INNOVATOR CAPITAL MANAGEMENT LAUNCHED a new Buffer ETF in July 2023 that seeks to provide equity upside participation with 100% downside protection. The Innovator Equity Defined Protection ETF (TJUL) is the first ETF to promise full downside protection over the outcome period. Note, a January 2024 series (AJAN) has also recently started trading, and others are planned to launch throughout 2024.
TJUL will track the return of the SPDR S&P 500 ETF Trust (SPY), up to a cap of 16.6% (before fees), while buffering investors against 100% of losses over the outcome period of two years. Investors forgo dividend income and pay an annual expense ratio of 0.79%. The outcome period for investors seeking full downside protection is double the standard outcome period of 12 months for most Buffer ETFs. So, investors need to be prepared to stay invested for the entire 24-month period to realize the defined outcome.
Like other Buffer ETFs, this product also invests in a basket of FLEX options with varying strike prices. The strategy involves buying call options to gain SPY exposure and put options for downside protection, and then offsetting the costs by selling call options, which caps upside returns.
Many investors purchase annuities, structured notes, or market-linked CDs that protect against losses, but come with higher fees, carry high investment minimums, long lock-up periods, and unfavorable tax treatment. ETFs like TJUL can be a better option for ultra-conservative investors.
To consider:
- You need to hold TJUL for the full 24-month outcome period to get the total downside protection.
While TJUL can be bought or sold at any time, just like any stock or ETF, you should understand that you’ll need to hold TJUL for the entire outcome period established by the fund in order to achieve the expected returns. This is in line with the structure of the FLEX options used in order to try to achieve the desired outcome, which in TJUL’s case is 100% downside protection. In its basic form, it works just like any other option contract.
In the case of TJUL, the outcome period is from July 18, 2023 to June 30, 2025. You’ll need to hold TJUL for the entire outcome period in order to have 100% downside protection. At the end of the two-year period, TJUL will automatically “reset” in a tax-efficient manner, and establish a new two-year outcome period (new upside cap with full downside protection). So, TJUL can be held as a long-term investment. - There’s a cap on upside performance.
In order to have 100% downside protection, you have to give up some upside potential. In TJUL’s case, the cap on the return is 16.62% (before fees) over the two-year outcome period. In other words, you capture 100% of the S&P 500’s positive performance up to 16.62%, but you’ll forgo any extra gains achieved by the S&P 500 during the outcome period – that’s the potential opportunity cost of having 100% downside protection. - Returns will vary during the outcome period.
It’s important to note that your returns during the two-year outcome period will vary if you buy TJUL before or after the reset date. FLEX options are designed to produce the desired outcome on the final day before expiration. Along the way, performance will generally correlate with the S&P 500, but not exactly.
During the outcome period, TJUL will not move in a 1:1 relationship with the S&P 500 up to the cap and down to the floor. Buffer ETFs usually come with much less volatility than their benchmark index and move gradually.
Again, returns will vary if you buy or sell within the outcome period. If you buy when TJUL is already up 5%, for example, you’ll (in theory) only have upside potential of 11.62% remaining. And, there’s also the possibility that you lose money investing in TJUL, in this example, because the 5% unrealized gain could go back to 0% if the reference asset declines and shows a loss at the end of the outcome period.
Again, Buffer ETFs are built with the end point in mind. If you buy at any time other than the reset date your personal returns will differ.
Who should consider buying 100% downside protection Buffer ETFs?
• You are extremely conservative and want total protection of your principal.
• You are wary of high stock market valuations and you believe the downside risk in the market is far greater than a typical bear market.
• You fear we may be heading for a market crash, but you’d like to hedge and remain invested in stocks with at least some upside gain potential, if your fears prove unwarranted.
Summary:
The idea of 100% downside protection built around an investment in the S&P 500 should be attractive to ultra-conservative investors, even if it comes at the expense of capped upside. But again, it’s important to consider how much potential return you might be giving up if the S&P 500’s return exceeds the upside cap.