How Defined Outcome ETFs Work

October 01, 2020

First Trust
First Trust was racing Innovator to the finish line to launch similar products, but ended up launching the first of its lineup in November 2019.

Its “Buffer” products protect against the first 10% of losses, while its “Deep Buffer” products allow for 5% in losses, but protect against the next 25% of losses up to 30%. First Trust currently has a lineup of more than a dozen buffer ETFs, with $1.4 billion in AUM across its family. All of its ETFs come with an expense ratio of 0.85%.

Interestingly, instead of FLEX options on the S&P 500 Price Index, the First Trust ETFs invest in FLEX options on the SPDR S&P 500 ETF Trust (SPY). This can have more tax advantages, but also potentially comes with a higher cost.

Another thing to keep in mind is that the First Trust ETFs reset in the middle of their designated month, while the Innovator ETFs reset on the first trading day of their designated month. This means their upside caps can differ quite a bit because of those dates and the fact that they reference different underlying structures.

For example, the Innovator S&P 500 Ultra Buffer ETF – June (UJUN), which has a downside buffer allowing for 5% of losses but prevents any losses beyond that up to 35%, has an upside cap of 7.25% before expenses. Meanwhile, the FT Cboe Vest U.S. Equity Buffer ETF – June (FJUN), which has a downside buffer preventing losses greater than 5% up to 25%, has an upside cap of 10.28% before expenses.

The reset dates are a point of differentiation. Upside caps are directly related to the prices of the underlying FLEX options and are fixed for the following year on their reset day. This means there can be a significant difference between the two.

Allianz Investment Management
AllianzIM, a large international financial firm, made its entry into the ETF space earlier this year with the launch of its first two defined outcome ETFs, though the firm already had a foot in the door through its subsidiary PIMCO. The Allianz approach to the space involves two lines of ETFs, with one protecting against a loss of 10%, and the other protecting against a loss of 20%.

The funds are intended to reflect the performance of the S&P 500 Index, but their prospectuses say that the FLEX options in the portfolio are based on “an underlying index.” The ETFs come with an expense ratio of 0.74%, and are currently available with reset dates scheduled for the months of April and June. Each of the Allianz funds currently has between $3 million and
$4 million in AUM.

TrueMark
TrueMark made its defined outcome ETF debut at the same time as Allianz, but with a key point of differentiation.

TrueMark’s twist on the concept means the buffer against downside performance covers a range—in this case, 8-12%, with 10% as the ultimate, average target—and there is no set cap on upside performance. The fund uses options contracts, including FLEX options, on the S&P 500 Price Index and SPY to achieve its goal.

Rather than seeing their upside participation halted at a particular level, investors simply see their percentage of participation in that upside reduced by a certain percentage due to the cost of the options contracts, the prospectus indicates.

According to TrueMark, investors should expect to receive 75-85% of the upside performance of the underlying index. The three funds in the TrueMark defined outcome lineup have combined AUM of roughly $23 million.

More To Come
Beyond the current roster of players, other ETF issuers are also eyeing the category, with IndexIQ and ProShares among the firms filing prospectuses for funds with defined outcome objectives.

Additionally, existing funds are already being packaged into strategies, with Innovator and First Trust recently rolling out on the same day dueling laddered ETFs that maintain exposure to multiple defined outcome ETFs.

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