Annuity-Like Safety with ETF Efficiency
The allure of variable annuities (VAs) capture many unsuspecting adults. With a VA, you get to participate in some of the upside of the investment markets with no downside; the insurance company ‘insures’ against losses. The problem with VAs are the complexity and costs. The typical VA costs 3% annually, and has steep “surrender charges” (15% is not uncommon!). What if you could have much of the upside of the S&P 500, with downside protection, no surrender charges, and daily liquidity—all for 0.8% per year? In July of 2018, Innovator ETFs began issuing an expanding suite of ETFs to provide exactly this. I imagine as time goes on VA sales will plummet, and buffered-ETFs will become hugely successful (Innovator’s buffered-ETFs already total >$1.5 billion).
[NERD SECTION: The investment strategy in each buffered-ETF uses a fairly simple four holding portfolio: two call options and two put options. Each set of options is based on one of five indexes: the S&P 500 Index, the Nasdaq (QQQ), the Russell 2000 (small cap stocks), and international and emerging market stock indexes. The options expire in 12 months, causing the upside cap and downside protection to reset annually. I formerly traded options using a similar strategy in both the Naked Alpha Fund and inside client accounts. It is much more efficient to do it inside an ETF, at scale. END Nerd Section].
An example of an S&P 500 Innovator ETF in a 12-month period (actual figures for ticker symbol PNOV—annual cost of 0.79%—as of November 1, 2019):
- Upside cap (the best you can expect in 12 months): 9%
- Downside Protection (you won’t lose money on a decline this size or smaller): 15%
- If the S&P 500 index increases before October 31, 2020, you should realize the return of the S&P 500, up to the 9% cap.
- If the S&P declines before October 31, 2020, you either maintain your principal, or lose 15% less than the S&P 500.
Every 12 months you should get nearly what you expect, minus the 0.8% fee. But does a ~8% return satisfy you if the S&P 500 is up 30%, like in 2019? Therefore, we feel buffered-ETFs fit well inside an “alternative” bucket, as well as inside conservative clients’ stock portfolios.
We have been developing a “rotation strategy” that aims to hold the best buffered-ETFs mid-term, based on upside/protection remaining, and expected volatility. Why limit your upside when you could rotate to an ETF with additional upside? Call us to discuss!