protection because I've moved half my
Speaker 4: equities in, but that zero to call it nine ten
Speaker 4: percent upside, you're still going to capture one hundred percent
Speaker 4: of that move because you've got that upside to a
Speaker 4: cap and then above the cap instead of being capped out,
Speaker 4: you're going to capture fifty percent of every move above
Speaker 4: the cap. So we're seeing advisors use this as an
Speaker 4: equity risk management tool, portfolio risk management tool. And then
Speaker 4: to speak, you know, directly to the Boomer Candy comment,
Speaker 4: retirees are using these in a big way. You know,
Speaker 4: there's institutions that have similar spending mandates, like pension plans,
Speaker 4: and so the way that retirees are using these, you know,
Speaker 4: they have to solve for a number of risks that
Speaker 4: they see in retirement, and a lot of them are
Speaker 4: largely financial. There's longevity risk, you know, being able to
Speaker 4: outpace you know, or outlive there spending. There's inflation risk,
Speaker 4: the ability to actually out earn the inflation rate is
Speaker 4: a huge risk for retirees. You know, like folks like
Speaker 4: us are working. We can still get pay adjustments and
Speaker 4: you know, can help pay for ourselves. But if once
Speaker 4: you're retired, you're locked in. You might get a Social
Speaker 4: Security adjustment, but you've got to be in the equity
Speaker 4: markets if you want to outpace inflation. And so this
Speaker 4: gives retirees an opportunity to outpace inflation over time, but
Speaker 4: do so with very little risk. The volatility on these
Speaker 4: strategies is in the low single digits. It's like two
Speaker 4: to three percent. And then the volatility piece is big
Speaker 4: for retirees. You know, if you're younger, you can afford
Speaker 4: to wait out the storms, ride out all of the
Speaker 4: volatility in the markets. But as you age, you know,
Speaker 4: you shorten your time horizon. You've got to have more
Speaker 4: safety to your money. And so this really allows or
Speaker 4: tirees to solve for all three of those risks in retirement.
Speaker 2: And then along what we're talking about here.
Speaker 3: So if you're taking David, you kind of hinted at this,
Speaker 3: you said some if rates go I think you said,
Speaker 3: if rates go down, this might become more of a
Speaker 3: bond alternative. But if we're looking at like a sixty
Speaker 3: forty portfolio, you gave a great example of like somebody
Speaker 3: who wants to de risk their equity side. But like,
Speaker 3: are people actually taking this from like like I said,
Speaker 3: in standard sixty forty? Are they taking it from the equity?
Speaker 3: Are they taking it from the fixed income. When I
Speaker 3: first started hearing about these like five ish years ago,
Speaker 3: I heard some people saying, like, well, bonds are yielding
Speaker 3: zero percent, So I'm basically doing this as a bond alternative.
Speaker 2: How are you seeing advisors do this?
Speaker 3: Are they putting it in a portfolio as again like
Speaker 3: you talked about to decrease the risk and equities? Are
Speaker 3: they doing it to juice up their fixed income? Are
Speaker 3: you seeing both like? And then how do you see
Speaker 3: that changing if rates do go down as you were
Speaker 3: talking about before, David.
Speaker 5: Yeah, I mean I think a lot of people you
Speaker 5: know right now it's Matt probably is a better idea
Speaker 5: of the end client, but it's it's at you know,
Speaker 5: alternative to CDs and you know, treasuries and whatever for
Speaker 5: the for the you know, the lower risk clients. I
Speaker 5: think at the advisor level, it's more coming out of
Speaker 5: equity right now. It's as Matt said, people you're using
Speaker 5: it to dial up and down risk. We had a
Speaker 5: big call with a client who ended up being a
Speaker 5: bigger investor in one of the series and they wanted
Speaker 5: to make a tactical bet on that underlying index, and
Speaker 5: but they were concerned about, you know, a bigger move
Speaker 5: to the downside, right, you know, having that negative skew,
Speaker 5: like if we think it's going to go up, but
Speaker 5: if it doesn't go up, and this really is a
Speaker 5: change of timing. We're worried about it being a bigger
Speaker 5: move down, and so they used it to tactically make
Speaker 5: that bet. And so I think for advisors you're going
Speaker 5: to have more tactical equity uses, and then for the
Speaker 5: retail clients you're going to have more. I just want safety,
Speaker 5: and you know, I don't want four per As Matt said,
Speaker 5: if you do the math on treasuries after paying ordinary
Speaker 5: income on it, you know, and you compare that to
Speaker 5: the potential outcome here and the tax advantages of an ETF,
Speaker 5: that's more of the trade offs I think people are
Speaker 5: looking at on the retail side.
Speaker 4: Yeah. I think when interest rates we're low, you know,
Speaker 4: people struggled to use fixed income for risk management and
Speaker 4: for income purposes. The light bulb moment for a lot
Speaker 4: of advisors is when they realize that you can use
Speaker 4: equity growth for providing income. You know, you don't have
Speaker 4: to just look at what's the yield number that I'm
Speaker 4: earning on this as far as income. But if you
Speaker 4: can use protected equities or the structured protection equity, something
Speaker 4: with a built in protection mechanism, well, now you can
Speaker 4: use the equity markets for risk management, because now you've
Speaker 4: got products that can deliver the risk management you're looking for.
Speaker 4: And if you can ride that equity growth up to
Speaker 4: nine ten percent cap and then pay yourself from that growth,
Speaker 4: you know you're you're going to be able to do
Speaker 4: over time a lot better than just a yield from
Speaker 4: you know, a bond that you might get. So when
Speaker 4: we talk to advisors, you know, it's not necessarily an
Speaker 4: either or you know, do I take this from equity?
Speaker 4: Do I take it from fixed income? But the light
Speaker 4: bulb moment really goes off for advisors when they realize
Speaker 4: they can now use, you know, more of their equity
Speaker 4: sleeve to help generate income. And it's a much more
Speaker 4: tax efficient way to do it than just to take
Speaker 4: a take a yield coupon that's being kicked off to
Speaker 4: you and then paying ordinary income rates on it. Here,
Speaker 4: if you hold it for a year, then you start
Speaker 4: paying yourself from that growth. You're generally going to earn
Speaker 4: more and you're going to be paying long term capital
Speaker 4: gains rates, which is which is more more times than
Speaker 4: not better.
Speaker 3: Yeah. So I mean, right now, from my point of view,
Speaker 3: for anyone listening, they're probably like all right, this sounds
Speaker 3: too good to be true, and I think there are
Speaker 3: a few things that we should talk about like the
Speaker 3: pros and cons here.
Speaker 2: Like so, like what is the catch? Here?
Speaker 3: Is the catch that you're just capped and over the
Speaker 3: long term you're definitely going to underperform. Like what other
Speaker 3: catches are there that you would basically warn people about
Speaker 3: when they're trying to use these products so they know
Speaker 3: what they're getting themselves into.
Speaker 4: Yeah, So personally, I view this more as opportunity costs
Speaker 4: than risk. You know, these products have been in the
Speaker 4: market for quite some time. They've withstood several tests. You know,
Speaker 4: we had one at the beginning of August again, market
Speaker 4: was down, you know, six percent, the structured protection ETFs,
Speaker 4: you know, the August series was down I think eighty
Speaker 4: basis points. So that the protection is holding up even
Speaker 4: intra period. It's not just over the outcome period. But
Speaker 4: with that at the money put you're getting protection all
Speaker 4: along the way. So we're seeing these products work extremely well.
Speaker 4: I think when you you know, when you're building risk
Speaker 4: managed products, if you if you're building technology products, you
Speaker 4: can build the beta version. You know, you can put
Speaker 4: out AI and try to generate the image of somebody's
Speaker 4: face and the eye you know, I looks crooked and
Speaker 4: the noses off. But it's like, Okay, I'm going to
Speaker 4: build the next version. But like, you can't do that
Speaker 4: with financial services products, like you have to innovate and
Speaker 4: you have to innovate with security. And we spent a
Speaker 4: lot of time making sure that these were built the
Speaker 4: right way, in a way that works, in a way
Speaker 4: that you know, retirees and pension plans and folks can
Speaker 4: trust that they will work going forward. One of the
Speaker 4: main things that help these work efficiently is the use
Speaker 4: of the flex options. So you know, we use flex
Speaker 4: options on some of the most liquid markets in the world,
Speaker 4: the S and P five hundred, the Nasdaq one hundred.
Speaker 4: We don't build these on you know, ill liquid reference
Speaker 4: assets that you know might price well or give you
Speaker 4: a good cap, but may not actually trade well in
Speaker 4: real time, And so we build these on very liquid markets.
Speaker 4: But we use the flex space because it allows us
Speaker 4: to customize those options. We can choose the exact strike
Speaker 4: prices that we need, the expiration, the style which we
Speaker 4: didn't get into here, but we want them to be
Speaker 4: European style, not American style, so they all expire on
Speaker 4: the same day and don't get called away along the way.
Speaker 4: So all that work has gone into this, you know,
Speaker 4: call it eight years ago or so, and people are
Speaker 4: benefiting from that today. So the opportunity costs in would
Speaker 4: be that you're capped out on the upside, like there
Speaker 4: is no free lunch. We're selling that out of the
Speaker 4: money call in order to fund the protection level. So
Speaker 4: those are the trade offs that you can think about.
Speaker 4: But you know, as far as like, as far as
Speaker 4: actual risks, the counterparty for these options is the Options
Speaker 4: Clearing Corporation. It's a too big to fail organization of
Speaker 4: financial market utility as it designated by the Dodd Frank Act,
Speaker 4: and so the occ would need to fail for there
Speaker 4: to be some sort of liquidity, you know, crisis in
Speaker 4: these types of products. But Dave, I don't know if
Speaker 4: you have anything else to add there.
Speaker 2: No.
Speaker 5: I think it was interesting when we first announced this, James,
Speaker 5: and you know, there was a couple of stories about it.
Speaker 5: It was amazing that the the comments where you know,
Speaker 5: first was this is too good to be true. There's
Speaker 5: you know, it's got to be something hidden in there
Speaker 5: that these guys are stealing from you, whatever it is,
Speaker 5: and then there's the equal there's not equal, there's less
Speaker 5: of them. But there was a people out there saying, no,
Speaker 5: this is just a simple option trade. You know, you
Speaker 5: could do this, and you know, and so having both
Speaker 5: of those spectrums that this is pretty simple and also
Speaker 5: too good to be true, I thought was pretty pretty
Speaker 5: interesting and probably a pretty good sign we were on
Speaker 5: the right track. But really it's it's closer to the
Speaker 5: other side. I mean, there's nothing that incredibly complex about
Speaker 5: these structures. It's just something that's really hard to do
Speaker 5: for retail or even an advisor. You know, you need
Speaker 5: an institutional options presence. You need the ability to do
Speaker 5: the flex contracts, you need the ability to put it
Speaker 5: in that ETF wrapper to get all of the benefits,
Speaker 5: tax benefits and other benefits of that. And so having
Speaker 5: the capabilities, the institutional capabilities to put all of those
Speaker 5: together and trade it, and the relationships to be able
Speaker 5: to farm it out and get good pricing on that
Speaker 5: and all of that. You know, that's something that you know,
Speaker 5: just retail and even advisors can't just can't do on
Speaker 5: their own. But you know, it's something that we you know,
Speaker 5: somebody with eight institutional option capabilities can do and so
Speaker 5: you know, there's no there's no you know, inherent risks
Speaker 5: and leverage and you know, anything that's really going to
Speaker 5: create any issues. It's it's a pretty simplistic option structure.
Speaker 5: It's just having the ability to create that and get
Speaker 5: pricing on that that works and all and and be
Speaker 5: able to put it in that et F rapp or
Speaker 5: that's really you know the thing that that that we
Speaker 5: can provide that that you know people can't provide for themselves.
Speaker 2: Yeah, I think if the OCC fails, the least.
Speaker 3: Of your concerns is going to be what happened to
Speaker 3: the structured product structured product.
Speaker 2: ETF I invested in.
Speaker 3: So, I mean, this is just a trend that we've
Speaker 3: seen that a lot of a lot of ETFs and
Speaker 3: what a lot of the growth we're seeing is it's
Speaker 3: packaged trades. And as far as I'm concerned, this is
Speaker 3: just etfizing structured products. And that's that's the overarching trends
Speaker 3: we're seeing with these buffer products. And the one thing
Speaker 3: I wanted to go back to is something that Matt
Speaker 3: said talking about the outcome period these things like they
Speaker 3: give you a hundred percent protection over the outcome here,
Speaker 3: and he talked about the fact that it was slightly
Speaker 3: down in August, and that's because that's not over the
Speaker 3: full outcome period. So I think that's the that might
Speaker 3: be another catch that people need to make sure they
Speaker 3: understand before they go into this.
Speaker 5: Yeah, for sure they are going to move they will
Speaker 5: move down a little bit early. Like you said, if
Speaker 5: you wait, If you wait, you can kind of you
Speaker 5: will get that back, but there is a little bit
Speaker 5: of mark to market risk. I think the interesting thing
Speaker 5: versus structured products, though, as you mentioned, is that if
Speaker 5: you ideally you wait for the entire outcome period, right,
Speaker 5: that's where you're going to get that full protection. That's
Speaker 5: where you're going to get that full cap. But you
Speaker 5: also don't have to you know, these are really liquid
Speaker 5: and pretty tight bit das spreads, and you know, yeah,
Speaker 5: it was down a little bit with the market down,
Speaker 5: but you know you could get out at that point,
Speaker 5: versus structured products, which are you know, a lot tougher
Speaker 5: to get out and a lot less liquidity along the way.
Speaker 5: And so I think that is you know, it's having
Speaker 5: a little bit of that mark to market movement is
Speaker 5: a little bit of a downside, but when you compare
Speaker 5: it to kind of some of the other structured products,
Speaker 5: it's the liquidity that you can get if you do
Speaker 5: want to monetize it is still it's still more of
Speaker 5: a pro in my mind.
Speaker 3: I mean, it's also way more opaque, often much higher fees.
Speaker 2: So I mean, I would say this, in my view,
Speaker 2: this is better.
Speaker 3: It's just you can't customize it quite as much as
Speaker 3: you could with a structure product. That's the only the
Speaker 3: main difference in my mind. I've asked a lot of questions,
Speaker 3: so I'll pass it over to David the mainos to
Speaker 3: come back and ask them more important questions.
Speaker 1: Well, actually, you know, we're kind of hitting our time limit,
Speaker 1: but I do have one question for the both of you.
Speaker 1: First we'll start with Dave. Any prediction for the future
Speaker 1: of back to ETFs.
Speaker 5: Yeah, I mean, I think you know, once you get
Speaker 5: more people comfortable with the structures, you know you're going
Speaker 5: to continue to see it grow. And I said, there's
Speaker 5: still you know, the flexibility and you know the benefits
Speaker 5: of that ETF structure, whether it's tax or just liquidity
Speaker 5: or all the things. We kind of touched on today.
Speaker 5: You know, it's still simpler for a lot of people
Speaker 5: to get exposure through an ETF than it is to
Speaker 5: you know, to buy the underlying assets, whatever they may be,
Speaker 5: or the o underlying structures, so you know, they're they're liquid,
Speaker 5: they're low cost, they you know, have tax advantages. So
Speaker 5: I think you're going to continue to see the space grow.
Speaker 1: How about you, Matt any predictions.
Speaker 4: I think the future is bright, and I think the
Speaker 4: potential is massive. You know, we talked at the beginning
Speaker 4: of this episode about where the ETF space was in
Speaker 4: the early two thousands. You know, it was in the
Speaker 4: maybe a couple hundred billion in assets, and you look
Speaker 4: at today, we're in about thirteen trillion in global assets.
Speaker 4: It's a massive number. If you look at a mature
Speaker 4: space like the mutual fund space, you know, there's about
Speaker 4: thirteen trillion and passive assets and a similar number in
Speaker 4: active assets. And then if you take that stacked bar
Speaker 4: chart over to the ETF world, you see about let's
Speaker 4: call it twelve and a half trillion in passive assets,
Speaker 4: and then that active slice of that top bar is
Speaker 4: six seven hundred billion. It's extremely small, and so I
Speaker 4: think over the next you know, ten years, we're going
Speaker 4: to see that five hundred billion dollar piece of that
Speaker 4: bar grow to in my mind, probably close to ten
Speaker 4: trillion dollars. I think it's a massive opportunity as people
Speaker 4: see the tax benefits and all of the efficiencies of
Speaker 4: the ETF wrapper. You know, one thing to note is,
Speaker 4: you know, we didn't see a ton of outflow from
Speaker 4: the mutual funds. I mean they're saying some, but you know,
Speaker 4: not a ton. That's still twenty six trillion dollar space,
Speaker 4: and so I think that the the ETF space is
Speaker 4: only going to continue to grow. And then it's in
Speaker 4: terms of the structured you know note space and the
Speaker 4: structured ETF space. If you look around the world, a
Speaker 4: lot of families invest via structured products, and they do
Speaker 4: it through the bank channels because that's how families invest
Speaker 4: their money, and so they get put into structured products
Speaker 4: and they're good products. But in the US, families use
Speaker 4: financial advisors, and so we are building tools and efficient
Speaker 4: tools that advisors are very used to using, and now
Speaker 4: putting the structured outcome and those payoff profiles inside of
Speaker 4: the ETF wrapper, which gives advisors access to these types
Speaker 4: of products. And so I think again, we're in the
Speaker 4: very early days of advisors using structured outcomes for families
Speaker 4: in the United States. So it's a massive space globally,
Speaker 4: and I think we're just getting started in the US.
Speaker 1: Well, it should be exciting to watch. Matt and Dave
Speaker 1: thank you for joining me today, and James, thank you
Speaker 1: for being my cost until our next episode. This is
Speaker 1: David Cohne with Inside Active