Innovator Capital Management has announced the upcoming launch of a new breed of defined outcome ETFs that combine “stacked” exposure to multiple US equity indices on the upside with single index exposure on the downside.
Bruce Bond, Chief Executive Officer of Innovator Capital Management.
The first three Innovator Stacker ETFs are due to list on Cboe BZX Exchange on 1 October, 2020.
The Innovator Triple Stacker ETF – October (TSOC US) provides upside exposure to the S&P 500, the Nasdaq 100, and the Russell 2000, up to a cap, while only participating in the downside of the S&P 500.
The Innovator Double Stacker ETF – October (DSOC US) provides upside exposure to the S&P 500 and Nasdaq 100, up to a cap, while also only participating in the downside of the S&P 500.
The Innovator Double Stacker 9 Buffer ETF – October (DBOC US) provides upside exposure to the S&P 500 and Nasdaq 100, up to a cap, while participating in the downside of the S&P 500 but buffering against the first 9% of losses.
The ETFs are linked to indices created by MerQube, an indexing startup founded by senior S&P Dow Jones Indices alumni Keith Loggie and Vinit Srivastava and technology veteran Praveen Yalagandula.
The MerQube indices consist of combinations of FLexible EXchange (FLEX) Options – customizable exchange-traded option contracts guaranteed for settlement by the Options Clearing Corporation – on mainstream US equity ETFs.
The reference ETFs on which the options are based are the SPDR S&P 500 ETF (SPY US), Invesco QQQ (QQQ US), and iShares Russell 2000 ETF (IWM US).
The Stacker ETFs do not capture dividend yield attributable to the S&P 500, Nasdaq 100, or Russell 2000 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.
Complexity
The strategy of stacking multiple stock market returns has been utilized by large institutional banks for decades; however, this is the first time such a strategy is being made available to a wider audience of advisors and retail investors in ETF format.
It is a relatively complex strategy and there are certain nuances of which investors should take note.
Each Stacker ETF offers a defined outcome profile that has been tailored for a specific one-year outcome period. With reference to the inaugural products, the initial outcome period runs from 1 October 2020 to 30 September 2021.
The caps on upside performance 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 initial outcome period when the ETFs launch on 1 October.
At the end of the initial outcome period, the ETFs will rebalance and reset, providing investors with new upside caps dependent on market conditions at that time. The Stacker ETFs, therefore, do not expire and may be considered as long-term portfolio holdings.
As the defined outcome profile has been tailored for the entire outcome period, this may affect the ETFs’ interim returns during the outcome period in two ways.
Firstly, due to the time value of the underlying options, the Stacker ETFs are likely to exhibit a lower beta than traditional passive index-tracking ETFs. As such, the Stacker ETFs may lag the combined performance of the reference ETFs when markets are trending upwards.
Secondly, while the Stacker ETFs are designed to avoid losses of the Nasdaq 100 or Russell 2000, as applicable, over the duration of the whole outcome period, an investor who purchases shares of a Stacker ETF after the outcome period has begun may be exposed to the downside of the Nasdaq 100 or Russell 2000 in so far as those indices have appreciated since the start of the outcome period.
While these dynamics can present a challenge, Innovator provides 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.
The ETFs will probably appeal most to investors who anticipate modest positive market returns over the outcome period and who wish to amplify those returns in a controlled way. Of course, on the flip side are the upside caps that stand to curtail returns should markets perform better than expected and exceed the caps.
Each Stacker ETF will come with an expense ratio of 0.79% which matches the cost of Innovator’s other defined outcome US equity ETFs.
Bruce Bond, CEO of Innovator ETFs, commented, “We are very excited to introduce the Stacker ETFs. We have been working diligently on this product concept for over three years. Now, for the first time in an ETF, investors who hold shares for an entire outcome period have access to triple or double exposures on the potential upside to a cap with a single exposure on the downside, the S&P 500.
“The Stacker ETFs seek to provide advisors with diversified exposure across the US stock markets and can magnify investors’ performance potential without increasing risk beyond exposure to the S&P 500, the benchmark many clients are most comfortable with. It has been an honor for us to witness the growth of the Innovator Buffer ETFs and we believe the ‘Stackers’ will be embraced in the same way.
“Another reason we see the ‘Stackers’ resonating with advisors is that they will be able to map their annual market return expectations directly to a specific Stacker ETF. The Innovator Stacker ETFs will allow advisors to know their potential outcomes prior to investing, including the environments in which they can potentially outperform the US large-cap equity market. To do all this with the benefits of liquidity, transparency, and tax-efficiency illustrates the beauty of the ETF vehicle and the utility we think the ‘Stackers’ will bring to advisors’ playbooks.”
John Southard, CIO of Innovator ETFs, added, “Today’s ultra-low yielding and low forward-looking return environment for US equities is challenging advisors’ ability to hit their clients’ return goals with traditional portfolio assets, strategies, and allocations. The idea with the Innovator Stacker ETFs is to allow investors to participate in the potential upside, to a cap, across multiple US equity market segments without taking on the potential downside risk and additional volatility of growth and technology, as well as small-caps.
“And with the ‘Stackers’, advisors don’t have to be right about which US equity market segment to allocate to based on fundamentals, technicals, geopolitics, or stimulus measures; you can get multiple exposures in a single ETF. Especially in low-return equity markets, we feel the ‘Stackers’ hold significant appeal and they could displace allocations to active managers given the transparency, return parameters, and outperformance potential.”