We'll start with a Barron's article that took quick looks at several categories of options oriented ETFs, mostly buffer funds and covered call funds. There wasn't anything new but there were some good points to reiterate. The space is growing dramatically of course and there are bound to be gaps between expectations and reality.
Keeping it high level, buffer funds typically don't protect against losses beyond a certain point. Nine percent and 15% are common points where there is no further protection. They also cap the upside. The S&P 500 is up 23% in some random year? Great! That's not what you're getting with your buffer fund. Not even close. Getting 9% when the S&P 500 is up 23% isn't automatically terrible. Building a portfolio that can get a long term real return of 4, 5 or 6% irrespective of broad market outcomes with less volatility solves problems for a lot of people. Or building a portfolio where part of it has the opportunity to capture the full market gain, while another portion gets an adequate real return with less volatility also solves problems for people.
The above about buffer numbers and how they work are basic building blocks, there's been a lot of innovation and product development in the last couple of years.
We've spent a lot of time on covered call funds. JEPI's great success early on might have been the catalyst for setting off the huge renaissance in these funds. Twenty years ago there were a lot of closed end funds that sold calls and now there are a couple hundred ETFs from various providers. We've looked at how to use them effectively because they also should be expected to cap the upside. Again, not a problem for people who realize this going. Having the correct expectation for something and having it meet that expectation is a great outcome. We have fun playing around with funds that are NAV incinerators but in real life, I would say they should be avoided.
The last category from Barron's was autocallable funds. There was no real attempt made to get into how complex these funds really are. Most of them are not NAV incinerators so there's that. Part of the appeal of covered calls funds is that they have the opportunity to be less volatile than the index but I wouldn't expect that from too many autocallable funds. Not every covered call fund will fit that bill either but JEPI does for example and with autocallables, CAIE is one of the biggest and it's volatility has been very close to the S&P 500. We've highlighted JELM from Janus as likely to be the least volatile but the trade off is that it is very low yielding compared to other autocallable funds. ACSP from ProShares has a very high targeted yield at 18-19% and it's day to day volatility is very high. It is unlikely that autocallable funds will malfunction or otherwise break but if it happens, it won't be easy to understand why.
Today I learned from Upworthy that there are Bitcoin buffer funds. iShares will be listing one soon with symbol PBT but there are a couple of others including QBF from Innovator and FirstTrust has a series of them too. For this post will look at BFAP from FirstTrust.
Uh oh, what's up with QBF? Gemini thinks that the quarterly reset is a mismatch with Bitcoin's volatility and reports that the fund will be liquidating in January. BFAP appears to be working. It's an annual reset (actually 53 weeks?). It will provide up to 26% upside and will protect any downside beyond 15%. If Bitcoin falls 10%, no protection. If Bitcoin falls 30% then BFAP should only fall 15% of course there is no guarantee from First Trust on that. A crucial point of understanding though is that the protection against the downside is intended to come from holding the fund to the reset date. If Bitcoin cut in half between June and October, BFAP would drop a lot in price too. Probably not that full 50% but either way the protection is designed around the reset date.
You're going to laugh at me but that one is very easy for me to follow.
Here's an interview from ETF.com with JD Gardner from Aptus ETFs. They have several options oriented ETFs. He talked about building a portfolio that is 75% equities and 25% options oriented ETFs to get a result that is similar to 60/40 but without bonds, he is not a fan of bonds. He says done the right way, 75/25 allows for more equity exposure without larger drawdowns.
The best Aptus funds to test the theory are too new to draw any conclusions. Gemini says their buffer fund of funds with symbol ABUF would be their best fund to use so we'll use BUFR from FirstTrust instead because it has a much longer track record.
Using BUFR, the theory stands up. The drawdowns were not bigger, the worst one was the same but BUFR doesn't go back far enough to take in the Covid Crash of 2020. If we swap BJUL in for BUFR which may not be apples to apples, we can capture the Covid Crash and 75% SPY/25% BJUL was down 30% versus 20% for VBAIX. I don't take that as a Karl Popper situation, more like there are some market events where there are very few places to hide and the Covid Crash was one of them. BTAL worked because it is essentially an inverse fund and although managed futures worked during that event, I attribute that more to luck than anything else.
Speaking of options, Matthew Tuttle was interviewed at TheStreet.com. Here's a snippet where he talks about the breakdown of his updated permanent portfolio idea that we looked at a few weeks ago. Here's the breakdown which includes option strategies.
- 25% Equities (he talked about higher volatility equity exposures)
- 25% "Beyond bonds" which he defines as property and casualty insurers and pre-merger SPACs
- 25% Hard money like gold, Bitcoin and digital credit like the Strategy preferreds
- 25% Tail risk which includes managed futures, options and T-bills
His theory about P&C insurers is lost on me. In terms of helping with equity market volatility the way bonds used to, the track record is mixed using the KWBP ETF as a proxy.
He said pre-merger SPACs mostly own T-bills and pay T-bill-like interest. So why own it if it is like T-bills?
He's onto something here. There is opportunity for mergers to increase the price of holdings in the fund and there is essentially a put option at $10 per share with SPACS, $10 is the price they get issued at. To the extent companies post SPAC merger might be crappy, the latest the fund sells is when the deal closes, sometimes it sells on the announcement but it does not stick around to find out whether it's a good company post merger or a piece of crap. Also, it would be reasonable to think that if SPAQ had existed in 2022, it would not have gone down anywhere near as much as the popular bond ETFs with duration. SPAQ mostly owns T-bills.
Let's take another run at replicating Tuttle Permanent Portfolio Update
You see zero allocated to STRC because the track record is too short but that is what he means by digital credit. We looked at SATA recently which is from a different company as another example. NOVIX is fund we have never mentioned, the Glenmede Global Secured Options Fund. It owns a mix of ETFs and option combos seeking capital appreciation while tamping down the volatility and declines. The track record on the second objective has been spotty but it has done well enough in its category to be a 5 star fund by Morningstar.
I didn't add more T-bills. SPAQ is in there for the theory that it is a better proxy for T-bills and managed futures is mostly T-bills under the hood.
Tuttle's idea certainly worked in the period available to study in terms of growth rate. We need to go to Portfoliovisualizer for the drawdown chart. There's some sort of distortion with NOVIX that I don't think changes the CAGR but does skew the drawdown.
This was a long post but productive and covering pre-merger SPACS is new for us.
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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