I stumbled into a couple of new (to me) ETFs. Innovator who might be most known for BALT and more generally buffer ETFs actually has 157 funds with $29 billion in AUM, I didn't realize they were that big.
The mindset for this post is funds that use equity stuff to create an intended outcome that looks nothing like the equity market. BALT is long a call spread on the S&P 500 and a put spread such that the outcome, the intended outcome is a horizontal line that tilts upward. When the S&P 500 is up, BALT lags, and in 2022 when the S&P 500 was down 18%, BALT was up 2.45%. It is not a proxy for equities. There is a sensitivity to large equity declines though. If the S&P 500 drops by 20% in one calendar quarter, BALT should be expect to feel any further decline beyond 20%. Back in the April panic, the S&P 500 didn't quite fall 20% but BALT did wobble a little bit with a fast 5% decline that was recovered quickly.
I do not know about too many of Innovator's funds so hopefully I can learn but I did stumble into a couple that do something similar to client/personal holding Princeton Premium Income Fund (PPFIX). PPFIX sells S&P 500 Index puts that are very far out of the money. There's a little more nuance than that but the effect is that PPFIX also looks like a horizontal line that tilts upward. It uses equity index derivatives to create an effect that is not intended to look like an equity index.
The two funds I want to mention are the Innovator Premium Income 20 Barrier ETF (OCTH) and the Innovator Premium Income 30 Barrier ETF (OCTJ). The high level description for these is that they are short out of the money S&P 500 put spreads along with another short position in puts that is not spread off as well as owning T-bills. OCTH protects up to a 20% decline like BALT and OCTJ protects up to a 30% decline.
BALT doesn't have distributions, OCTH yields about 7% and OCTJ yields about 6%. It looks like the distributions are characterized as ordinary income. It is important to note that there is a lot of complexity to these that would take far too long to explain here. Anyone interested in these for real should learn those complexities.
Here's how they did in the April panic.
In certain fast declines, PPFIX sometimes has to mark their positions to market in such a way where the NAV can drop more than expected, only to bounce back a day or two later. Is seems plausible that OCTH and OCTJ have to do something similar.
All five of the portfolios are 60% in the S&P 500. The backtest doesn't go far enough to look at 2022 but where BALT and PPFIX did much better than AGG in 2022, I would guess that the strategy underlying OCTH and OCTJ would have also held up better for not taking interest rate risk.
There's not much differentiation between the five portfolios and that is the point. Getting the fixed income effect without taking on interest rate risk. Allocating 40% to a strategy that sells volatility, even vol that is very far out of the money, is a very bad idea. The way to use something like this, is in a small slice as a differentiated return stream from other fixed income proxies also used in small slices.
A fund that sells volatility in this manner would take on different risks than some sort of arbitrage or some sort of credit risk. Catastrophe bonds have their own unique risk factors. Some sort of blending of different risk factors only to get a very similar result to AGG is not a bad outcome. If AGG never has another down year again, underweighting it avoiding it still avoids the risk is poses. I choose to avoid its risks.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
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