(ETF Strategy) - Innovator Capital Management has introduced a new breed of defined outcome ETFs, known as Innovator Step-Up Strategy ETFs, which opportunistically refresh their return profiles when considered advantageous.
The Innovator Buffer Step-Up Strategy ETF (BSTP US) and Innovator Power Buffer Step-Up Strategy ETF (PSTP US) have been listed on NYSE Arca with expense ratios of 0.89%.
Traditional defined outcome ETFs provide upside participation on an underlying reference asset, up to a cap, while protecting or ‘buffering’ against a pre-determined amount of potential losses over a specific outcome period, which is usually one year.
The return profile is established at the beginning of the outcome period by utilizing combinations of FLexible EXchange (FLEX) Options – customizable exchange-traded option contracts guaranteed for settlement by the Options Clearing Corporation.
Defined outcome ETFs typically only rebalance and reset at the end of the outcome period, effectively starting new outcome periods with fresh buffers and new upside caps which are dependent on market conditions at that time.
As defined outcome ETFs have been tailored specifically for their entire outcome period, their interim returns during the outcome period may behave differently.
Not accounting for the time value of options, an investor who purchases shares of a defined outcome ETF after the outcome period has begun may be exposed to immediate downside risk in so far as the reference asset has appreciated since the start of the outcome period, and the fund may offer little to no upside potential for the remainder of the outcome period.
Similarly, an investor who purchases shares of a defined outcome ETF after the outcome period has begun may enjoy less downside protection if the reference asset has depreciated since the start of the outcome period but will typically enjoy more upside participation before the cap is reached.
Some investors in defined outcome ETFs attempt to navigate these challenging dynamics by rotating into other defined outcome ETFs as needed to secure gains or refresh buffers, a process known as ‘stepping-up’. Innovator, like other providers of defined outcome ETFs, seeks to facilitate this process by offering an extensive suite of products with outcome periods beginning every month of the year.
According to Innovator, however, many investors have raised concerns over timing risks, stating that they are unsure when would be the advantageous moment to step up into another defined outcome ETF.
Innovator Step-Up Strategy ETFs have been designed to address this issue. The funds automatically reset their options portfolio – selling the existing contracts and entering into new 12-month contracts – if their NAV rises or falls within a pre-determined range or if volatility has increased such that an options reset will offer higher upside caps.
The first two Innovator Step-Up Strategy ETFs are based on Innovator’s flagship ‘US Equity Buffer’ and ‘US Equity Power Buffer’ approaches which provide defined outcome exposure relative to the S&P 500 by investing in FLEX contracts referencing the SPDR S&P 500 ETF (SPY US).
The Innovator Buffer Step-Up Strategy ETF replicates the US Equity Buffer strategy of protecting against the first 9% of losses on SPY over a one-year outcome period while offering upside participation to a cap.
The Innovator Power Buffer Step-Up Strategy ETF, meanwhile, replicates the US Equity Power Buffer strategy of protecting against the first 15% of losses on SPY over a one-year outcome period while offering upside participation to a cap.
The ETFs evaluate the return parameters of their options portfolios on a monthly basis using a rules-based process, refreshing and resetting their options portfolios when considered advantageous.
Bruce Bond, CEO of Innovator ETFs, said: “The Step-Up Strategy ETFs bring to market a concept we’ve been working on for some time and one that many advisors have asked for. As we completed monthly issuance on our flagship US Equity Buffer ETF line-up in May 2020, ‘stepping-up’ became a popular strategy amongst some advisors who used the defined outcome ETFs in non-taxable retirement accounts.
“These new funds in our line-up will seek to provide advisors with tax-efficient strategies that manage the process of trading up from the set of return parameters of one monthly series of US Equity Buffer ETF to the current month’s opportunity set, depending on market movements and conditions. We feel that the managed process behind BSTP and PSTP will provide greater access to the type of ‘step-up’ strategies that many advisors have employed, automating the process of stepping-up into new and potentially higher upside caps and refreshing the buffer against market loss.”
By James Lord - CFA
Mar 10th, 2022
