Defined Protection Reaches The Masses

After their introduction in the 1990s, electronically-traded funds (ETFs) became one of the most popular investment vehicles. Since then, they evolved beyond simple index fund tracking, often representing a complex financial product.

Last month, Innovator Capital Management introduced the Innovator Equity Defined Protection ETF (TJUL), the next-generation ETF oriented at complete protection against losses in the S&P 500 index over a specified time frame.

“We continue to hear that investors are looking for a way to get back into the market without sitting on the sidelines, but that the level of risk is simply too high,” said Innovator’s CEO Graham Day.

“Our aim is for TJUL to provide a way for our clients to stay in the market with significant built-in risk management,” Graham added, reflecting on the inflationary risks of staying in cash, as well as the ever-present fear of missing out.

Defined outcome investing involves shaping the potential results of an underlying asset or index to achieve specific protection and return levels, resulting in a more controlled investment experience. While existing defined outcome ETFs offer partial downside buffers (from 5% to 30%), TJUL offers 100% downside protection in its 2-year outcome period from July 18, 2023, to June 30, 2025.

Some analysts argue this approach is not revolutionary, as an investor could construct an options portfolio that yields similar results—for example, investing most of the portfolio in 2-year Treasuries with a minor investment in SP500 ITM options. However, most investors lack the know-how to execute such strategies successfully.

While TJUL can be bought or sold at any time, its performance may vary depending on when shares are acquired. Furthermore, the strategy entails a trade-off between downside protection and upside potential. TJUL's upside performance is capped at 16.62% over the two-year period, which means investors benefit from the S&P 500's positive performance up to this threshold but not beyond.

Unlike traditional ETFs that closely track their benchmarks, TJUL's returns exhibit a lower beta due to the time value of the underlying options. As a result, the ETF may need to catch up to the S&P 500 during upward market trends.

Moreover, the buffer is established from the start of the outcome period, meaning investors who join after the period begins might be exposed to immediate downside risk if the S&P 500 has appreciated since the start.

Innovator addresses these complexities by providing transparent daily disclosures for each defined outcome ETF, including information about the remaining buffer, cap levels, and days left in the outcome period.

The ETF is listed on Cboe BZX Exchange, offers no dividend income, and carries an expense ratio of 0.79%. Since its launch, the ETF amassed almost $50m in assets.

While some investors might suffer a recency bias, thinking that the 16.6% cap is not worth it, it is worth noting that long-term S&P 500 returns have averaged 8-9% annually. Thus, TJUL provides a solid solution for those prioritizing principal protection in anticipation of economic downturns or bear markets.