Any thoughts about defined outcome ETFs?

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tman9999
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Any thoughts about defined outcome ETFs?

Post by tman9999 » Tue Dec 04, 2018 3:01 pm

Any thoughts about so-called Defined Outcome ETFs that are tied to a particular index and designed to shield investors from drops up to a specified amount in that index, with capped upside returns should the index go up. Three examples: Innovator S&P Buffer (BJUL), Innovator S&P Power Buffer (PJUL) and Innovator S&P Ultra Buffer (UJUL) — offer downside protection ranging from 9% to 30%.

Just curious whether these are worth the 70-80 basis points, and if so, what percentage a conservative portfolio might contain.

Disclaimer 1: I did do a search on a couple symbols as well as some terms and couldn't find anything. If this has already been discussed, pointers or search terms would be appreciated.

Disclaimer 2: I know trying to time the market is a no no, but... as I am within 18-24 months from retirement, I'm getting mighty nervous about the bear, so looking for ways to minimize exposure to adverse events.

Thank you for any input
Tom

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vineviz
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Re: Any thoughts about defined outcome ETFs?

Post by vineviz » Tue Dec 04, 2018 3:10 pm

tman9999 wrote:
Tue Dec 04, 2018 3:01 pm
Any thoughts about so-called Defined Outcome ETFs that are tied to a particular index and designed to shield investors from drops up to a specified amount in that index, with capped upside returns should the index go up. Three examples: Innovator S&P Buffer (BJUL), Innovator S&P Power Buffer (PJUL) and Innovator S&P Ultra Buffer (UJUL) — offer downside protection ranging from 9% to 30%.

Just curious whether these are worth the 70-80 basis points, and if so, what percentage a conservative portfolio might contain.

Disclaimer 1: I did do a search on a couple symbols as well as some terms and couldn't find anything. If this has already been discussed, pointers or search terms would be appreciated.

Disclaimer 2: I know trying to time the market is a no no, but... as I am within 18-24 months from retirement, I'm getting mighty nervous about the bear, so looking for ways to minimize exposure to adverse events.
Adding complex, unpredictable, and illiquid ETFs is the OPPOSITE of "minimizing exposure to adverse events".

The first line of defense in lowering the volatility of a portfolio should ALWAYS be to adjust your stock/bond ratio.

The second line of defense would be to convert some of your equity holdings from pure market-cap weights to a low-cost minimum variance or low volatility strategy like iShares Edge MSCI Min Vol USA ETF (USMV), Vanguard Global Minimum Volatility Fund Admiral Shares (VMNVX), or iShares Edge MSCI Min Vol Global ETF (ACWV), or SPDR SSGA US Large Cap Low Volatility Index ETF (LGLV).
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

ThrustVectoring
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Re: Any thoughts about defined outcome ETFs?

Post by ThrustVectoring » Tue Dec 04, 2018 4:13 pm

These are pretty pointless. If you want to buy downside protection for the S&P 500, the market for this is extraordinarily liquid. You just buy S&P 500 put options at the desired timeframe and strike price, and there's no shortage of sellers.

That said, you have to pay for the positive skew. On average, buying puts will lose you money - but the losses happen when the stock market doesn't fail, so you improve your worst-case. It's not worthwhile, IMO, which kind of implies that selling the put options is, but that's complicated and has execution risk, so I don't recommend doing it.
tman9999 wrote:
Tue Dec 04, 2018 3:01 pm
Disclaimer 2: I know trying to time the market is a no no, but... as I am within 18-24 months from retirement, I'm getting mighty nervous about the bear, so looking for ways to minimize exposure to adverse events.
You minimize exposure to stock market crashes by selling stocks and buying bonds. The only tricky part is making sure you maintain enough exposure to stock market rallies as well. What % of your portfolio is currently in stocks? How many years of annual expenses do you have saved? For reference, my target portfolio at retirement is 60% stocks, 40% bonds, and 30x annual expenses saved.
Current portfolio: 60% VTI / 40% VXUS

tman9999
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Re: Any thoughts about defined outcome ETFs?

Post by tman9999 » Tue Dec 04, 2018 4:53 pm

ThrustVectoring wrote:
Tue Dec 04, 2018 4:13 pm
These are pretty pointless. If you want to buy downside protection for the S&P 500, the market for this is extraordinarily liquid. You just buy S&P 500 put options at the desired timeframe and strike price, and there's no shortage of sellers.

That said, you have to pay for the positive skew. On average, buying puts will lose you money - but the losses happen when the stock market doesn't fail, so you improve your worst-case. It's not worthwhile, IMO, which kind of implies that selling the put options is, but that's complicated and has execution risk, so I don't recommend doing it.
tman9999 wrote:
Tue Dec 04, 2018 3:01 pm
Disclaimer 2: I know trying to time the market is a no no, but... as I am within 18-24 months from retirement, I'm getting mighty nervous about the bear, so looking for ways to minimize exposure to adverse events.
You minimize exposure to stock market crashes by selling stocks and buying bonds. The only tricky part is making sure you maintain enough exposure to stock market rallies as well. What % of your portfolio is currently in stocks? How many years of annual expenses do you have saved? For reference, my target portfolio at retirement is 60% stocks, 40% bonds, and 30x annual expenses saved.
Thank you (and thanks @vineviz) for your input on this - very helpful. We're sitting at around 50/50 equity/bonds, cash. Curious that you are aiming for 30x annual expenses. Seems high, unless you are planning on retiring early (or living to 110!). Or?

ThrustVectoring
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Re: Any thoughts about defined outcome ETFs?

Post by ThrustVectoring » Tue Dec 04, 2018 5:13 pm

tman9999 wrote:
Tue Dec 04, 2018 4:53 pm
ThrustVectoring wrote:
Tue Dec 04, 2018 4:13 pm
These are pretty pointless. If you want to buy downside protection for the S&P 500, the market for this is extraordinarily liquid. You just buy S&P 500 put options at the desired timeframe and strike price, and there's no shortage of sellers.

That said, you have to pay for the positive skew. On average, buying puts will lose you money - but the losses happen when the stock market doesn't fail, so you improve your worst-case. It's not worthwhile, IMO, which kind of implies that selling the put options is, but that's complicated and has execution risk, so I don't recommend doing it.
tman9999 wrote:
Tue Dec 04, 2018 3:01 pm
Disclaimer 2: I know trying to time the market is a no no, but... as I am within 18-24 months from retirement, I'm getting mighty nervous about the bear, so looking for ways to minimize exposure to adverse events.
You minimize exposure to stock market crashes by selling stocks and buying bonds. The only tricky part is making sure you maintain enough exposure to stock market rallies as well. What % of your portfolio is currently in stocks? How many years of annual expenses do you have saved? For reference, my target portfolio at retirement is 60% stocks, 40% bonds, and 30x annual expenses saved.
Thank you (and thanks @vineviz) for your input on this - very helpful. We're sitting at around 50/50 equity/bonds, cash. Curious that you are aiming for 30x annual expenses. Seems high, unless you are planning on retiring early (or living to 110!). Or?
If you're at 50% equity then you can just stay the course, that allocation should work under the standard 4% withdrawal (25x annual expenses), even with a bear market in the near future.

The 30x isn't all that much more than the standard 25x. The 25% extra saved is a combination of a buffer for miscalculating parameters, ensuring a longer retirement period is covered adequately, investing for heirs, and "unknown unknowns". Like, I kind of expect some of the awesome things that the future will make possible will end up being extraordinarily expensive.
Current portfolio: 60% VTI / 40% VXUS

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nisiprius
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Re: Any thoughts about defined outcome ETFs?

Post by nisiprius » Tue Dec 04, 2018 6:30 pm

Regarding "downside protection," I see that the prospectus says
You should not consider this investment if:
...you are unwilling to accept the risk of losing your entire investment.
What's with that? Why would any investor who doesn't want to take the risk of losing more than 9% be willing to take the risk of losing 100%? And, no, this isn't standard boilerplate. No such warning appears in the prospectus for VTI or SPY, for example (I just checked).

I believe that if you want the risk premium, you must take the risk. When you think you've found some clever way to get the risk premium without the risk, then the two possibilities are that you really have found the financial equivalent of cold fusion, or that is some risk hiding somewhere that you haven't spotted yet.

Simply having a stock allocation lower than 100%, and putting the rest in low-risk, low-return assets (bonds or good interest-earning bank accounts) is a dead-simple way of cutting your risk while, of course, cutting your return. Clever strategies surrounding stocks shouldn't be looked at in isolation, they need to be compared to the dumb, simple alternative of just putting part of your portfolio in bonds or cash.

A humble retail investor like me can easily find enough data online to make some of judgement about the risk and return of stocks, bonds over long periods of time. I can also find decent lengths of data on simple, long-only mutual funds that invest in stocks and bonds. Most of the fancy-schmancy stuff, the trendy stuff doesn't even have a enough data to go back past the global financial crisis, let alone more than one business cycle.

Don't tell me, let me guess: there's less than five years of data available for the things, and that despite being ETFs they have expense ratios higher than 0.5%. Let's see if I'm right. I wrote the sentence and I'll report the findings whatever they turn out to be.

BJUL, inception 08/28/2018, ER 0.79%
PJUL, inception 08/07/2018, ER 0.79%.
UJUL, inception 08/07/2018, ER 0.79%.

There isn't even six months of data available, and, yes, the expense ratio is way out of Boglehead territory.

My sour guess is that like many "innovative" ETFs, the average retail investor is not going to be able to understand what's in this ETF or what it does, know what to compare it to in order to evaluate whether it's meeting its goals... that the data for figuring this out is not readily available without access to expensive data sources.
Last edited by nisiprius on Tue Dec 04, 2018 6:41 pm, edited 1 time in total.
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nisiprius
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Re: Any thoughts about defined outcome ETFs?

Post by nisiprius » Tue Dec 04, 2018 6:41 pm

Holy cow. Total assets:
BJUL $3.76 million-with-an-m.
PJUL $5.65 million.
MJUL $5.00 million.

One completely random web page that showed up when I searched on "minimum etf size" suggests
Here are three simple questions to ask of all ETFs, and why they matter for your costs....
  1. Is The Expense Ratio Under 0.15%?
  2. Does The ETF Trade Commission-Free?
  3. Are The Assets Over a Billion?
For these funds, the answers are no, no, and no.

Wait a year and see if they even survive, keep an eye on the ETF deathwatch column.

ETF mavens, what's the lowest amount of assets you'd consider, for an ETF that really appealed to you?
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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vineviz
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Re: Any thoughts about defined outcome ETFs?

Post by vineviz » Tue Dec 04, 2018 7:56 pm

nisiprius wrote:
Tue Dec 04, 2018 6:41 pm
ETF mavens, what's the lowest amount of assets you'd consider, for an ETF that really appealed to you?
About 10% of my portfolio is in an ETF with less than $5.2 million in assets.

I don’t really worry about AUM per se, but I try to be careful to make sure the bid/ask spread isn’t outlandish. And those are often related.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

GuyInFL
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Re: Any thoughts about defined outcome ETFs?

Post by GuyInFL » Tue Dec 04, 2018 8:37 pm

Nisiprius sez
BJUL, inception 08/28/2018, ER 0.79%
PJUL, inception 08/07/2018, ER 0.79%.
UJUL, inception 08/07/2018, ER 0.79%.
So if you are withdrawing 4% from your vanguard portfolio (approx 0.04% ER)
The equivalent withdrawal from these ETFs is 3.25%.
I suspect you'd have lower portfolio risk just withdrawing 3.25% from your vanguard portfolio.

Theoretical
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Re: Any thoughts about defined outcome ETFs?

Post by Theoretical » Wed Dec 05, 2018 1:19 pm

tman9999 wrote:
Tue Dec 04, 2018 3:01 pm
Any thoughts about so-called Defined Outcome ETFs that are tied to a particular index and designed to shield investors from drops up to a specified amount in that index, with capped upside returns should the index go up. Three examples: Innovator S&P Buffer (BJUL), Innovator S&P Power Buffer (PJUL) and Innovator S&P Ultra Buffer (UJUL) — offer downside protection ranging from 9% to 30%.

Just curious whether these are worth the 70-80 basis points, and if so, what percentage a conservative portfolio might contain.

Disclaimer 1: I did do a search on a couple symbols as well as some terms and couldn't find anything. If this has already been discussed, pointers or search terms would be appreciated.

Disclaimer 2: I know trying to time the market is a no no, but... as I am within 18-24 months from retirement, I'm getting mighty nervous about the bear, so looking for ways to minimize exposure to adverse events.

Thank you for any input
Tom
I consider these even worse than 3x oil etfs or VIX trading, as those at least have a potential benefit re: hedgers. These ETFs are structured to provide you with a fully limited upside and a partially hedged downside if you buy on the exact day of issue/reset. This means that you retain most to some of the fat left tail (crashes) and none of the fat right tail (surges like March 2009). The word I'd use for these products is devilish, especially after 2008. They're sophisticated in all of the worst possible ways.

If you're nervous about the potential crash risk, consider lower your stock allocation on a long term basis as you near retirement. Or pull out enough cash to weather even a good 3-5 year bear and don't touch the stocks at ALL.

If you still want the high equity position, there are far better products to use for this kind of downside protection. Something like Cambria's TAIL, which is 10 year treasuries plus a ladder of S&P 500 out of the money put options. (.59%). Or the Ned Davis Long Flat US Large - LFEQ - .59% - which is invested in t-bills and equities based on trends in the equity market. Or the Pacer Trendpilot series, which use a couple of signals to determine whether to be 100% stocks, 50-50 with t-bills, or 100% tbills (.60%).

They're all cheaper and far safer assets to do what you're trying to accomplish, especially the last two. The first will lose money in good times because it's a tail risk hedge and put options have a high option premium, but it is one that is guaranteed to pay off if stocks go into a nosedive. The second two are better options than these defined outcomes because there's no cap on the upside and the trend signals will keep you flat rather than crashing further. All three options are better than the "Defined Outcomes" because there are no limits on the potential upside. If S&P goes back to 700, TAIL will be making money hand over fist, and you're not limited in the potential gains because it'll be going the other way. The other two limit your downside exposure as it's plunging down but don't cap your upside.

You are pretty much guaranteed to get lower returns in a bull market with all 3, given both the higher expense ratio and the being on the wrong side of the volatility risk premium for TAIL, but if you're looking for insurance-type situations, look for something that limit your upside while extracting a premium from you.

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Re: Any thoughts about defined outcome ETFs?

Post by garlandwhizzer » Wed Dec 05, 2018 1:31 pm

vineviz wrote:

Adding complex, unpredictable, and illiquid ETFs is the OPPOSITE of "minimizing exposure to adverse events".

The first line of defense in lowering the volatility of a portfolio should ALWAYS be to adjust your stock/bond ratio.
1+

These products are expensive, will almost certainly underperform long term, and their risk/reward tradeoff is inferior to a standard balanced portfolio over the long term IMO. They are designed to be marketed and sold by offering the risk averse the illusion of safety, not safety itself which comes from quality bond exposure.

Garland Whizzer

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Re: Any thoughts about defined outcome ETFs?

Post by asset_chaos » Wed Dec 05, 2018 3:25 pm

tman9999 wrote:
Tue Dec 04, 2018 3:01 pm
... as I am within 18-24 months from retirement, I'm getting mighty nervous about the bear, so looking for ways to minimize exposure to adverse events.
I believe this kind of "collar" arrangement is useful for highly specific situations where someone wants to limit possible losses but is also constrained from selling. That doesn't sound like your situation. If you're nearing retirement and are worried about stock losses, what you need is more bonds, not some new, exotic stock instrument. Sell some stocks to buy some bonds. More bonds in your portfolio is the way to minimize exposure to adverse stock market events.
Regards, | | Guy

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