Talk Your Book: Putting a Floor on the Nasdaq 100

0:00Today's Animal Spirits Talk Your Book is brought to you by Innovator ETFs. Check out InnovatorETFs.com to learn more about their managed floor ETFs and their defined income products. That's InnovativeETFs.com.

0:42Today's Animal Spirits is brought to you by Innovator Capital Management. On today's show, we spoke with Bruce Bond about what they're doing over there. The ETF industry is a mature one, right? At this point, there's like two different camps. There's the index side, and adjacent to that is the smart beta stuff. And that's all basically free at this point, 10 basis points or less. And then on the other side of the barbell, there are, I guess, active, thematic, creative ones. And Innovator is definitely on that side of the spectrum, bringing new ideas or old ideas, the structure note, into a new wrapper, the ETF.

1:27I guess not new, but you know where I'm going. And I think a lot of it had to do with rule changes too, that you couldn't really do these in the past. So I think the first ETF came out in 1993, SPY. Although my Canadian friends up north tell me it actually, the first one was in Canada, I think in 1991. Really? Oh, I did not know that. Like the TSX 35 or something like that. And so it's been, yeah, you're right. It's been, you know, 30 plus years of ETFs. And I'm sure a lot of people thought that a lot of this stuff would never make it in ETFs, right? We're talking about structured note type products that are fairly esoteric, a lot of paperwork involved if you're going to do one through a bank.

2:02Yes. So a lot of stuff that wasn't just, just wasn't available and now it is. And yeah, it's kind of mind boggling how many choices investors have these days in a product like this that they never would have had access to in the past. So the category that we spoke about today, like the defined outcome one to be able to say, okay, uh, 10 % down, I'm making these numbers up 10 % downside, 17 % upside. Nah, I don't really like that. Okay. Well, uh, 20 % down, downside, 37 % upside. Yeah, that sounds, whatever it is, to be able to actually see your risk, see your potential reward and make decisions based off of that is an interesting concept.

2:46And the proof is in the pudding in terms of advisor and client adoption. There is a lot of money in these ETFs because people want them. I'm guessing the demographic skew older. I'm sure we've talked about this before, but if you have wealth and you're in the wealth preservation mode, having these defined outcomes would seem to be, would make a lot of sense. I don't, yeah. If you're, if you're in accumulation mode, I don't know why you would want to cap your upside. Right. Unless you're really a nervous nally in which case own less stocks, but whatever. But yeah, Ben, you're right. For the people that are in preservation mode, who have no interest in living through another meltdown, they might say, yeah, listen, I don't need all the smoke of the S &P 500.

3:27I don't need, okay. The queues were up 55 % last year. I I'm happy with X. Whatever your X is, you're now able to get inside of an ETF wrapper. Pretty neat. All right. So with no further ado, here is Bruce Bond from Innovator.

3:43We're joined today again by Bruce Bond. Bruce is the co-founder and CEO of Innovator Capital Management. Bruce, welcome back. Nice for having me, guys. I say it every time you come on, but it's the truth. We get plenty of things wrong. This, The success and growth of the category that you have defined, I'll call the defined outcome category. Innovator is now at$18 billion under management, which is incredible considering that. Did you guys pass your fifth birthday? Yeah, we just passed it. Yeah. So five years. So not a bad run, to say the least. All right. So the company started, the first product that Ben and I saw in Chicago way back when were the buffered ETFs.

4:28And we had a feeling that advisors would clamor for this, and they sure did. And now you've spread your tentacles out into some other categories. You've got, we'll talk about a bunch of this today, equity-defined protection. You have defined income, an equity-managed floor suite of products. The environment today, and when I say the environment, I'm really talking about 5 % interest rates looks a heck of a lot different than it did in 2018 and 2019. So with that lead, and I'm curious, where are you seeing the most interest today from advisors and their clients? I think we're still seeing the most interest in the annual buffers, the things that we started with.

5:07I think that's primarily because that's what we've talked about the most over time and what people have gotten comfortable with. So, you know, the 10, 15, 30 buffer, it still continues to be kind of our number one asset grower. But we are seeing a tremendous amount of interest in the managed outcomes, you know, kind of, you know, the ones that we're going to talk about today with like Q floor and S floor, floor type products, as well as in the protect series as well, where you have 100 % protection. There's a lot of interest there as well. So we're really, you know, from the buffers. And, you know, when I talked to you guys originally, we were trying to keep it as simple as we could so people could digest how these products work.

5:54I think that's one reason we're as proud as we are of how it's gone over the last five years is, you know, we had to introduce this whole new concept within an ETF. So we had to keep it really simple. People are comfortable with that now. That allows us to introduce some ideas that are a little bit different, although still keeping it simple, to give them more control over their assets. Bruce, there's been a ton of other products that have come, not just from you, outside of different fund providers using options. And we don't need to name any names, but there's some option funds that even in the ETF space have blown up.

6:29And the whole point of your business is to help investors define, even though you can't predict ahead of time, it puts some, I guess, some ranges on what the outcomes could be. Has anything surprised you since you started the business and started running these funds in terms of the behavior of the funds or how these strategies have worked or implementing the options? Any big surprises there that you wouldn't have expected? Not really, Ben. I think that's the thing that has really bode so well for us. You know, I think the beauty of the buffers where we started is, you know, you just say, okay, look, for one year, you get this much upside, you have this much protection on the downside, and, you know, this is what you get.

7:07You know, like you said, you know, we're kind of putting buffers on a bowling alley, you know, kind of keeping you within the lanes, giving you a sense of what your outcome will be has really been what it's been. And I think the fact that we have over 300, you know, we call these outcome periods, you know, the one year period or the quarterly period, 300 of those now, and basically all of them have completed exactly where we expected them to. And, you know, for most investors and advisors, you know, being able to deliver on a promise is key. I mean, how many times any of us on the line here today have been involved with a product and we think we're going to get this, but we get that, or we think we're going to get that, we get this.

7:49It's so frustrating. And I think having reliable and predictable and repeatable outcomes for people is just really why the category is growing. You don't get that in investing much these days. And being able to deliver that's been really huge and a lot of people gravitating toward it. Ben and I were actually just talking about one of those products this morning where we were looking at it and we said, whoa, that's not what we thought would happen with that one. So the fact that you lay out what you're going to do, uh-oh, what? Oh, I mean, maybe it didn't do what you thought it was going to do.

8:27I think typically it does. Now, this is not something that we invest in. It's just something that we were observing from afar. I'm curious, and before we move on to the newer stuff, I'm curious with the buffers, because there are different periods of time. Is there one for every month? Yeah, there's one for every month in those three different levels. Yes. So the question is this, is there any one month for whatever reason where you just see a lot more flows? Is it January or is there really no rhyme or reason? Yeah. I mean, you would think, you know, we had over a billion dollars flow into our January funds this year.

9:09You know what I mean? And you would think it would be January because in the industry, we all kind of think, you know, January, January, what's my return? Season track, you know, how you performed. But it really doesn't matter. And the other thing I would say that we do see a lot of, like July was massive too, like a billion and a half into July or something. And what we see is that when we're getting up close to where the cap is, sometimes you'll see a big adjustment. And if you think about July, right, for a run up to July last year was a huge run up. And then we had a big adjustment after that where people locked in their veins pretty much and then went for another year.

9:50And so July became a big year. So it all depends on what the market's doing is what we're seeing. You know, the market's way up, people may roll and lock that gain in. Or if the market's down, we see flows too because people are saying, okay, I'm going to get in now because the caps tend to expand when the market's down. So, you know, we see both. Yeah, I'm trying to put myself in the shoes of an investor. And I originally was going to say, it doesn't make sense. Correct me if I'm wrong. It doesn't make great sense to invest in a buffered ETF in a bear market. Because in a bear market, you really want to be there for the upside bounce.

10:26So if we're October of 2022, the Nasdaq's down whatever it is, 35%, the S &P's down 27%. Why would you want to cap your upside at that point in time? Yeah, I think that's fair. And just think about earlier this year or even think of the beginning of last year. What would you do then? You know, you didn't think, what did everybody tell us? Mediocre gains. It's not going to be much, but we still have some potential downside. We're coming in for a rough landing. You know, you really have to put yourself in the moment. And, you know, Michael, you're pretty good at, hey, the market's sold off. It's on sale.

11:07I'm going to get in. I'm going to buy that. Well, people want to do that, but you know what? People don't want to go in for a big downdraft. They're still not up for a huge downdraft. So they'll say, you know what? I'm going to buy the nine buffer. I still got 9 % on the downside, but I'm getting 20, 21, 22 % of the upside. I'll take that. And so that's why people do it is because it takes some of that guessing out of it. And it says, look, do you really think the market's going to do over 20 % over the next year? I mean, some people might say, yeah, I think it's going to do 30. And if you think that, but But you have to really put yourself in the moment.

11:45Even early this year, we are already in the S &P past most of the predictions. Just in the year already. You know, of all the guys out there, yeah, it's going to be 8 % or 9%. I think the average is, you know, 7 % or something. We're already past that. Yeah, I think that the strategists on average had 5 % and we're already past that gain. Yeah, we're already past that. Yeah. And so we told people, well, you're going to get about, you know, 17%, 18%. Why not grab that, have downside in case we do have some kind of a hiccup in the market, and you get that upside and the insurance for free on the downside that you're going to have a buffer in there.

12:22For the advisors that you and your team are talking to, and it's kind of hard to figure this out with ETF flows and such, but how many are being more strategic in jumping around depending on what the market is doing, and how many are just saying, I want a static allocation to these buffers, and every whatever month or year, I'm going to add a new one. How many are being more? Hang on, let me jump in. I'm sorry. You have to be active with these things. Bruce, you may disagree and tell me if I'm wrong, but if you bought that product and you've got the 9 % downside and the 20 % upside, if the market rips 20 % and you're at the cap, why would you, unless I'm missing something, why would you stay invested if there's no more further upside potential?

13:05Well, remember, it lags the market a little bit, as you've experienced, right? So it's not going to be up all the way to the cap. If you're six months through the period, you're not going to be right on the cap. You're going to be moving up. But let's say the market's up 12 or something like that. You might be up six or seven, something like that. You have to wait through the fall outcome period to get the whole cap. That's one thing. Okay, I got it. You see what I'm saying? I do see what you're saying. But let's say that the cap is 20. and I know this is hypothetical, but the market's up well in excess of that.

13:38Or let's say the cap's 10 and the market's up 20. Is there a point in time in which you would fully get to the cap or is there really a big time delay baked into the product? Well, okay. So let's just take that example. Let's say that the cap on the ETF was 20 and the market is up 20, but you're only six months in. So you're only up 10 % right now. And you're looking at it and you're like, okay, I know I got another potential. And this is where people start to think about it, Michael. They say, okay, I got six months. Now, if the market holds, I'm going to get that other 10%. Now, I could roll out and lock in the 10 that I have and get another cap and potentially get more upside.

14:18But I already have that future 10 locked in as long as the market holds. So all of a sudden, you start balancing it and you start saying, ah, yeah, if it just holds, I get another 10%. If it comes down, it's got to come down a long way for me to lose anything. And so that's how people start to think about it. So you would think, Michael, that you would just say, wow, I'm at the cap. I'm rolling out. I'm grabbing the new one. It's not sometimes as straightforward as that. I get that. But wouldn't you also, so let's just say, fine, let's say that the market's up 20, you're only up 10. But if you were to sell and to lock into the, roll into the next one, wouldn't you also raise your floor?

14:59Your cap, you would raise your cap, right? The cap would jump. Oh yeah, and you would raise your floor, right? Your buffer would be locked at a higher level. So you're going to - Exactly. The market goes 10 down, 10 from that point, well, you're buffered, right? You have a buffer. Exactly. Yeah. And that's what I was mentioning earlier, you guys, like in July of last year, the market ripped the cover off the ball the first six months. We had a huge adjustment as a lot of advisors adjusted their portfolio when locked in for another year, and they made that adjustment and locked in their game. So we see both, Ben, to your question.

15:33We see some people just saying, this thing is great. I'm just letting it run. I'm not going to mess around with it. But then, Michael, to your point, we have some advisors that think they view themselves as more of a manager in protecting these assets. They're not really asset gatherers. They're more managing, and those guys are more tactical, we see them get in and make adjustments. All right. So as far as the other things, the newer things, the managed floor, the defined income, where should we go next? What are we excited to talk about? Well, let's talk about these two new products that we have with Parametric a little bit.

16:10I think those are very interesting, something you guys probably aren't super familiar with and your listeners aren't. And I think a great opportunity for investors. All right, great. So, so parametric, for those who are unfamiliar, parametric is a pioneer in the custom indexing space. They were, correct me if I'm wrong, they were bought by Eden Vance, who was bought by Morgan Stanley? Yep, that's right. I'm saying, right, Michael, yep. So what does the partnership with parametric look like? So our partnership now, and I think that Parabetric had two things going on. You know, they had this custom indexing thing, you know, but then they also are one of the most respected institutional asset managers that write these cover call strategies.

16:53They've been doing this forever. This has kind of been their business or secret sauce from an asset management standpoint. point. They manage, I think, almost$500 billion in these types of approaches. So I think they're, obviously, they have a lot of credibility. So after they saw the buffers, they were super intrigued with those. And they contacted us and say, hey, we think we got something that could be really compelling in an ETF. And so we started talking and we're working together now. We have two different products. One is called Q-Floor. The Q is for Q-Q-Q. And one is called S-Floor. And S is for the spider, you know, or equity, U.S.

17:35equity exposure floor. So just think of that Q-Floor, S-Floor. And what is a floor? So a floor is different than a buffer, right? A buffer is the first 9 % or the first 15%. So a floor, these have what is called a 10 % floor. And what that means is you're exposed for the first 10 % down. After that 10%, you have no more risk. So you have 90 % protection on the downside and you have 10 % exposure the first 10%. So what are you giving up on the upside to get that protection? So, okay. So these are a little different than the buffers. And these are designed to give you the upside of either the Qs or of the Spyder.

18:24And to not really, you don't have a cap on these, right? So you're not really being capped out on these. But you have this 10 % floor. Now, there has been, it's trailed a little bit. In a really aggressive upward market, you might trail a little bit. but in a trending market, you're going to keep pace with the underlying. And, and so for these two, we actually buy the underlying or, or, you know, we, we buy a representative sample of the cues or, or of the spy and we trend with that. And then what they do is they write covered calls on this. They have this, um, uh, custom cover call writing strategy that they use.

19:05It's a shorter term cover call writing strategy. And they raise premium with that, right? So that premium they raise, we buy puts. And we buy these puts, you know, 10 % out of the money. So you have 90 % covered. And so writing the calls covers the cost of the puts. Okay. And now, you know, sometimes you might get a benefit of the calls. Like if the puts are less expensive than we thought, then you might actually get a little income from the cover call writing strategy. but typically we think they're kind of designed to where they will take care. There are 20 Delta calls, if you guys are familiar with that, not to get into details, but it gives you 20 % of the upside before you could get them called away.

19:49So they're writing them out there every two weeks through a series of cover call writing to raise enough premium to be able to pay for the put. So what does that mean? That means that you have 10 % exposure. Let's just talk about the Qs, right? Let's just talk about the Qs. So you have 10 % exposure on the downside of the Qs. That's it. You have 90%. Now, one other thing I want to explain about the put is these are one-year puts, 90%, but they're trunched out quarterly. So we buy them every quarter for one year. So it moves a little, and we're rebuying it, so we're tracking the market. So your puts are moving up as the market moves up.

20:34We're writing these 90 % out of the money, or I mean, 10 % out of the money puts. So two questions of clarification. So you only have 10 % downside risk. I assume that's at maturity or at the annual marker or what exactly? That's all the time. That's all the time. You can buy at any time. That is at the end. But if you think about it, you buy the puts up front, so you have the put. So if the market crashes, the put becomes very valuable, right? So they move up in value. And so it's significant. So the put has its value. So at any given time, you might have a maximum of 11, remember, because the market is moving and they're tranched out.

21:13And so it isn't like buying one put at 90 percent. We're buying, you know, four puts across the year quarterly at 90 percent. And so it moves a little bit, but it's designed like that. So, you know, it's, we, so one of the things about the buffers people get concerned with is like this one year period, you know, they, they want to be able to get in anytime or participate with it. And what, binding these quarterly like this, it allows you to get involved and, uh, at any time and have that 90 % put in place pretty much. So this isn't the kind of fund that's going to be rolled out on a monthly a quarter of the basis of some of the other ones.

21:47This is just going to be a standalone - This is just one fund. It's just one fund. One is on the S &P, and one is on the NASDAQ 100. I guess the selling points here, especially for the Q floor, which is the NASDAQ one, would be, listen, NASDAQ has run a ton in the past 10, 15 years, but I'm also positioning for an AI bubble. So I want the upside, but I want to be protected on the downside. That's kind of the, at least the NASDAQ 100, that's the selling point. You're right. I mean, I don't know if you guys know the number, but the MAG-7 has contributed like 40 % or 50 % of the return so far in the Qs, right?

22:21I mean, so it's like, okay, guys, they are not of the return. They represent and weight 40%, I think it is, of the Qs. So, I mean, you have huge exposure to these guys as well as a bunch of the AIs that are the up-and-comers. And so what this allows you to do is to put it in the floor on your wrist there. So let's say you're kind of a conservative investor, but you want more tech exposure. I mean, to me, this is really a brilliant way to do that without taking on the risk of the NASDAQ. And let's face it, the NASDAQ moves around a lot, and it can be down 10 % without any trouble. So this really puts a floor on your risk as far as that goes.

23:03We expect and, you know, parametric expects that this will keep pace with the NASDAQ 100 over time. And in fact, you know, if you look back to 2000 from today, it's actually outperformed the NASDAQ historically because it took out some of those massive downdraws. You know, so other drawdowns. Bruce, I have to politely push back a little. this sounds like a free lunch and we know that free lunches don't exist so one of the catches is that this will track i assume the the price return index i know that not that there's really dividends i mean yeah yeah so all right so the queues have well no no no no i hear here's the thing michael remember this owns the underlying stock okay so so this it you know um usually we're we're buying a deep in the money call the internet to give representation to these different market.

24:01This one, actually, Parametric owns a representative sample of the underlying stock. But remember, too, NASDAQ doesn't have much dividend yield. Right, right, right, right. You know what I mean? All right, so what is the catch? Well, so the catch is that, I mean, if we have a really skyrocketed market, you're going to trail the NASDAQ a little bit. Yeah, but that can't be the real risk. I mean, who cares about that? That's it. That's it? It's not really a cap, but these are written, quote unquote, just think about them like 20 % out of the market. So if the market runs up and it really goes above, you could lose some of those stocks.

24:41So the timing of the options is kind of part of the risk there then, right? The Qs were up 55 % last year, right? What would the strategy have been up last year? Yeah, we didn't have it all last year, so I wouldn't be able to tell you what it was. I will tell you this. Let me give you this. Parametric has been running this over time. Over the last 10 years, the QFLR strategy would have been up 13.9%. The NASDAQ was up 17.9%. Okay. So that is a big spread. However - Okay. That's a big spread. Okay. Go ahead. Okay. But the sharp on this is 0.95 versus the sharp on the NASDAQ 100 is 0.76. The volatility on this is 13 versus 21.

25:27And so that's the thing. If we have a super aggressive market, you could get some self-called away and you may not keep up with the underlying, but at the same time. So that's the risk. That's the give up. Michael, you know, I always say, yeah, there's no free lunches and we all know that. So that's the potential. But if you have a trending type of a market, you're going to participate in that with this on the bottom. And we think for a lot of people, it's better than a cap. I mean, how many people keep up anyway? You know what I mean? To be honest with all these active managers. I mean, you know, I mean, seriously.

26:01So here you do that and you know where your floor's at. All right, fair enough. So let's talk about this defined income product. What's the deal with this one? So, you know, think about the defined income product as basically it's kind of like a buffer, okay? We have buffers and barriers. Now let me explain the difference between a buffer and a barrier. A buffer, as I mentioned earlier, is you're buffered for the first 9%. A barrier, our first barrier is at 10%. And so, you know, when you're buffered for the first 9%, it says 0 to 9. You don't lose any money from 0 to 9. But then when you go to 10%, you're going to lose 1%, you know, 11%, you know, lose 2%.