Innovator’s Buffer Solution Sprouts

Bruce Bond and his business partner John Southard were the driving forces behind PowerShares, which they eventually sold to Invesco. They then teamed up again to acquire small issuer Innovator ETFs, and worked to launch the first defined outcome ETFs, which allow investors to participate in the market’s upside performance up to a cap, while protecting against losses in the fund.

Although Innovator’s initial launch, the Innovator IBD 50 ETF (FFTY), remains the firm’s largest ETF, at $318 million, the defined outcome family has expanded to include 25 funds with total assets of more than $1.5 billion. Here Bond discusses his return to ETFs and how he worked to bring to market the most exciting product the ETF industry has seen in years.

Will the expansion of commission-free ETF trading that we saw earlier this year be helpful to the Innovator ETFs?  
Yes. We’ve seen that it’s been significantly helpful already. A lot of advisors are on those platforms. They’re attracted to the fact that they don’t have to pay a commission at all when they buy or sell an ETF. We’ve had advisors calling, saying, “We’re definitely considering your products now that they’re available commission-free.”

It’s gone a long way to leveling the playing field for everyone. The small guys really couldn’t compete in that world like that. It gave the larger providers a significant advantage over the smaller issuers. Now, everybody can compete at the same level.

What were the barriers to launching these defined outcome ETFs? Did the SEC have any issues with them?
They did. It took us probably nine or 10 months to get the products approved. We thought it would be quicker than that. I would say, in general, that the SEC saw that the products had value for investors and that they provide risk mitigation opportunities for them that weren’t currently available.

To their credit, the SEC wanted to definitely make sure they were safe for everyone and worked with us to figure out the best ways to do that. To that end, we put together a web tool that people can look at and understand each day, for all the different products, if they bought it that moment or that day, what their outcome would be if they bought at that particular share value.

That brought the SEC more comfort.

The defined outcome ETFs have really been doing well with asset gathering. How much of this is the result of face-to-face conversations with advisors? Or is there something else driving the messaging?
We have a big marketing and sales effort to try to educate advisors as to the benefits for them and their clients—for advisors who want to grow their business and who are looking to differentiate themselves from other advisors, and have a very interesting and valuable tool available that others aren’t using.

This is one of the tools they would want to consider, to really build their business. So that’s one thing that resonates with some of the advisors. But at the same time, if you have a large advisor that has wealthy clients who are retired or near retirement, these people that have made their money don’t want to have to make it twice. They’re looking at ways to be able to continue to grow their assets and, at the same time, preserve or have a buffer against the market if it were to go down.

Advisors like it because they’re protecting their clients, and they’re not intentionally hurting the relationship with their clients by risking a loss in the market. It’s just a message generally that resonates among all investors and advisors, who want to protect assets but grow their books.

Who are your users of these products? Traders, long-term investors?
The bulk of the users are people who are just going to put it in there and let it run. But by and large, we think the best usage is for people to own them over a calendar year, get the outcome, and go from there.

We had a substantial amount of assets go in last January, when the market crashed. And the buffer ETF itself had a cap of 22% with a 9% buffer. By February, the market was up 13%, and that ETF was up 10%. It basically captured 80% of the upside in the market at that period.

This is one of the only truly original ideas to hit the ETF space in a few years. Any concern about copycats?
There is. And we’re doing what we can to protect our position in the market in a number of different ways. We’re trademarking a lot of the nomenclature that we’ve come up with to describe the products and what the products do in the ETF space. We filed for the patent around some of the technology and how the products operate to try to protect ourselves as well.

The copycat nature of the ETF business is a little disappointing. But it happens. To a large extent, it puts at risk the smaller providers that the bigger providers just copy their good ideas, and they don’t have a way to protect themselves. I think that’s a little bit disappointing, because it limits the diversity within the space.

We intend to keep our leadership position here. With PowerShares, we were copied a lot back then, with the things we did. It was the things that were successful that were copied. To an extent, one of the things we realized is that there’s a little flattery that’s there that they would copy what you’re doing. But also, it’s good to have a larger provider out there saying, “This is a valid strategy. You should consider it.”

What’s your vision for the future of Innovator?
We’re focused on introducing additional defined outcomes to give people options. The products we have out right now are very straightforward and vanilla. We want to start there, build that product lineup, to get people really comfortable.

We intend to continue to evaluate, research and develop new investment approaches, using options and other types of tools to deliver those outcomes to people and continue our leadership within this space.

We worked together with Cboe Global Markets [parent company of ETF.com] to get the approval for in-kind transfer for options within ETFs. Because of that, on a go-forward basis, we believe we’re going to be able to deliver the same tax-free management within the Innovator ETFs using options, so that people will be able to defer their gains as with other ETFs, and so that their assets will compound in a greater way, and they’ll have their own personal tax experience.

Things like that are tremendous developments for our product, and for options, and for another big development in the ETF space. That’s going mean more options used in ETFs, and is going to introduce more types of outcomes in ETFs using options.