Innovator set to launch first defined outcome ETFs with leveraged upside

Mar 29th, 2021 | By | Category: Alternatives / Multi-Asset

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Innovator Capital Management is set to introduce a new suite of defined outcome ETFs which will be the world’s first to deliver a multiple of the upside return on a reference asset with single exposure to the downside.

Bruce Bond, Chief Executive Officer of Innovator Capital Management

Bruce Bond, Chief Executive Officer of Innovator Capital Management.

The firm has announced that an initial four Innovator Accelerated ETFs will be launched on Cboe BZX Exchange on 1 April 2021 with a further two Accelerated ETFs due to list in the near future.

Of the six Accelerated ETFs, four will target defined outcome profiles relative to the S&P 500, while the other two will be based on the Nasdaq 100.

Each ETFs’ defined outcome profile will be tailored for a specific outcome period, either three months or one year.

Similar to Innovator’s existing defined outcome ETFs, the Accelerated ETFs gain their exposure by investing in FLexible EXchange (FLEX) Options – customizable exchange-traded option contracts guaranteed for settlement by the Options Clearing Corporation – on mainstream US equity ETFs.

The ETFs on which the options are based are the SPDR S&P 500 ETF (SPY US) and the Invesco QQQ (QQQ US).

Accelerated ETFs do not capture dividend yield attributable to the S&P 500 or Nasdaq 100 as the FLEX Options are based on the price returns of the reference ETFs. However, they are anticipated to be as tax-efficient as traditional equity ETFs with investors being able to defer taxes until selling.

The ‘accelerated’ gains achieved when the reference ETF is rising come at the cost of a cap on upside performance over the outcome period. These caps are determined by market conditions at the time when the FLEX Options are purchased. As such, investors will only know the cap levels for the Accelerated ETFs’ initial outcome periods when the funds launch on 1 April. Innovator has, however, provided estimated caps, before fees, based on average market conditions over the ten days preceding 23 March 2021.

At the end of each Accelerated ETF’s outcome period, the fund does not expire but, instead, rebalances and resets, providing investors with a new upside cap dependent on market conditions at that time. According to Innovator, this makes the ETFs better suited as longer-term core holdings rather than tools for ultra-tactical trading like traditional leveraged products.

The ETFs launching this week are:

The Innovator US Equity Accelerated ETF – April (XDAP US) provides double (2x) the upside performance of SPY, to an estimated cap of 19.55%, with single exposure to SPY on the downside, over a one-year outcome period.

The Innovator US Equity Accelerated 9 Buffer ETF – April (XBAP US) provides double (2x) the upside performance of SPY with single exposure to SPY on the downside as well as a buffer against the first 9% of losses, over a one-year outcome period. Due to the presence of a downside buffer, the ETF will come with a lower cap on upside performance – estimated to be 11.46% for the initial outcome period.

The Innovator US Equity Accelerated ETF – Quarterly (XDSQ US) provides double (2x) the upside performance of SPY with single exposure to SPY on the downside but resets after a three-month outcome period. Its estimated cap on upside performance is 8.12%.

The Innovator Growth-100 Accelerated ETF – Quarterly (XDQQ US) provides double (2x) the upside performance of QQQ, to an estimated cap of 11.33%, with single exposure to QQQ on the downside, over a three-month outcome period.

The additional two scheduled to list in the near future are:

The Innovator US Equity Accelerated Plus ETF – April (XTAP US) provides triple (3x) the upside performance of SPY, to an estimated cap of 17.06%, with single exposure to SPY on the downside, over a one-year outcome period.

The Innovator Growth-100 Accelerated Plus ETF – April (QTAP US) provides triple (3x) the upside performance of QQQ, to an estimated cap of 22.23%, with single exposure to QQQ on the downside, over a one-year outcome period.

Each ETF will come with a management fee of 0.79%.

Investors should note that, as the defined outcome profile has been tailored for the entire outcome period, an Accelerated ETF’s interim returns may behave differently during the outcome period.

Due to the time value of the underlying options, the return on an Accelerated ETF will not be directly proportional to the return on its reference ETF. As such, it may lag the leveraged performance of its reference ETF when markets are trending upwards, especially in the earlier stages of the outcome period. The ETFs that reset quarterly, however, are likely to provide a closer tracking experience due to the shorter term of the underlying FLEX Options, though these funds will have lower starting caps.

According to Innovator, investors can use both outcome periods to tactically respond to changing market conditions.

Investors who purchase an Accelerated ETF after the outcome period has begun may also be exposed to magnified risk on the downside in so far as the ETF has risen since the beginning of its outcome period. Again, the degree to which downside risk is magnified would depend on the time value of the underlying options.

These dynamics of defined outcome investing can present a challenge, particularly for more complex products such as Accelerated ETFs. Innovator does, however, provide full daily disclosure for each of its defined outcome ETFs including remaining cap and buffer levels, remaining downside before buffer, and remaining days in the outcome period.

Innovator currently offers 57 defined outcome ETFs with total assets under management exceeding $4 billion. In September 2020, the firm unveiled another industry first with the launch of the Innovator Stacker ETFs which combine “stacked” exposure to multiple US equity indices on the upside with single index exposure on the downside.

Bruce Bond, CEO of Innovator ETFs, commented: “The Accelerated ETFs have always been part of the vision for our defined outcome ETF line-up, and we are very excited to introduce them to advisors and ETF investors. The Accelerated ETFs seek to enhance investors’ equity performance potential to a cap without taking on additional downside risk. This is a growth investing product concept we’ve been working diligently on since 2017 when we filed for our first Buffer ETFs.”

Bond continued: “With the launch of Innovator Accelerated ETFs, investors will have even greater ability to construct strategic, diversified portfolios with defined outcome ETFs. Alongside our Stacker ETFs, we believe the Accelerated ETFs will provide powerful growth tools to potentially enhance equity returns.”

John Southard, CIO of Innovator ETFs, added: “Given the popularity of such asymmetric accelerated or enhanced equity return strategies in other structures, we think the Accelerated ETFs will really resonate with advisors who have been attracted to these types of strategies but were deterred by the illiquidity, opacity, high relative costs, and credit risk of structured notes.

“No one can predict the future but, if history is a guide, certain domestic equity markets could have a very slim chance of beating the annualized returns they’ve produced over the recent decade. With valuations elevated, Wall Street strategists are near-unanimously forecasting a low to moderate growth environment for domestic large-cap equities in the mid- to long-term outlook. The Accelerated ETFs seek to provide the potential to enhance returns in such challenging environments, helping to support investors’ accumulation goals.”

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