Structured ETFs offer fresh twist on popular variable annuity strategy

Downside protection and upside caps without the commission or lockups that come with VAs

Sep 6, 2018 @ 12:46 pm

By Jeff Benjamin

There's nothing quite like the month of September to remind investors and financial advisers that the financial markets are fraught with risks, which is the kind of mindset that Innovator Capital Management is banking on with its new suite of exchange-traded funds.

The three ETFs, which started trading last month, offer varying levels of downside protection coupled with upside limits, following a model established in the variable annuity market eight years ago.

"There are lots of investors looking for exposure to the equity markets who want the upside but can't afford to be exposed to downside, or want to limit downside risk," said Bruce Bond, co-founder and chief executive of Innovator Capital.

He describes the ETF strategies as "a structured annuity without the fees and lockups."

The structured annuity market was created in 2010 with the launch of Axa Equitable's Structured Capital Strategies.

While the ETFs are not exactly like structured annuities, they are similar enough to potentially tap into the booming niche of the variable annuity market.

"These ETFs look like a reaction to the success of the structured annuity business, which has quickly grown to represent 10% of all variable annuity sales," said Steven Saltzman, principal at Saltzman Associates.

According to Limra, structured annuity sales totaled $9.2 billion last year, and $4.7 billion through June of this year.

Since Axa established the structured annuity market, seven other providers have entered the space.

In the bank and credit union channel, structured annuities, which Limra calls registered index-linked annuities, represent about 30% of all variable annuity sales.

"This has been one of the few categories that has seen growth in the annuity space in the past few years," said Todd Giesing, Limra's director of annuity research.

"They fit in between other annuity products by offering some down protection and not full principal protection," Mr. Giesing said. "They're not providing complete protection, so there's some shared risk on the downside."

The strategy's popularity in an annuity wrapper, which typically includes commissions and multiyear investment lockups, made it a no-brainer in an ETF wrapper, Mr. Bond said. "We were surprised no one else had looked into doing it sooner."

The ETFs — Innovator S&P Buffer (BJUL), Innovator S&P Power Buffer (PJUL) and Innovator S&P Ultra Buffer (UJUL) — offer downside protection ranging from 9% to 30%.

For example, if the price of the BJUL ETF falls by 10%, the investor's loss will be just 1%. And if the fund price drops anywhere within the 9% buffer, the investor's principal is protected.

Part of the trade-off for the downside protection is the cap on the upside, which can fluctuate slightly based on multiple factors, including the share price and overall market volatility.

As of midday Thursday, all three ETFs had caps of between 8.11% and 10.85%, meaning any gains beyond those caps would not be earned by the investor.

The ETFS, which have expense ratios of 79 basis points, are pegged to benchmarks created by Milliman Financial Risk Management, an actuarial consulting firm that specializes in calculating market risks for large institutions and insurance companies.

The ETFs invest in options that mature about every 12 months, which is why each ETF also resets after 12 months, enabling investors to stay invested in the next version.

But unlike a structured annuity that offers similar downside protection and upside limits, the ETFs offer the same kind of liquidity as any other ETF.

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