Animal Spirits Podcast - Talk Your Book: Protecting the Downside

Episode Date: March 28, 2022

On today's Talk Your Book we had Bruce Bond from Innovator ETFs back on the show to discuss how advisors are using managed and buffered ETFs to protect the downside in their portfolios.   Find complete shownotes on our blogs...  Ben Carlson’s A Wealth of Common Sense  Michael Batnick’s The Irrelevant Investor  Like us on Facebook  And feel free to shoot us an email at [e-mail] with any feedback, questions, recommendations, or ideas for future topics of conversation.    Learn more about your ad choices. Visit megaphone.fm/adchoices

Today's Animal Spirits is brought to you by Innovator ETFs. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching. Michael Battenick and Ben Carlson work for Ritt Holtz Wealth Management. All opinions expressed by Michael and Ben or any podcast guests are solely their own opinions and do not reflect the opinion of Ritt Holt's wealth management. This podcast is for informational purposes only and should not relied upon for investment decisions. Clients of Ritthold's wealth management may maintain positions

in the securities discussed in this podcast. Ben, we just got done talking to Bruce Bond, I think for the third or fourth time. Probably more like fifth or six time. Is it? We've had him on quite a bit. I don't even know what year it is. Yes. Bruce is one of the original talker book guest, and he's been on many times. Great guy. Always puts a smile on her face. Very sharp. He's been in around a long time of the ETF business as well. Bruce is the founder of Power Shares. ETFs, the fourth largest ETF provider in the world. And so he has seen some things. And actually, we ended it with a comment on how remarkable it is, how far ETFs have come. I don't know how long it took for mainstream adoption to accept and understand ETFs.

Actually, when we started talking about ETFs, like in 2013, they were still a big learning curve. Like, what is this creation of redemption? I don't understand how this whole works. So anyway, the fact that you can put these sort of... Structured products now within an ETF. Yeah, it's super cool. And I think that they've obviously done an amazing job educating the advisor force because I'm guessing that 90% of their flow is coming from advisors and a little bit of DIYers. But this is pretty much a product that has to be bought, but also, I don't want to say sold, but it has to be understood and explained. And so obviously they do a good job explaining

their advisor force. Back in my endowment days, we invested in a handful of structured products. And you would have to go straight to a bank to do it. And then you had to sign an ISDA agreement, which I'm pretty sure I still don't know exactly what that means, but it was like 120 pages long. And you'd get like a monthly mark on these things. And it was very difficult to understand what you were getting. The fees were kind of complex. The fact that you can now do it in an ETF wrapper and not have to go through all that crap anymore. And you get daily liquidity. It is pretty remarkable. I think one of the reasons why we were so bullish on this product the first time we spoke to them back in, I'm guessing 2018 or so, was because we understood the design.

desire to define the outcome, both on the upside and the downside. I think investors are dying for some certainty, even if some of the certainty is I'm going to give up some upside above and beyond, whatever your cap is. But so long as I get protection on the downside, I'm good with that tradeoff. And this is the opposite of the stuff that we talk about a lot is the Robin Hood crowd and the crypto crowd and that being more younger. That money skews younger. But guess what? the money that skews older, like he said, they have money and they want to protect their wealth. And that's why that money is going into this. And it's much more quiet, obviously, but $7 billion, I think they had a couple hundred million when we first talked to Bruce a few years

ago. That growth is just massive. Yeah, pretty impressive. All right, so let's not step on any of this conversation. Here it is Bruce Bond from Innovator ETFs. We're joined today once again by Bruce Bond. Bruce is the founder and CEO of Innovator ETFs. Bruce, glad to have you back on the show today. Thank you for having me. Really happy to be here. So this market has been an interesting one where bonds, which were supposed to be the downside protection to offset some of the volatility in stocks, it seems like maybe bonds or interest rates rising bonds falling is almost causing some of the volatility in the stock market. So it seems like this is probably a pretty good environment for the solutions that you're offering. Why don't you bring us up to speed on what's been

going on with Innovator ETFs? Yeah, I'd be happy to do it. Thanks. I'd be happy to do it. Thanks. think it's been a crazy market, hasn't it? I mean, you're not sure what's going to happen with the equity market. You don't know what's going to happen with a fixed income market. I think most people are trying to say. Speak for yourself. What's going to happen with these fixed income investors? I think I mentioned to you guys last time I was on back at the COVID crash, I like pulled all my money out of fixed income when rates went to zero and went into the buffers because I was like, I mean, there's nothing left here other than losses. So I moved out back then. And I think a lot of advisors, we're stuck in the same position of trying to decide, what do we do here? I mean,

where do we go from here? And for us, it's been really great. This last quarter, I mean, ending here at the end of March, we're not quite there, has been our best quarter ever from a net AUM growth standpoint or flow standpoint. We're going to probably take in a billion dollars, take us almost to $7 billion at this point. Wow. Even after the market has moved down on us, so it's been a great quarter for us. And it's been terrific because people are starting to realize, okay, these are another tool I can use rather than fixed income or I can stay in the equity markets and not be worried about it. So that's the reason we've really been excited about the flows over the last quarter or so. Bruce, I know you guys talk to a lot of RAs and investment advisors. Do you find that

they're taking their portfolio and they say, well, we're 6040 call out for most of our portfolios. Are they taking most of the money for these products and taking out of fixed income? Are they taking, all right, we're going to take 10% from stocks. We're going to take 10% from bonds and use that. Like, is that how that generally is working for advisors? We're seeing a lot of different ways. We're seeing some people are scared of the equity market, what the equity market was going to do. So they're pulling money out of their equities and putting it into different buffers.

They think meet their projections. But a lot of people that really didn't know where to go versus fixed income, pulled money out of fixed income. I mean, they didn't do it all, but I mean, they did 10 or 15% of their fixed income position and put it into here and linked their upside potential to the equity market more with a buffer. So it didn't change your risk profile much, but they changed what their conservative investments were linked to, rather than being linked to fixed income, which you knew rates were going up and they're going to get smoked. They switched over to the equity side.

They've done very well. So bring us up to speed on the products. the first time we spoke to you, I think we were calling these defined outcome ETFs where you could, there was the buffer and the cap and you sort of knew where you were going to fit in. What is going on with these managed outcome solutions that you're bringing to the market? Michael, as you said, we started with a defined outcome, which says, okay, you're going to buy it here, you're going to get this amount of upside, you have this amount of buffer on the

downside, it's going to reset in one year and it's going to just keep doing that every year into the future. and what we heard back from advisors was, well, I don't want to have to manage that. I don't want to have to watch that. If the market's up, what do I do? If the market's down, what do I do? They don't want to have to be involved day to day on it. So they said, could you bring more of a managed approach to that?

We have four different what we call managed outcomes. So you have defined outcome. Now remember, when you go to a managed outcome, you lose that outcome at the end. You don't know if the market's up 10, I'm going to get 10. If it's down 10, I'm buffered for 9. or I'm buffered for 15, you lose a little that known outcome. But you still have a managed outcome. And so I'll explain to you how that works.

So we have two types. One type, it just ladders across the entire group, which says we have like a 9% buffer for January, February, March, April, May, June, July, all the way through the whole year on a monthly basis. So you own all 12 and one ticket. You buy out with one ticket. you get coverage across all 12 and what we call a ladder because when one stops, it resets and it just keeps doing that. So you get a 9% buffer doing the ladder or you can get a 15% buffer that are

completely laddered out across the year. Now, what does that do for you? And why would you do that? Well, it gives you a diversified exposure and it lets you know that you have exposure to buffers on the downsides. You don't have nearly as much risk on the downside, but you have a sense of which you're upside potential is. Now, then, once we just released are called step-ups. Now, what is the step-up? So the step-up, what it does is it says, you're going to buy in. If the market's up five, we're going to rotate into the next one the next month, and we're going to get the new one. So we're going to lock in that 5%, and then we're going to give you a new cap and a new buffer whenever that happens. And we're going to keep doing that, stepping up and locking in. Now, even when the market's

down like on the 9%, if the market's down to, we're going to move to the new month and we're going to rotate to the new month. Now, why would we do that? The reason we do that typically is because remember these strategies, they have less volatility than the market. So if the market it's down two, we might be down one. So we're going to rotate into the new one. We're going to take that 1% of our performance and usually expand and give you a better cap. And so that's the one that really is a little more, we're not really calling it tactical, but it's more opportunistic. And as the market makes these moves, you move into the new buffer based on these rules. And let me just tell you the rules real quick. The step up for the 9% is, if it's up 5%, we step

into the new one at the beginning of the month. And if it's down 2%, we step into the new one at the beginning of the month. And then for the 15%, if it's up 4, we step up. And if it's down 1, we step into the new one. So we're making these adjustments, it's quantitative. There's no subjectiveness to it. We're just saying, just like, let's say you guys bought the 9% and you're like, I think, Michael, you might even brought this up a while back. You said, okay, I bought the 9%. Now the market's up. I'm getting closer to my cap. Now what do I do? If you want to, you don't have to do anything. But if you want to, you can roll a new one. Now, this does it for you. Why would you use this one instead of do it yourself because this switch between the different ones is not

taxable. Whereas if you did it yourself, it would be a taxable event. So here, it's not taxable. We can roll to the new one, lock in your game, give you a better cap, and we just keep doing that through time. That's the reason we think these four either going with the ladders or going with the step-ups are going to be really powerful for people that love the buffers, but they don't want to day-to-day do the management of them. Michael, this is what we asked for. Yes. We planted the seed. What can I tell you? I'm listening. You're only doing these tactical moves at the end of the month.

If you have a move intram month, you're not making any changes there. No, we're not doing them interim month. We're just making the adjustment at the beginning of each month. We're taking a look at the month. We did some evaluation of moving on the fly like that, fully active. And we just found it really doesn't add anything to the overall performance. And therefore, it just makes sense to wait to the end of month. Now, the reason it's good to wait to the end of the month,

is for people that are familiar with our products, then you're going to get the current month. Let's say it rolled into April right now. You can look at the April and you can say, oh, okay, here's my outcome. If they stay in here, I'm going to get 16% of the upside in the nine and I have a 9% buffer. It does give you a sense of where you're going, but it can switch again at any time or any month, I should say. You have sort of a rolling downside protection then. Yeah. It captures the growth that you have as you're,

go. You know, if you're up 5% it locks it in with a new buffer each time and continues to capture that. That's what we call it the step up. It's stepping up your buffer, it's locking in the gains as you go. Can we talk about some of the ways that this fund actually operates under the hood? So, for example, what the heck is a flex option for people like me that aren't familiar with the options market in depth? It's really simple. Everybody knows like what listed options are. We've all had to learn there. But a flex option, the easiest way to think about it is, it's a custom option. And what that lets us do, and the reason we use those is we can say, okay, we want an option that starts on the first day of April, and it ends on the last day of March next year. And so we get

exactly that one year. And we can tell what the parameters are. We can dictate the parameters of that. We want a 9% buffer in this package. And then what happens is we put that out to the street. these people bid on it to give us the best cap. So the best cap then is the one we choose and we do the deal with the best cap. It's the same thing as if you had an equity security and you said, I want to buy Tesla and you put it out there. I want to buy a billion dollars of Tesla. And everybody, whoever comes back with the best price, lowest price for you, you take that price. It's really similar to that. So who's doing this for you? Like how complicated is this? Well, Milliman, who you guys may be familiar with, they're a huge asset manager. The reason,

reason you probably haven't heard of them is they deal primarily on insurance balance sheets. What they do is they protect insurance companies and their balance sheets against big losses. And so they're professionals, their actuarials, they deal in the life insurance business and all this type of thing. So that's the business there. They're one of the largest traders of these types of products in the market. That's the reason that Innovator has teamed up with them to work together to manage these products. So I will say credit to you guys for making marketing materials that are super digestible

and pretty easy to understand. But it's one thing to read a faction and be like, okay, I got it. It's another thing entirely to be able to implement this in real time. So how are you working with advisors? Like how closely are your salespeople or your internal people or whatever? Are you having conversations with advisors all day? Your people? Oh yeah, all day long. That's what we do. We have advisors send us portfolios and say, okay, how would you incorporate them in our portfolios? We give them ideas and what we would replace and how we would do that. And we also have just cookie cutter approaches that just say, look, take 30% of your assets, some out of bonds, some out of equities, and do this.

And this is what we think you could expect. I think I mentioned this to you guys before. The beauty of these particular products is they are forward looking. It allows you to express your opinion about where the market's going and how much protection you think you might need or might not need in the marketplace. And so you can use the buffer that suits you or your client the most. And that's the reason so many advisors love these. And there just isn't anything like this available to them that is so easy to use across their book of business. You mentioned that a lot of people are coming to you because they're so worried

about the bond side of their portfolio. It sounds like you're trying to answer that question, not only through the buffered ETFs with more stock exposure and some upside, but this defined wealth shield ETF, I guess that seems to me like it's something more defensive. So maybe you could talk how that one works and how it's similar and different from some other strategies. I'd love to. This one grew out of demand from advisors. Advisors came to us and said, if you guys had something like this, we would really use it. We can see a huge spot for this. The defined well shield is really designed to replace core bonds, is the way to think about it. Now, how does it work?

It's underlying assets that it's linked to is the spy or the S&P 500. And it looks at that quarterly. And what it does, it puts a 20% buffer on the spy quarterly. Now, to get that much downside buffer, so you have no risk for the first 20% down in the market over a quarter. But you're only going to get about 1%, 1.3, 1.4. and when yields move up, you'll get more, maybe 2%, but you're only going to get that much upside potential quarterly. So you don't really have much downside risk to the equity market,

but you have this upside income potential. So let's say, just to keep numbers simple, you have a 20% buffer and you have a 1% cap. So you get that every quarter. So you're saying, okay, I don't want to tie my core bond exposure to bonds because it's a losing game right now. I want to tie it to the equity market, which I think, even in inflationary times, the equity market tends to go up over a year. So they're saying, hey, I'd rather get whatever the equity market would give me with a big 20% quarterly buffer on.

And historically, we've looked at it, I think there's only one time back in 1958 that the SMP has actually been down over 20%. It was down 26% in one quarter. What happens if you do get that? Well, if you get that, what tends to happen is then your cap expands way. up. So you get like a 4% cap the next quarter and you make it up very quickly as the market rebounds. And so it really is a super stable investment. But if you are down 21%, the entire floor protection disappears? If you're down 21, you lose 1%. Huh. Yeah, you lose 1% in a quarter. I look at a chart of this and it's very stable. And so I guess super stable. Right. The idea here is

that if you're trying to make this like your fixed income exposure, you're not going to be subject to interest rate risk either. Bonds are down right now and this thing is not. Yeah, this thing is not. You can see it's bucking the trend. And so we're telling people is, look, take a portion of your core bond allocation. Don't link it to fixed income right now. Don't link it to interest rates. Link it to the equity market. You cannot beat inflation with bonds. That doesn't happen. You can't beat inflation with bonds. You have to have another way to beat inflation. The equity markets tends to outperform inflation over time. So link it more than. of that. And so that's what we're saying. Get that small potential on the upside from this with

little risk on the downside and not be beholding just to the interest rate market. And this isn't like your other strategies where you potentially have to roll this over. This is just one continuous fund. Yeah. All the other ones are continuous funds too, Ben. After a year, it just keeps going. But this one happens every quarter. So it follows very closely. So each quarter, it just resets. It gives you whatever we can give you in cap, but it gives you a 20% buffer. So you always have a 20% against any losses in the SMP 500 every quarter. And then you get whatever we can give you in cap. And guys are really starting to like it. It's really starting to catch on. On the other side of the spectrum, you're introducing a hedge Tesla ETF. Why would somebody want to cap their upside on Tesla?

Isn't that sort of the whole point? What's the thinking here? It is the point. But I think when I think of Tesla, I think back to Amazon, this isn't a great argument for me, but remember Amazon back in 1999, 2000, and we were all like on my goodness. I've seen the charts. I've seen the charts. Yeah, I know, I'm an old man, but I remember back then it said Amazon would have to sell every single CD and book. It sold that Christmas to justify their price and blah, blah, bra, blah, but and let's face it, AWS bailed them out. They wouldn't quite be where they are today. If you think about Tesla guys, they sold a million cars. They have a market cap of a trillion dollars. Each car adds one million dollars to their market cap. Every car, a million dollars to their market cap. My point is, it's way beyond what it can be. Bruce, have you seen the price of use cars lately? That seems reasonable. Exactly. None of those are elector. You know what I'm saying? My point is, I'm like, I don't know, 1,500 percent in my Tesla position or something. I would roll out into this. Now remember, and two, this is a good point, guys.

This one doesn't have a buffer. It has a floor. So what's the difference? So a buffer is the first amount of loss. So the first 9% of the first 15%. A floor is you can lose 20%. But after 20%, you can't lose any more. So you can cap your downside.

Yeah. So it's like the tail risk. You can't lose past this amount. Okay. What does it do to your upside? It improves your upside because that first bit is really where you're most risk. skins. I mean being down 9%, 15% or 30%. But beyond 20% it's not as big of risk. So now on Tesla on a quarterly basis, now this is every quarter. You have a 20% below each quarter. You have the

potential to get, we've been looking at the caps around 30%. She gets 30% of the upside on Tesla from here. But if Tesla crashes like all these other companies that didn't have enough furnished to support their price, you're good. You lose 20, but you're not going to lose 20. But you're not going to lose more than 20. Is this something that theoretically could be replicated by somebody just doing their own option strategy, but most people have no idea how to construct this and they're just outsourcing it to you? Absolutely.

Somebody could figure out how to do this. But better off. This is a little more specialized than most guys can do. And we're buying all the options at institutional levels and it's packaged for them. It's ready to go. They don't have to mess around trying to figure out, okay, where's my 20% or where's this at? Can I tell you a true story? this is probably like 2010 or 2011.

I wanted to buy, I can't remember. Let's say I wanted to buy weekly calls on Zenga. And by accident, I bought puts. And so I was like, all right, I guess I'm bearish now. Exactly. So maybe it's better off to just outsource it. Maybe it's better to outsource it. You could theoretically do this for a bunch of other individual holdings.

Like, how many would it actually make sense? I mean, maybe you can't talk if you're going to put them in the pipeline, but you could do this on Bitcoin or Amazon or like, obviously, Tesla is a huge name that's followed a lot. Like, what other individual securities would it even make sense to do this is something like the sudden? First of all, I would tell you this is the first time this has ever been done in an ETF where you have a single stock ETIF providing a hedge on something.

But we could do it all kinds of things. I think it makes sense. When does it make sense? It makes sense when you have a company that's way overvalued, but you really believe in them long term. Remember, you're not giving up. If you can get 30% a quarter, that's 120% for the year if it continues to go up. So you're not really giving up.

upside. Remember that. You're just putting a floor on how much you can lose on a quarterly basis, which I think is really powerful for a lot of people. If I'm up 1,500 percent, I roll out of my position into this. Guess what? I've locked in most of that game. Hey, I know that it's like impossible for ETF issuers to see where your flows directly are coming from, but you talk to advisors pretty intimately. So you must have a good sense of where your flows are coming from. The end user of these products? Because the fact of the matter is, in order to protect on the downside, you have to give up some of the upside, which clearly $7 billion worth of assets says a lot of people are willing to make that trade. And credit to us, Ben and I were super bullish and

innovator when we first heard the idea. So credit to you and credit to us. But who are, do you think the users, are these primarily people that are more risk-averse or older people? Or is that maybe am I making that assumption up? Here's the thing. wealthy people, they're not trying to get rich, they're trying to stay rich. People that are close to retirement, of course they want to grow their assets. It allows them to do this, but it also allows them to have much more control of their outcomes. And that's what they want to do. They're not trying to necessarily hit home ones every time.

They're just trying to hit singles and doubles very consistently. That's what this does for people. And so advisors, remember 75% of the investable assets is pre-retirement or retirement right now. So most advisors, their best clients are those people. And so they're trying to manage your outcomes. And they're trying to give them upside, but control their downside. This allows them. So it's really good for, am I recommending this for people that have 30 years in the market? No, I'd go swing for the fences. Like me, listen, I might be bold, but I'm still young. It could be a little shorter than that. We'll have to see. I'm bald, but I'm young. I'll take all the downside as long as I get all the upside. I want it all. Yeah. So, I mean, the bulk of the assets, these are investments. And advisors are starting to realize, wow, this is taking a little time just because they're realizing they haven't had access to this kind of thing in this way before. And so they're trying to figure out, okay, how do I incorporate this? You're excited about them. But we're helping them figure out how do we fit them in? I'm sure you get a ton of questions then and advisors are probably always constantly asking for

new things and that's why you keep adding products. What are they asking you about the most these days and why is it inflation? Because that's all we're hearing about, obviously. It's got to be that, right? Is there anything else advisors are really like hankering for? I think the biggest thing that advisors have been concerned about so far is inflation and income too. I mean, they want to find other sources of income, an income that doesn't put them at huge risk. And I think that that's the reason we're trying to help them understand, look, you may have to give up your income position and buy a buffer and get capital gain and sell some of that off at the end rather than just go for straight up income. You're going to have to think about it. People are trying to look at decumulation strategies as people take their money. Everybody's been accumulating for so long. Now they have to think of, okay, what's the best way to break this down and to start to live off of this? And so I would say that. I would say decumulation, income. and inflation. What do we do about this going forward? Hey, what's going on with your relationship with Raymond James? Is this like a Tom Brady situation? He came out of retirement? What's happening

here? Exactly. Exactly. Well, what happened was, well, you guys know, I think we might have mentioned to you before that we're not in a lot of major distribution right now. I mean, we are primarily available to RIAs who are on like Schwab, TD and these platforms. A lot of the firms have really blocked the ability for their advisors to use these products, which to me is mind boggling. I don't get it. I think you remember these compete a little bit with structured products. You've got to pay the Piper. Well, right. We compete with them. They don't want competition for their structure products. And I think that's part of the challenge. So they're like, okay, what are we going to do about these things? Well, Raymond James isn't a bank in that they put structure products out, but they know a good

thing when they see it. And they want their advisors to have access to the best products available in the marketplace. And so Raymond James, to their credit, and I would say they're advisors, some of the luckiest ones out there right now, they have access to these buffers. And if you want to open some new accounts, go after these clients with these products because your competitors can't use them right now. And we're seeing them really use these as they try to grow their businesses because it's a unique opportunity for them.

Hey, who's that little cutie behind you? Where? Hey Got the grandkids there That's rough Yeah That's rush Adorable

Okay Hey Get out of here I'm on the phone I'll be right there All right last question Then we'll let you hop Okay

You're a pioneer In the ETF industry You've been in the game For quite a while Are you surprised delighted to see the state of the industry That you could do such cool stuff

Like this Given how long it took for user adoption to just hit like SPY, for example? Yeah. When we launched Power Shares, it was like really tough. The great thing that we have going now is that people know ETFs. They trust ETS and we launched Power Shares. Nobody even knew what an ETF was.

They were maybe buying the Q's in the Spider, but they were just like they didn't really know what they were or how they worked. The industry wasn't mature at all. Now people are familiar with them so that when you bring a product like this, a lot of the operational questions and how does this work? what does it do? Those aren't the questions we get. We get okay. We understand it. How do we use it? And it's more use case than it is how does it work kind of thing. All right. This is awesome. Where could people learn more about innovators, ETFs? Go to innovatoretoffs.com. We have some great tools on the website and

love to work with you. Give us a call if you have any questions. We got the best team in the market to explain all these things in detail how they work. Bruce, this is great. Thank you so much for coming on. Thanks, Bruce. Fellas, great to see you again. and thank you very much for having me. Thanks again to Bruce for coming on. Thanks to Innovator ETF, remember it's innovatoretefs.com, and send us an email, Animal SpearsPod at gmail.com.