ETF Edge - Elevated volatility elevates interest in buffered ETFs 3/12/25

Episode Date: March 12, 2025

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The ETF Edge Podcast is sponsored by Invesco QQQ, proud provider of access to innovation for the last 25 years. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you are looking to learn the latest insights on all things, exchanged, traded funds, you are in the right place. Every week we're bringing you interviews, market analysis, and breaking down what it all means for investors. I am your host, Bob Pisani. Elevated Market Volatility has elevated interest in so-called buffer ETFs. Goldman Sachs is just the latest.

launch a new suite of products. Here is my conversation when Brian Lakey's the chief transformation officer at Goldman Sachs and Mike Akins from EF Action. Brian, Goldman, you just came out with a new buffer one last week. You've got three of them. Let's not assume everybody knows what these products are. Explain to us how these buffer products work. What kind of protection are you getting? What are you giving up when you do? Yeah, let's start as an investor. I'm an investor, you're an investor. The folks watching are investors. And there's an incredible amount of uncertainty right now, tariffs, the widening out of equity markets away from Mag7, geopolitical issues, there's a lot of uncertainty. The buffer products are designed to help protect people to the

downside while also allowing them to participate to the upside. Now what we've done with this suite of products is the way they're designed is they'll protect from down 5% to 15% while still allowing you to participate upwards of 5 to 7% and then those reset on a quarterly basis. So you are protection from 5 to 15%. There's another protection 30% below that. It's sort of two levels of protection in this product. And then you participate in the upside, up to 5 to 7%. You're giving up.

If you do more than 7% upside, you're giving up that. Yeah, the challenging market, which is the question I always like to ask, is what's a challenging market for these strategies? Straight up. A straight up market would be a challenging because you would be capped to the upside. But again, that's the cost of getting the protection to the downside, which so many investors are looking for in this. market environment. Right. So there's three of these that you had. You just had a new one. And they reset

every three months, right? Yeah. But that's an intentional design thing. So it's a suite of three. Each of them set every quarter. But the way that we've staggered the launches is that any month at the beginning of the month, you've got one of our buffer strategies that's resetting and ready for you to invest in. So this reset date is very important. Again, let's not assume anybody understands this. It's important, we've said this before, to own these near the reset date and then hold them through the entire period. Why is that important? Explain to the viewers what happens with these. So the market's going to move intram month, but as we strike the options that are going into these strategies, they're the most precise for the outcomes that we're trying to design at the beginning

of the month, because that's where we've priced it. Now, as soon as we go to day two, the market's moved a little bit and those hedges that we're providing, either that downside protection or the cap on the upside is going to have moved. a little bit. But if you enter at the beginning of the month, you should have it pretty set the way that they're designed. You can also go on the website and see exactly where we sit on any given day so that you can understand exactly what your outcome should look like over the next quarter. Mike, you're sort of the grand ETF pooh-bah around here. I have you here to sort of explain these a little bit more. Give us your general thoughts on these buffer ETFs. Are these valuable products?

Talk us a little bit about how you feel about them. Yeah, so I think first and foremost, I do think they're valuable products, but like all ETFs out there in the market that are going away from your true traditional beta, it's in the way that you use it and how you apply it to your portfolio. So, you know, I always think of the Eric Clapton song that was in the color of money. It's in the way of the use it in the sense that if you're properly understanding how the product reacts to your portfolio and you know that, hey, is this a replacement to equity? Is this a complement to fixed income?

Putting that in there and understanding your results, they provide a very unique way to get access to the market and really buffer away some of that, that downside that you might see in an ordinary course market like we're seeing recently. But there's key elements to this that really need to understand. I think Brian did a great job talking about it, but one, how much protection are you receiving? Two, what are the reset months? Because owning it for the entire period of your reset is key because of that time. element of pricing options. You know, recently, as we know, we've had a ton of market volatility, and markets have been down, you know, some cases that queues was down 4% a couple days ago. A buffered ETF doesn't mean that you're not going to lose some of that 4% on the day it goes

down percent, even though it's in that protection period, because you have to hold it for the whole time period to get that full protection because of the pricing element of those options. That's really important to understand. So if you were to just turn around and sell it, you're not going to get that 2% or whatever protection that you lost on that one day of elements. So that's really important to understand. I think that's why you're seeing strategies like Goldman's becoming more popular because instead of having to hold up for entire reset period and having one strike price for that whole period, they're resetting on every month for a portion of the portfolio, giving you more of a smooth ride. You also see that in the laddered strategies, which are getting a lot of.

lot of the flows. So from a viewer's perspective, you're just looking to protect and you don't want to have to manage that where you're at with that buffer cap, both on the downside. Look at the laddered strategies and the strategies that reset more often. So just to review here, what you're doing with these buffer ETFs, you're trading some of the upside potential for downside, for reduced downside risk, essentially, right? So you allow to participate up to some level of market gains. five to seven percent on the S&P you said, and then you use options to protect on the downside, essentially. And this resets at the end of the very period here.

In this case, every three months, each one. There's three of them, right? So here's your basic summary of what's going on with these. So tell us about the risks and the considerations of investing in these products. I mean, obviously there's this market timing thing you were talking about. Tell us about the expense ratio. There's costs involved here. and your pricing options?

Just give the viewer a sense of what's the risk here? Yeah, I mean, these are importantly tried and true strategies that have been used by investors for decades now. The Goldman Sachs, sophisticated Goldman Sachs, the Goldman Sachs trading desk has been doing this strategy for decades, right? There's nothing radically new here. It's just in an ETF wrapper. The innovation is that we're delivering it now through this ETF wrapper,

which is so convenient for all types of investors to get access to. So there's definitely history, history around these. Now, we talked about one of the major risks, that if the markets go straight up, you could be foregoing some of the upside that you would be getting if you didn't have this option strategy. But that's kind of the cost of getting that downside protection, which, again, if you think about where the markets are, historically, you know, hitting all-time highs not too recently ago, or just recently, I should say, that's good. The expense ratio here? 50 basis points.

So, you know, we're really delivering these really sophisticated strategies, the ETF wrapper that's super convenient for investors to use at a pretty attractive price point. So, you know, what's interesting is that, and here we're listing some of these risks consideration, the timing, the expense rate, 50 basis points, they have a percent. This is a sort of subsector of the ETF space. I don't know what you call it, alternative ETFs. Mike calls it that, just did a lot of innovation in the last couple of years here. Some people want more yield. You became quite famous with JEPP Morgan product that basically sells call options and collects yield. Some people want yield.

They're like the JEPI product and you have a Goldman Sachs product. Some are worried about the highs and getting protection, which is what we're talking about today. But the point is that this kind of like, I don't know what you call, Alt-TTF space is really kind of grown in the last few years. Yeah, I want to be careful with the wording here because I think Alt means a lot of things to a lot of people. Give me more specific. But I do think about, you know, I think buffers a really healthy way to talk about it, is it can buffer your returns, and we're using options in order to do that. Some of the strategies that we offer, like the premium incomes, GPI and GPIX that we offer use options to give you more income. And so these are strategies where we're using options that, again, are available, have been available for decades, embedding them into ETF strategies, and then making them available at really attractive fee levels for investors to build better points.

portfolios. And I think that's what this is often about, right? What you now have are thousands of ETF so that every investor can build their perfect portfolio, what they're trying to accomplish there. There are more tools than ever for them to pull them in and try to drive the outcome that they're seeking, not just some generic outcome. Mike, it's a little dizzying sorting these alternative ETF is the word I'm using out, but give us your thoughts on this. We just put up a board here showing some of these strategies. So there's buffering for strategies that use options to provide downside protection. That's what we're doing right here. There's synthetic income.

They use options to generate income. There are leverage and inverse products. They use derivatives to magnify their turn, so you get one or two times or three times to leverage an inverse. We have single stock ETFs that amplify positions, like Nvidia two times or two times inverse. And then we have option overlay products, call options.

Sort this out for us. Explain where these products have a particular use case or where is the growth area. Yeah, so one just clarification. We do refer to these as non-traditional. Alternative we save for things like managed futures, true alt strategies. We do call these non-traditional. So if you were to go to our website and look at, you know, look at one of our dashboards. This would be under our non-traditional dashboard.

Okay. But the growth has been incredible, right? You've gone in just the buffer space from basically no ETS five years ago to over $60 billion today, seen the same type of trajectory, though they've been around longer, the same time of growth trajectory in synthetic income. The leverage inverse is continuing to grow, though. You know, big caveat between leverage inverse and what you're seeing like with buffers and synthetic income. We see buffers and synthetic incomes being used by institutions to a large degree.

when you look at the ownership data that's available publicly, you don't see any of that with these single stock leveraged inverse ETFs and very little with just leveraged inverse strategies. So little different fires market. Is that what you're saying, Mike? It's all retail? You mean leverage and inverse? Yeah.

Leverage and inverse. So like 95% of leveraged inverse strategies. You can't tie back to 13F filings. Yeah. I think of those as more trading vehicles. And so yes, they're in the ETF. But, you know, the strategy. that we're talking about here, they're part of a broader portfolio where you're thoughtful

about what you want to deliver over time. The leverage and inverse is really designed to be a traded vehicle, and you can get in and out of those on that, but of course you need to be very aware. So in my mind, and I think for investors' minds, they need to really separate those things very differently. A buffer strategy is going to lower the volatility in your portfolio. A premium income strategy is going to lower the volatility in your portfolio, whereas some of the leveraged and inverse things are going to move in very different patterns than the other things. Well, that's a very good point. I mean, people don't ask this question enough, which is if I buy these products, which includes everything, I mean, includes Bitcoin, too.

What does it do for my portfolio? I own stocks. I own bonds. I own cash, money market. I might own some real estate. Okay, why should I add an option overlay strategy? Why should I add Bitcoin? And a traditional question, that's the question is, Does it improve the return? Does it reduce volatility? There's certain standard questions, and yet a lot of people don't ask it. They just say, oh, I think Bitcoin will get me rich quick. Let's buy more.

Yeah, you know, Bob, and you and I have talked about this a lot, which is we love this industry because at the heart of our industry, it's helping people achieve their financial goals, whether that's retire with dignity, whether that's pay for health care, whether that's vacation, education. There's a lot of good objectives that people have. And so we're developing these tools to help people achieve those objectives. Now, these strategies go into a portfolio construction methodology that allows you then to help drive different outcomes for that. The other reason you and I love the ETF industry is it's 100% transparent.

You can go onto our website at any point in time and you can see exactly what we own within these. And you know, we encourage people to do that because it's a great benefit of the ETF. You know what you own. And with these strategies, it's the same. You can go on there. You can look at the holdings. And there's also pieces there to educate and to help understand what these are intended to do, which again then helps educate people and they get better outcomes for their investments.

I think the key point you're making here, you made a very good point about the volatility. What is it adding to your portfolio? And leverage and inverse increases volatility, whereas buffers, aesthetic income lowers volatility. That's a very important consideration when you're putting together a product. I've always said I've had problems with leverage and inverse for years for exactly that reason. and people can't wrap their head around the reset, the daily reset. Yeah. Tremendant.

When we talk to clients, when we talk to clients about the buffered strategy and synthetic income, the key data point we tell them to dial into is up-down capture. Right. So what percentage is up-down capture? And buffer is a great example because these buffer ETFs, they all have different amounts of losses that they're looking to buffer away. And the ones with lesser amounts of losses tend to have higher up-down capture ratios relative to their broad market. ones with more that provide more protection are going to have lower up-down capture ratios.

That's just the sense of your beta, your volatility to your underlying index, what you're willing to give up in terms of upside capture to protect on the downside. And that stands true for the synthetic income products as well. And it's a key element to look at. If you're capturing a neutral or better yet, a positive up-down capture to the market that you're tracking, they definitely have good benefits to your portfolio if used correctly and understanding what it means to your overall risk return perspective. I want to just go ahead.

Do you want to say this? I was going to agree with Mike there. And what he just said goes into the design process for how we build products. So we talk to investors and we say, what are you actually trying to achieve? And if you were to use a buffer in your portfolio, what would be those thresholds that you would, that you would find attractive to building better portfolios, which is why we've intentionally picked this 5 to 15% range with the 5 to 7% on the upside. That was an intentional choice that we made based on how we talk to investors and research and experience that we have at Goldman.

I want to talk a little bit about synthetic income products. You became quite famous over at J.P. Morgan for helping create JEPP. Goldman has products here that provide premium income, essentially. You have an S&P product, GPIX and a NASDAQ-100, GPIQ. So what does this mean, synthetic income? You're using options to generate income. Explain how this works with the S&P product. This is GPIX is the symbol.

It's pretty straightforward. You're using covered calls on equities or on indexes that you own within the portfolio. What that allows you to do. So you're taking, now all of a sudden you have money, a premium. You have something there that you give back to the investor. But there is a cap on the upside because you're selling a call, right? Right. Yeah.

So you sell that call. You get the premium in for that, and then you can pay that out as income. And, you know, as we look at this space, that's one category that's been Evergreen for investors. lot of investors are looking for income on a consistent basis. Right. So here it is. What is this paying out right now? By the way, this is not protecting you from, you know, you can see here. This has been down the last few days like everything else. But you're collecting money here. What kind of premium are you paying out here right now?

If I would own this right now. Yeah, I don't know the yield off the top of my head to be completely transparent with you, Bob. What you tend to think about is the VIX, the higher the VIX is, the more your income is going to go up with that. And so with the increased volatility that we've seen, the income should be... Could you collect more money for selling the call? Yeah. Yeah. Okay.

You know, we were talking yesterday. You had a great career at J.P. Morgan. He moved a while ago to a big position at Goldman Sachs. And you told me yesterday you've learned a tremendous amount since going from J.P. Morgan to Goldman. These are the two big firms on Wall Street. This is a big move to make from two big firms. What have you learned in the last six, eight months? Tell me how you seem to apply your thinking has changed a bit of grown, expanded.

I don't know. Yeah, well, I mean, you know, it goes back to the core of what we talked about earlier is good outcomes for investors. And we're seeing innovation happen in so many different places in this industry that it's really just a great opportunity to do that. And at Goldman, where we're a top five provider in active equity or in active public securities, we're a top five in alternative capabilities. And we think increasingly combining public and private and portfolio.

is going to be a really big trend. So the fact that we have public and private capabilities to deliver, I think, is really important. We also think that increasingly solutions and customized solutions are going to play an important part in investors' portfolios. So whether that's direct indexing, SMAs, models, that's another area where we're leading and continuing to develop technology that helps do that for investors' portfolios. And then the last thing that we've been talking about here is active ETFs. There's no doubt in my mind that active ETFs are going to continue.

to grow at a very rapid pace. But as we step back and think about the entire investor's portfolio, there's a lot of things that are now becoming available to them to help build those portfolios. Retail alts, separately managed accounts, direct indexing, and active ETFs all coming together to help drive better outcomes. The beauty is the wrapper itself, the ETF wrapper is what has enabled all of this. ETF has enabled a lot of this. I would argue that technology has enabled a lot of this.

I mean, you know, here we are on the floor. of the exchange, the change from fractions to decimalization unlocked a lot of this. And you could argue that ETFs were the first FinTech, but as technology came along, that's allowed us to do direct indexing at much lower levels, which helps drive better tax outcomes for some investors because you can offset some gains in those strategies. It allows you to build model portfolios where you're combining different asset classes, different ETFs to help drive that. Or as we were talking about earlier, alternative assets.

private credit, private equity, infrastructure, real estate, all of these things contribute to portfolios. Private equity can help drive returns. Private credit can increase your yield. Real estate and infrastructure can be diversifiers in your portfolios. And so you're now seeing all this innovation come along with those. And as you incorporate that into the total portfolio for investors, you're really starting to see some pretty cool innovation that's happening. And I think that those are things that are going to continue to grow. Well said, we just have to keep on top of being able to explain it to the viewers. Couldn't agree more. Thank you for helping us explain all that. Michael, thank you as well. Interesting discussion, folks. And again, we're on top of all the

innovations going on in the ETF world. And that does it, though, for this week's ETF Edge. My thanks to Brian and to Mike. We've asked Mike to stick around and provide more insight into current ETF trends that's on the ETF Edge podcast coming up. And remember, you can see all of our shows on our website. It's our seventh year, folks, etfedge.c.cnBC.com. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Markets 102 portion of the podcast. Mike Aiken's from ETF Action continues with us now. Mike, a great discussion with Brian Lake on Bufford ETFs.

But give us some broader perspective. This has been a pretty wild start to the year. We started off with big inflows and do sort of the traditional products, long products like the S&P 500 and other. standard products, but it's changed around a little bit. What kind of money are we seeing now? Where are the flows in the ETF business? Yeah, I mean, I think the flows into ETFs is still incredibly strong, right? We're on place for a record first quarter in ETF flows.

So the ETF wrapper itself continues to see large levels of flows. What we're seeing is going underneath and looking under the hood a little bit, a change in where those flows are going, right? So at the top level, at the asset class level, fixed income is keeping up with equities, which historically hasn't, right? The whole ETF space, about 80% of assets in the ETF space is equity, 20% fixed income. Flows here today is about 50-50. So big portion of that money is going into fixed income.

That's at the asset class level. Then when you get up underneath and within each asset class level, what you're seeing is in fixed income, it's ultra short, right? So people are not sure what to do. They're parking their money in ultra short vehicles and they're like, hey, let's ride it out. collect our income and see where we want to deploy as the risk comes off the table. Within equities, we're seeing rotations across, first, regionally. The U.S. is still leading an asset gathering, but not nearly by the margin it has in the years past.

We're seeing a lot of flows internationally, developed XUS, primarily if you look at the regional level, inside of Europe. And then going further by style, we're seeing a rotation from growth to value. Growth is still positive flows, but value is far out exceeding flows on a year-to-date basis in growth, especially over the last few weeks, this heightened volatility. So the ETF wrapper itself continues to grow and is healthy. But underneath the hood, there's a lot of action going on that we haven't seen in the last few years. So, you know, we always say one of our rules here is flows follow prices.

That is, a lot of investors are trend followers, and they start putting money. and after starting things move. Technologies had a very rough time the last month, really since the middle of February or so. What are we seeing there and things like not just the big names, like S&P Tech ETF, but even Kathy Wood's ARCETF, which is sort of a stand-in for speculative technology. What are we seeing in those areas?

Yeah, so thinking like sectors, industries, themes, you've definitely seen a rotation there as well. You know, technology has gotten all of the flows forever. Technology is still positive year to date, but barely. Last year, if you looked at all flows into sector and industry ETFs, over 100% of those flows were driven by technology. Wild, right? So, you know, multiples of billions of dollars came into sector ETFs.

Most sectors had negative outflows. Technology was just so large and it drove everything. You're seeing that reverse out. You're seeing the defensive sectors, healthcare, staples, things of that nature. the tech, disruptive tech stuff has been under a lot of pressure. But making up for that is a lot of flows into energy infrastructure, a lot of flows into, you know, traditional natural resources, things of that nature, where I wouldn't call them defensive, but more potentially going to benefit from the current policy environment we're in.

Yeah. And I want to ask about international. after years of underperformance, finally Europe is outperforming a bit. Parts of Asia are. Nobody has cared about investing in Europe for years. Every year I do this and there's no flows. Is that changed at all this year? Yeah, I mean, the, well, the appetite for Europe has changed significantly. We're seeing significant flows into Europe, you know, on pace for the best quarter it's had. in since I believe it was the first quarter of 2002 from a perspective of inflows into European ATFs. Now that ended up being a head fake and didn't pan out very well. But we are seeing that. And then of course returns here to date are massively in favor of developed XUS versus U.S.

So far into the year. So perhaps this change in perspective from administrations is going to have a lasting effect. That remains to be seen. But certainly the big Alex, are positioning as if that's the case. Yeah, it's about time. I mean, we're all believers. We're all Jack Bogle disciples and believer in mean reversion. But boy, it's been a long, long time. I mean, Europe has underperformed the U.S. for, I don't know for how long.

Maybe there were brief periods in the last 15 years, but basically it's underperformed for at least 15 years since the financial crisis. So it's kind of remarkable. I mean, I do the standard diversification. You know, I own 10% of my portfolio and international. And, of course, as Bogle pointed out, 40% of your revenues for the S&P 500 come from overseas. So you already have some international diversification. But heavens, it hasn't helped much in the last 15 years.

No, it's the worstification for sure. You know, I think the Europe play is interesting. Just a quick stat on that. If you look back 10 years ago, the MSC AQUI, All-C-World Index, was less than 50% U.S. from a pure market capitalization perspective. Today, it's over 65%. That just illustrates how insane the performance differential

of the U.S. markets has been versus international. Just to highlight that point for the viewer, because you can get lost here. The index you're referencing is the entire global universe, basically, of stocks. And what you just said is the United States is 65% of the value of the entire global stock market. And by the way, if you're wondering what the numbers are, do you know what the numbers, Mike? It's roughly $100 trillion, a little over $100 trillion.

It's $126 trillion, I think. $126, thank you. And so the total value of all the stocks that are publicly traded around the world is $126 trillion. And the United States has two-thirds of that, about $80 trillion. It's really staggering because even recently it was only 50% just a couple years ago. Yeah. I remember. Yeah, it's wild.

How fast it moved? I mean, that really tells you. And the question, of course, Mike, is if you all believe in mean reversion is, is that kind of a market top right there for the United States? And I don't know the answer to that, but mean reversion principles would say, really, how much further can you push this? Yeah. I mean, I think you can see it in the valuation multiples, right? important caveat about that change. It's not all just performance driven. The U.S., of course, has also had large IPOs. It's been a more popular market to bring companies out. So there's been a larger allocation there. But yeah, just a mean version perspective, we're at historic highs and valuation differences between the U.S. market and the European markets, the Asian markets. And so just from a standpoint of applying multiple. Valuation. If you come back, yeah, valuation.

Yeah, yeah, yeah. It baffles me, frankly. All I can just say, folks, is growth. The world has wanted growth, really, since the financial crisis. And that's why the S&P is so top-heavy on technology stocks. I'm going to have to leave it there. Mike, we could get into this forever. But that does it. Thank you, Mike. That does it for ETF Edge, the podcast. Thanks for listening. Join us again next week. Remember, you can see all the shows, etfedge.cc.com. Rethink Possibility by rethinking access to innovation and the NASDAQ 100. Let's Rethink Possibility, Invesco Distributors, Inc.