Talk Your Book: 100% Downside Protection

0:00Today's Animal Spirits is brought to you by Innovator ETFs. Go to Innovator ETFs.com to learn about the new ETF. I think it's the first one in the US, at least, that offers 100 % downside protection on the stock market. That's InnovatorETFs.com. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions.

0:37Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:45Welcome to Animal Spirits with Michael and Ben. We had on Bruce Bond today who kicked the hornet's nest the other week inadvertently on social media with his announcement or their announcement at Innovator ETFs that they have a new product, that it's an ETF that fully protects the downside. And we got into this on the show. People were none too pleased. I think when I say people, I mean, you know, critics, people in the industry and sorry, not sorry. I, I, I'm a fan. I think the, the tagline of a hundred percent downside protection in the stock market just got a lot of people riled up. And this one was on Twitter.

1:23It was, uh, it was trending a little bit, this, this story. And we get into it on the show a little, but my whole thing is that investing is full of trade-offs and the trade-offs for this fund are glaring. So I think the thing is, if this fund and the trade-offs that it has are not for you, that's fine, I think. But there are going to be some people who say, okay, these trade-offs actually make sense to me. And I'm willing to accept them, understanding that there are pros and cons. So we get into all of that on the show, how this works. I guess what I am sympathetic to, if people are of the view, If this is the critique that there are going to be unscrupulous financial professionals that sell this product to their clients without really explaining to them the costs involved in terms of the missed opportunity costs and all that stuff that we get into, yeah, that's bullshit.

2:13And I don't think anybody likes people tricking people. but in terms of what this product is and what it can do for you in terms of peace of mind and the behavioral coaching that advisors purport to be doing for their clients, I have no problem with this. I think that investors like certainty. They just do. And even if there is a cost, i.e. they're not getting all of the upside, if the upside is over a cap, okay. Right. I think people are, people are, that's a choice that, that is, is personal to everybody's risk tolerance. And so let's not step in any more of it because we get into all of them.

2:51To your, to your point, to your point about like hiding stuff. I think the beauty of these products and what innovators doing is that it was way easier to hide stuff and be, you know, non-transparent in annuities. Like there's nothing wrong with annuities. I think the problem is it was hard for people to understand what they are and what they're doing. And then what the person selling it is actually getting out of the deal. I think this taking out that middleman and just putting it out there, it's way more transparent than that. Yeah, I totally agree. All right. Here's our conversation with Bruce Bond.

3:23We are joined once again by Bruce Bond, one of our favorite returning guests, the founder and CEO of Innovator ETFs. Bruce, I think one of the reasons that we like talking with you so much is because the whole idea of investing itself is a series of trade-offs, right? There's different risks that you can take and different expectations you can set. And the way that you've all created your products is that those trade-offs are just stated upfront, a little better than maybe some other things because they're defined. And we've talked in the past about different products you have with different upside potential or different downside potential caps.

3:57And the latest product that you've released has, you know, maybe the one of the better defined ones that we've seen in terms of getting people to talk. So T-Jewel is a basically capture losses at 0%. There are no losses, right? No downside. And so I'm just curious how the thought process of this fund went in and then kind of want to get into the details too. Yeah, exactly, Ben. And thank you guys for having me again. I really appreciate it. Yeah, we're super excited about these products. If you think about a lot of people, they are not comfortable going into the equity market, what we call naked, you know, with no protection at all.

4:34That's why they buy annuities, right? They buy annuities because they want to know that their money's protected, they're going to get it back, it's not at risk, or at least that's how they feel. And so we are, with our types of products, we're trying to give people a sense of the knowledge of what their outcome will be down the road so that they don't feel like they're just gambling with their money, but they know what their risks are and they're able to contain their risks. And that has been a huge thing for investors. And as you guys know, really not available to investors before this on the equity side of the market.

5:09They just couldn't access these types of investments, most of them. You know, there were some structured products and some annuities and things like that. But in the open market, it wasn't available to a lot of people. And that's the reason we're excited about the buffers, but also what we call defined protection. And one thing I just want you to note and your listeners to note how big a deal this is, you know, the SEC does not approve to put protection in the name of products. You know, if you guys were talking to your clients, how much how often can you say you're protected? You can't really say that.

5:44It's not a term you're allowed to use. But they actually allowed us to put defined protection in the name of these products because people actually have protection from the downside. So I didn't realize that the SEC actually restricts certain words because it could connotate something that would throw investors off potentially. Absolutely. They are very strict about what you can call your product. And if you look around all 40-act products for the most part that you see in the marketplace that people buy, I don't think you're ever going to see protection in the name. Because that name is reserved.

6:20Protection is – it's just not – it's like insured. saying insured for something. I mean, it's a very difficult thing to use. And so, but the SEC with these particular products have allowed us to say protection, even with the buffer products that we have, you know, we have to say a level of protection. We're not able to just say protection. Here is defined protection is the name of these products. So the level of protection is really, if you buy them opening day and you hold them through the end of the period, which is two years, You have no risk on the downside. You only have an opportunity on the upside of the equity markets over that two-year period.

6:55And hopefully, we're going to unpack that and talk about it a little bit more. Oh, we're going to for sure. I'm excited to dive into the actual product and what it is because this – to Ben's earlier point, this definitely lit social media on fire, particularly those working in asset management and wealth management. And I think part of the consternation is maybe they're – they think that this is Wall Street pulling some sort of a trick. And I actually – I'm on the other side of that for the most part and I'm not saying that just because you're here and I'll give my reasons why I actually think this is a reasonable solution.

7:25And it's the opposite of fooling anybody. You're, you're, it's incredibly transparent about what it does. So I'm, I'm going to come to your defense again, not just, not just cause you're, you're paying to be at the show, but let's get into, let's get into the specifics of the product downside protection. Tell us about it. When does it kick in? Is there anywhere that you could violate the downside? Like exactly how does that work? Okay. So basically how we brought the T jewel and that's for July. J U L is for July. So you would need to have bought this thing first day of July. Now you can buy it at any time, as you guys know.

8:02Anybody wants to go to our website, look up T-Jule, look at where it's trading. It will tell you exactly what your protection level is, as well as what your upside potential is on the website today. But just to keep things simple, if you bought this first day and you held it through the end of the period, which is two years, you have no downside risk and you have the opportunity to get up to 16.67 % of the upside in the market over that two-year period. So now, if in the middle of the period, the market's down, you might be down a slight amount. But remember, it's not going to go down a lot because it knows you're not going to be able to lose money in this over two years.

8:45And so it might down draft a little bit if the market's down significantly, but it knows it's not going to be down at the end of the two years. Therefore, we don't expect to see much on the downdraft. Now, also, if the market's up 8%, let's say at the end of the year, it may only be up 5 % because there's a lot of time value in the options that are in the portfolio. So in order to get the 16.67%, you have to hold it to the very end of the two-year period, and you are going to have some movement in the middle. It's not going to track one-to-one with the market in the middle. Now, the beauty of this, though, is let's say the market's up eight and you're up five and you need your money, you can sell it and get your money and take it out.

9:28And there's no penalty to you. If it's within a year, you're going to pay short-term gains. If it's over 12 months in a day, you're going to pay long-term gains. But it keeps the investor in control of the assets. And I think that's the beauty of it. You don't have credit risk with an insurance company. If you did an annuity, you don't have that. You own the underlying. It's very simple. Basically, we have 100 % put and at the money put that covers you all the way down. So you can't risk money on the downside over two year period. So to your put. And then we have to we have an in the money call to give you the upside of the market.

10:04And then we sell a call, which creates the cap. Now, why do we sell a call? We sell the call because we have to raise enough money to pay for the whole package. For investors that are getting into this, This is a zero cost package to them. They get in, it's all done at the institutional level, right? So you get in, the package has no cost to you. Your cost is you have to give up whatever's above the 16.67 % over two years. That is your cost, the obvious, and also the dividend. You don't receive the dividend because we use the dividend plus whatever's above that to finance the deal in the future.

10:40Bruce, correct me if I'm wrong, but I think most of your other products that we've talked about in the past, have a one-year time horizon or one-year period. That's correct. So what is the reasoning for this one being two years? Is it just because of the way these options are structured? Why is it two years instead of one? The reason it needed to be two years is because if we tried to do this over a one-year period, the cap is very, very low. And so we couldn't get really any cap that we thought would be attractive to anyone. So we needed to go out to two years in order to accomplish that. And so now the important thing for people to remember is that two years, like with the one-year product, Ben, you don't have to do anything.

11:17You just let it roll another two years. We tell you what the new cap is. And if you don't like the new cap, you can sell it and do something different, or you can just let it roll into the future knowing you don't have any downside risk. You only get the upside of what the market's going to give you to whatever the cap is. Bruce, you mentioned there's no cost. The ETF itself charges 79 basis points. So my question to you is if you state that the cap is 16%, does that mean that you are going to get 16 % or are you saying that you will only get up to 16 % if the market's up 40, you get 16. If the market's up 10, do you get 10 or do you get 16?

11:54Okay. So that's a great question, Michael. So first of all, the 16.67 that I'm quoting is gross. So you're going to have to pay 79 basis points each year, basically 150 basis points. so if the market's up 10 you're going to be up 10 percent less 150 basis points if the market's up 16 you're going to get the 16 uh less 150 basis points roughly if the market's up 20 you're still going to only get the 16.67 less the management fee so that's what you get got it all right so let's talk about so the reason why i would say that this is not what those people are suggesting this is, that it's misleading.

12:34I think this is a reasonable solution. The reason why Ben and I were so bullish on Innovator when we first had you on, I don't know, four, five years ago at this point, whatever it was, people want certainty. And if you know yourself as an investor and you know that your past behavior is a very good indicator of your forward behavior and that you do get nervous and that maybe, not that you're going to make a mistake, but you don't want the anxiety, There's nothing wrong with giving up upside, right? I think that's a very reasonable thing. And I don't want to put words in your mouth. I don't think that you would say that this is anybody's whole portfolio.

13:12But if this is a way to keep you on track and to help you sleep a little bit, knowing that a portion of your money is protected, and yes, you might give up upside, you're not getting dividends. If the market's up 25%, you're only up 16.7 minus whatever the expense ratio is. I think that's a – I mean, call me crazy. I think that's reasonable. Just like Ben said, these are tradeoffs. right? These are trade-offs. Do you want the upside? You know, 35 % for baby boomers, they have their money in cash right now. People that have money, wealthy individuals, they have their money in cash, a lot of it.

13:42Why? Because they're nervous. Well, why wouldn't you take that 35%, throw it in here, get potentially 16 % of the upside, sell a little off if you need to get some cash, but at least have that money growing for you. Right now, if you have it sitting in cash, you're losing money because we have inflation out there. You have erosion of your purchasing power, you're losing money. You're not making any money in these bank accounts right now. So get that money invested. Also, remember, it's not FDIC. You have 250 FDIC. Here, you own an asset. I mean, you're not commingled with everybody else's cash.

14:17You own an asset. And credit risk isn't an issue for you here because it's the option clearing court backs this whole thing, which is backed by the government. So this is a great alternative for people. And Michael, you're exactly right. We're not recommending this for anybody's whole portfolio. But what we're saying is this is a great tool for many people that are fearful of the market. Why do people buy bonds? Why do some people only buy bonds? They won't buy the equities, which they got hurt pretty good by. They didn't think they had to. They were holding them to maturity because they're fearful of the equity market.

14:53This is a way for those people, to get a better return potentially for themselves to get into the equity market, but not have the risk that they're fearful of. That's what these tools are for. The foreknowledge of what your potential return will be. And in fact, with these products that you don't have a risk of loss over two years is a great tool for many, many people. If you think of, you guys have heard of the MarketLink CDs. Banks sell these things like they're going out of style, right? This is a perfect alternative to that, but you don't have to depend on, will this regional bank go under?

15:27Will it not go under? You don't have these risks. And also with those, you have phantom income. When you get your money out, it's ordinary income. You have all these issues with those here. Allows you, gives you full control, full exposure, sell at any time. So this takes all that stuff that's kind of not transparent and it puts it out in the open. And it's as efficient as it can possibly be and allows people to do it directly rather than have an intermediaries between them and the investment. That's the goal of this product. That cash piece is something I have a question on. So do T-bill rates impact this strategy at all?

16:06Like if you're selling some options, is any of that money invested in cash? So like the Fed raised rates again this week, you know, T-bill rates are pushing towards five and a half, six percent. Is any of that option premium invested in cash, and does that have an impact at all on the return? No, this is all an options portfolio. There's nothing in T-bills. In the income products that we had before that we talked about, it does invest some in short-term T-bills. But those are based on it. Those are for income. This one here is just a very clean options portfolio that gives you the upside of the market over two years with no loss potential.

16:41That's really what it is. And so, yeah, the interest rate market or inflation has no impact on this from a bond standpoint. Now let me play devil's advocate, Bruce. Yeah. I'm an investor and I can get five, five and a quarter when rates adjust for overnight rates in cash. Right. I could just do a high yield savings or whatever. Right. Now, is there enough juice in this strategy? Like, why would I not just park my money in cash and just clip the coupons for as long as they might last? Yeah. And there's nothing wrong with doing that if you want to do that. But if you look at a two-year treasury, it's about 4.7 right now.

17:25Now, remember, what is that 4.7? That's a pre-tax number. You would have to get 11%. If you look at our 8%, you'd have to get at least 11 % a year, 22 % over the two years to keep pace if the market gave you the full amount of their return. But isn't your number pre-taxed too? Well, our number's pre-taxed, but there's no cap gain. I mean, it continues to roll out. It defers all your gains. Whereas when you got an interest payment being made by Treasury, you get the payment, but you have to pay tax on that payment at ordinary income. So taxes are not realized with T-Jewel or something like that until you actually get out.

18:04Until you sell the investment, it's not realized. So it's mostly long-term and you can defer into the future. And that's why I'm saying you would need at least an 11 % return. Like if you do a taxable equivalent, like for a tax-free bond versus a taxable bond, if you look at this in a similar way, you need about 11 % on a treasury in order to get the same return over time. so i i've okay this might be a dumb question but i'm going to ask it anyway because i have seen people say this why wouldn't if i'm an investor and i want exposure to a product like this why wouldn't i just buy the s &p with whatever whatever i'm trying to allocate let's say i do 10 grand why wouldn't i put eight grand in the s &p and then i sell a call and i buy a put why wouldn't i just do that you could do that 99 basis points absolutely you could do that but i think what you're going to find is is much more expensive for you to try to do that on your own than it is to just do it in this package.

18:57Can you talk about that? How so? What do you mean by that? Well, because, you know, buying options is a very expensive proposition. And not only that, but you have to sell the call at the right spot. I mean, remember, if you're going to have it fully funded, you have to sell a call, you have to buy a call in the money, and you have to sell the put. So there's three transactions you're making in order to finance the deal. So now you could buy the spider underlying it and sell the call and the put. It's not going to be lined up perfectly and you could probably try to do it on your own. But at the end of the day, it's still going to be more expensive to try to do on your own.

19:35This is all done at the institutional level. So, I mean, I can provide some numbers to you guys. Execution is everything. Bruce, every time I've bought an option, I feel like immediately I'm down 11%. Oh, yeah. I mean, they're super expensive. Let's face it. One time I said, hey, let's buy some options, protect this portfolio. And, you know, it cost me a fortune. I'm like, I'm never doing that again. Yeah. Right. So the beauty of this is it's set up for you. You don't have to think about it. You don't have to waste your time with it. And you know what? And most of these firms, especially like the big broker dealers, these guys aren't qualified to buy and sell options.

20:10They aren't even registered to do that kind of business. And they don't want to know how to do that business. What they want to know is an expert that has it put together for them. That's going to to do exactly what it says it's going to do. And that's what we're putting here together for them. Yes, it's 79 basis points. That's going to be much cheaper in the long run than it's going to take for them to do it on their own. Bruce, I'm curious if you have any converts from the insurance world, people who have been selling annuities or selling these types of structured products, or do they just hate you guys?

20:37Well, they're not real happy because, I mean, you can do this. If you're in a rap account, you can just buy this thing and you get it. There's no cost to it. You get all the flexibility. You don't get the credit. I mean, it clears up all these issues people have had in the past. You don't have a big agreement you have to sign. And let's face it, some of these annuities, you got to go out six years to get this kind of an agreement. You are tied up. And then when you get your money out, it's at ordinary income levels. And you're locked in. If you try to sell, there's a big redemption fee, surrender charge.

21:13So here, you don't have that. And so now the product is new. It's gathering a lot of assets. And as you guys have seen, it's been a lot of visibility in the marketplace of how can it be that there's an ETF you can't lose money on, but you get the upside of the market to a certain spot. And I think it's really got a lot of people interested in how do I participate in this and how do I use this? Innovator, our job is to help people understand these are the ways you can use it. And these are the ways that good advisors are using it and to help relay that to people. And listen, yeah, it's 79 basis points now, but wait until iShares comes in here and Bruce is charging 15 basis points next year.

21:54Yeah, that's not going to happen. At least I hope, you know. Wait, Bruce, but let me ask you a question about that. Why did it take you, why now? I feel like this is something that you probably have, I'm guessing it's been on your mind for a while. Why now? Why is the time now right? I think a lot of people got really burned in bonds. and they feel like bond was their safe investment in the past. And a lot of them got hurt. And what we're trying to do with this, as well as with our income products that we brought out, give people alternatives to just their traditional bond investments and to help them see that they can participate in the equities market and generate income for themselves or protect their investments.

22:37I mean, these tools just haven't been available. And so we have been watching this opportunity. We had looked to do it before on a one-year basis, but it looked like the risk-reward just wasn't there for people. And so we came out at a two-year level that we think is very suitable right now. The other reason I think a lot of investment professionals might be skeptical of this at first is because they're looking at this in a pool of all other investments. And they're looking at stocks as this very long-term asset where people in the financial advice space look at this in terms of goals. And so the way that I think of this, especially if you want to stick with a two-year time horizon, let's say your child is going to college.

23:18You know you're going to have to pay that in a certain amount of time, right? In two years, I'm going to be writing a check. I want to have that money protected, but I also want to have it potentially go up. Michael and I had questions all the time when rates were at zero of where do I save my money for my down payment or my wedding? And I want to actually earn something, but I don't want to lose that money because if it's not there when I need it, then I'm screwed. Right. So I think in terms of goals-based investing, if you're not measuring it against the stock market over 20, 30, 40 years, obviously it's going to lose.

23:45But if you're measuring it in terms of goals in this two-year timeframe, I think it makes a little more sense to think about it that way. Yeah. And I think that's right, Ben. And think about if you're in retirement or close to retirement. I mean you want exposure to the equity market. You know that you need to do that to grow your assets. But there's nothing been really available to you unless you want to really tie your money up. been subpar product structures. Now there's a product structure available that makes that available to you that you can get the upside of the market without the risk of the downside.