New ETF Strategy Sparks Immediate Interest

New ETF Strategy Sparks Immediate Interest

Key Take-aways:

• These new actively managed ETFs use derivatives to create extra income or protect against losses, but didn’t exist 4 years ago
• Over $31 billion has been raised for these new ETFs in the past year
• Some analysts question whether these ETF strategies work at all, especially if not held for the full period they’re designed for
• The guys caution that strategies being rolled out now may be based on “what worked recently,” not what will work going forward
• The guys also emphasize these ETFs are neither inherently good nor bad, but are products created to meet investor demand
• There are concerns about the complexity of explaining these products to clients and potential misunderstandings
• The ETFs often involve options strategies like covered calls or put spreads to limit downside but also cap upside potential
• Reducing volatility in a portfolio will generally reduce returns as well
• These ETF strategies are similar to those found in some mutual funds and annuities
• New investment products often launch after the optimal time to have owned them, driven by investor demand after market events

New ETF Strategy Sparks Immediate Interest – Links

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Wall Street Journal article (paywall): “Boomer Candy”

New ETF Strategy Sparks Immediate Interest – Transcript

Welcome. Welcome everyone to the four hundred and eighty first episode of the Mullooly Asset Management podcast. I am Tom Mullooly and in this podcast we have a conversation that we recorded recently between Brendan Mullooly, Tim Mullooly and myself regarding an article that was in the Wall Street Journal recently. The headline, which we’ll link to in the show notes, is “These Hot New Funds are Boomer Candy for Retirees.”

What they’re talking about are these newer exchange traded funds which are actively managed and use derivatives. The derivatives are used to either create extra income for ETF holders, or to protect against losses in the market or against particular positions. These types of exchange traded funds didn’t even exist four years ago.

Over the last twelve months (and we’re recording this in mid 2024), these types of new actively managed exchange traded funds have raised thirty one billion dollars in the past year. So someone is selling these funds to investors and investors seem to have an appetite for them. But some analysts, as mentioned in the article, question whether these strategies even work at all.

For example, while exchange traded funds can be bought and sold at any time on the exchanges, some of these strategies used in these ETFs are designed to work only if you hold the investment for one year. So it may not be suitable or appropriate for everyone and we always caution that you should be looking under the hood before making any type of investment into any kind of product, especially one like this.

We’ll also add, and this is mentioned in the conversation, that a strategy that’s being rolled out now is probably for something that’s working right now or recently worked. So you know what worked in the last year may not be appropriate for current market conditions or for market conditions over the next twelve months. So as always, we caution folks to do their homework.

But at this point I’m going to turn it over to the conversation that we had between myself, Brendan and Tim. Thanks again for tuning in to our podcast.

Welcome back to the Mullooly Asset Management podcast this is episode number four hundred and eighty one. Thanks for listening. Uh I’m Tim Mullooly here today with Brendan and Tom. We’re gonna dive right in.

Maybe just as like a preface to this conversation I feel like it’s important to remember that like any of these things that we talk about like these ETFs, like they’re literally products which are neither good nor bad because they are inanimate things. And people are either sold and these things are being misrepresented or people like just want to believe that they’ve discovered magic.

And that is not the fault of product. Yeah. I was gonna say that like I don’t blame That’s important. That’s just that’s my take. And I don’t wanna like arguing with you guys. The podcast about like whether these things are good or bad I don’t think like it’s not that. They just are. They’re just a thing.

Like It’s a thing that like there are people enough people want, you know because like they wouldn’t exist if there was no demand for it. So yeah, wanted to lay that out there because I just there’s a market for it. Like it’s not and it’s not those it’s not the people’s fault to like, that are creating these funds. They’re not doing it maliciously. What are creating a product for a for a space.

Yeah I just I don’t know I would rather have a constructive conversation about like the pros cons as opposed to like feel like sometimes in the past we just like, bring an article use it as a straw man and just like and just punch. And it’s stupid and I don’t think it I don’t think it’s helpful to anyone who listens. So just because we don’t like something doesn’t mean that they’re not that there isn’t a use case for it.

Yeah Well clearly there’s a demand, uh for it because they’re selling they’re putting billions. Thirty one billion dollars into it uh, I also think it goes back to things that happen in our line of work. These things are not clearly explained sometimes.

I don’t I don’t think that happens as much as much as like the good advice want to tell people sometimes to like some bad advisor told you this let me save you I’m superman. I was like come. Alright So you have also opened my eyes over the years to the thought that sometimes people just want to remember things a certain way and they choose to opt out of listening. I see it happens to me and I know that I’m doing my.

So I’d like to give other people in our profession the benefit of the doubt in most cases because I don’t think that they’re out there like trying to steal people’s money. It’s just like Why would this someone’s like not like People aren’t doing this to be criminals. Yeah. In ninety nine out of a hundred cases. No Are obviously like exceptions to what I’m saying but it’s like come on.

Yeah There’s a there’s a there’s a demand for something like this. These fun companies created a product that fits that so good. Just know going in what you know totally what the risks are. Anyway I just Yeah No I It just I’m just particularly useful to people to be like hey, bad advisors are selling these and beware and it’s just like that’s alright. That’s that’s not helpful.

These some of these ETFs are option writing. They’re all options Yeah. They’re they’re right with the writing calls. They’re writing calls, uh against this. I got blown up in nineteen eighty six and nineteen eighty seven when the bond market moved the way no one expected, and I was buying a mutual fund, a government bond fund that was they were buying long term treasuries, and then they were writing calls against them and when the market moved when interest rates changed, these these funds got whacked pretty bad.

And I got a very quick lesson on how these things cannot be what they seem. And I was a rookie broker didn’t really understand what do you mean they could write options on treasuries. What are you talking about? Uh you know then I had to basically carry that message back to my, my new clients I really wound up getting a very costly education, uh going through that process.

So now when I see actively managed ETFs and their writing options, uh against some I get a little worried. I’m like okay I’m getting flashbacks to nineteen eighty seven. I don’t know if this is going to be such a good idea. I don’t know if it’s gonna provide a happy ending for clients.

Uh I will say that that factors into part of my decision tricks in the sense that I have this bad memory from way back here. I just worry about having to explain why the portfolio manager did whatever they did. I think that the more complex a product gets, the more outlier cases there are when you’re thinking through com.

So I agree with that. It’s but again I don’t feel like that’s being misrepresented it’s just being about doing their homework when they put money into these things. That is the point. And the risk that you’re talking about exists whether it’s a mutual funds and ETF or you’re doing the options to yourself like an idiot.

So We we definitely agree on all. You know what I mean. Like these strategies aren’t new. The new part is that they’re in an ETF rep right now. Right That’s the new part. Yeah Because people have been doing covered calls and you you’re buying and it’s a straddle when you’re talking about the buffer funds. Like that’s that’s all we’re talking about here.

You sold you bought a put at the money and you sold one like ten percent down. You’re protected in the interim you’re gonna lose the rest of it if it goes down further. Right I’m not saying I like these funds I’m just saying like it’s uh Yeah. I just I don’t talk about all of them then. Sure Yeah I don’t really have like that much of an opinion on them. The my only opinion is that I think that they’re unnecessary. Yeah I’m not gonna use them.

Right You want less risky. And I think that’s the point that we’re like trying to convey in the in the episode is that it’s like not magic. They’re not they’re not good bad or anything. It’s just I think they’re just an unnecessary more expensive way to do it when you could really just like right size the amount of money that you have in stocks versus bonds versus cash in the market as a market as a market as a market as a process that you need to own.

Yeah The rest of them like there are other ones that are alternative. It’s why they’re talking about chunky chunky fees like they’re gonna you’re gonna pay more money to have this done for you in an ETF and you could do it for less. Right And potentially you’re gonna get some outcome between stocks and bonds and that’s it. Right. It’s not stocks. It’s not bonds. It’s not cash. It’s something else. It’s a it’s a magical third thing.

Right I forget if it was Charlie Munger or Warren Buffett who said if you can explain this to a fourth grade it’s too complicated. Mhmm And that’s really I mean I wrote on the back I mean, it’s complicated. It’s hard to explain. Yeah Getting back to what we were saying earlier about some people wanna just selectively remember certain things that they heard when this was being presented to them then they wanna know – like:

“Well the S\&P is up whatever — but we’re not.
QQQ is up whatever – but we’re not.”

It just puts the advisor in a very defensive position. And you don’t know if it’s the client not listening or it’s just not syncing in or hard to hard to define. I think that that happens and with it would happen with these funds and it happens with what we put clients in as well, though you know like the strategy. And usually the timing of when you select the strategy matters a lot.

And so these particular funds were huge last year. Yeah Because the year before that the market was down. So we’re talking about hedging strategies just like doing trend following got big after. And then it was not helpful for another decade afterwards. Yeah Um so you want the hedge after. It’s like you want really good car insurance after you have an accident, and you need to continue owning it until the next accident for it to actually pay off and the thing that you want to have had in the past.

Yeah. Um but maybe when you’re getting into it your focus on the down side. So you’re you’re implementing a new strategy to hedge volatility because the downside is scared you and you’re actually not asking questions about what the opposing thing is you know what what am I giving up by by trading you know this risk uh and I think it’s our job as an advisor to bring the full picture to the conversation.

But that that’s probably not happening if it’s somebody doing this on their own, or, uh or the conversation’s just not as thorough as it probably should be. Like we’re making our lives more difficult as an advisor when we talk about the pros and the cons of every strategy that we can implement and there’s a pro and a con to every single strategy that you could implement.

Yeah. Sometimes people don’t wanna hear it um or it’s just not that interesting to them because it’s their finances or whatever. And so yeah sometimes you have to like revisit the conversation and be like yeah. So what we did when we when we implemented the strategy is we hedged our downside because we were we were worried about that at the moment. Right However, the opposing end of that is we also capped our upside.

I mean that’s the same like we that comes from our allocations that we put people in. That’s just a trade off of not being a hundred percent in the market. But these funds in this article do the same thing. It’s just like you get capped at ten percent you know and if the market goes up, twenty three percent you get ten, you know and then people are like why am I capped. And it’s like well you wanted the downside protection. So like here’s the trade off.

You have to have a pretty deep understanding of market history. Mhmm. And kinda like the bell curve of returns and it’s not a normal curve. It has fat tail on either end. And if you chop off one of them you also have to chop off the other one. Right And average market returns when you’re talking about average annualized returns over multi decade periods that everyone signs up for when they get equity exposure are driven by the tail in a lot of cases.

Yes And and the upside tails. Yeah Uh but the returns always include the downside tails as well. And so when you when you shrink that opportunity set it’s gonna a major impact on the returns that you realize as an investor and that that just is what it is. There’s no way around it. Right Anything that you do to reduce the volatility portfolio will reduce your returns. Right. No matter what.

Yeah Yeah Whether it’s uh I wish it didn’t have to be that way. Whether it’s just like a natural cap of having less money in stocks or a hard cap that this fund has implemented uh just based on you know the strategy itself and you know it’s identified. Okay The cap is a plus ten percent like or or plus fifteen percent or whatever it is.

You were were kind of you’re kinda implementing that yourself if you’re not using these funds and you’re you just don’t have like if you have a sixty forty portfolio you shouldn’t expect a percent of the stock market returns you should expect less than that. Maybe like like just ballpark like sixty percent. Maybe a little more than you know it depends on what you’re doing with the other forty percent.

But And we’re not trashing these exchange funds because you can get the same approach, the same type of strategy in a mutual fund in an annuity. Uh they’re in they’re all out there. The buffer fund product is really similar to what you see in an equity index annuity in terms of in terms of the defined outcomes. Yeah And and what you will bear and will not bear. And the strategies run the same way.

If anything, the buffer funds might be an improvement on the I was gonna say maybe the cheaper. Well if they’re cheaper that’s a good. They’re not as cheap as not using a buffer fund or just implementing like. They’re also more liquid. Yeah You can like actually get your your money. However, I don’t know granted grant us all with that because like these are ETFs so you can trade them whenever the market’s open but buy one of these buffer funds in particular it’s designed to work over a specific time period.

And if you don’t hold it for that time period you’re. It’s not absolutely not going to get the outcome that signed up for. So Right Maybe liquid I don’t know maybe the uh, surrender charge on the annuity doesn’t end up being different than the haircut you take if you’re presumably bailing out of it at I would imagine a bad time. I don’t think you’re gonna be selling it early. Because things have gone well.

In those situations, having a surrender charge does I think stops most people from bailing out at a bad point for sure. I mean that’s that’s what they’re there for kinda. I feel like these these funds like what they were talking about in the you mentioned they were popular last year coming off of twenty two. They might be becoming more popular again this year because I feel like we’ve been hearing from other clients just our personal experience that people are like, you know the market’s been going up for a while I feel like corrections do like we we can’t keep going up and up and up.

And while that’s true we don’t know when the next correction is gonna happen but there is a stress and volatility inducing event happening later this year that people seem to be worried about. Um so like funds like this where you can get your market exposure and cap the downside if you’re worried about what might happen after the election. It could be uh enticing to some folks right now.

So maybe the timing of an article like this kinda highlighting these these funds. Um I’d rather see people taking an approach like that uh and consider these sort of strategies and uh you know like derisking in you’re almost describing like a counter cyclical fashion. That’s better than wanting to buy this like on January first of twenty three after the market drops twenty plus percent in a calendar year. That’s the worst possible time to be considering a team risk. At least they’re preemptively considering it before the market’s gone down.

Yeah Like if they’re if somebody’s nervous all the time about their portfolio they’re probably just taking too much risk. And however they get there whether it’s considering something like this or or just having less you know less market exposure their plan can bear having less market exposure than uh, you know I think that’s probably a good signal that have too much at risk. And and again, the financial plan and how it’s designed to work is probably gonna be the the driving factor there if it’s something they’re not with on a personal level.

Right I think to tee up something that you just said in that the products do seem to come out right after the perfect time to have them. Part of that comes from um, the investor demand. You know the market’s going down in twenty twenty two. Gee I wish we had something that could help buffer that. Uh but then they also have to, uh these fund firms have to decide is there enough interest demand for something like this then they have to register the product, uh with the SEC that all of these things take time.

And so when these products come out, it’s usually right after one of the optimum periods where you could have really owned it. I always remember at my last firm before going out and starting this firm. They started the twenty-first century fund, which was all internet stocks.

Uh, they launched it in February of twenty of two thousand. This was after the Nasdaq had risen fifty-five percent in the fourth quarter of nineteen ninety-nine. And it was just a few weeks before the internet bubble completely popped.

Poor timing. That’s a great example.

So yeah a lot of times these products come out right after when you, it would have been great to own. Right When there’s when there’s a demand for it. Well yeah there need there need demand otherwise they wouldn’t create it. So it’s not anyone’s fault. It’s just human nature that we want the thing that just worked. And um I guess it’s up to us to consider whether such a good time to be doing that or if it’s something we can stick with over a full market cycle.

Right. Um or not because That’s even important to it. Yeah. And this time the purchase, and you buy it after you wouldn’t needed it.

It doesn’t mean that if you’ve just discovered a new strategy that worked last time that it’s not that it can’t be a good your portfolio moving forward, but I think you need to understand the shortcomings and when it’s gonna work and when it’s not going to work before you put it into the portfolio. So that you’re not jumping in after the good times and then selling during the bad times and just completely mistiming everything.

Yeah. And I think kind of tying that into the the funds from the article. Like you mentioned before they have like time frame that you need to hold these things for.

So if you wanna but you’re, you know if someone’s purchasing this just as…you know a couple month hedge here while we wait for the dust to settle after the election. Yeah That’s not that’s not the reason to do it. So I I wanted to make that point as well.

Strategy that’s gonna accomplish that. Exactly yeah I mean that’s. Yeah Whether you’re talking about buying one of these or like swinging a car and finding the market you’re gonna if that’s your approach to anything without dusting.

Yeah Along the same lines the the idea…that, uh these, uh two times inverse…or these two two X leverage funds and triple X leverage funds when these things came out now…fifteen years ago, they were…hotter than sliced bread, but, uh over time, these, uh, leveraged…funds were two times whatever the index fund the index did that particular day. And when the numbers started coming out and getting circulated at the end of two ten and into twenty eleven people were realizing, Hey this triple leveraged fund actually did worse than just buying the index self because of all the changes…on a daily and weekly basis.

So these things don’t always work as advertised…or…understood to…I thought this was going to work today. They work as they’re designed to work. It’s just whether or not you understood stand how how it works.

Yeah We’re talking about something that’s kind of like saying like uh, particular kind of car…is…like a like, bad like it like saying like uh a particular car brand…creates more accidents, like, cars don’t create accidents people create accidents right. So like the the way that the vehicle is being used is the problem not how the product was designed. Right.

Unless it’s a self driving car, Brendan.

I think that’s a good place to wrap up. Thanks for listening to episode four eighty one of the Mullooly Asset Management podcast. We’ll catch you on the next episode.

Tom Mullooly is an investment advisor representative with Mullooly Asset Management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not necessarily reflect the opinions of Mullooly Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Mullooly Asset Management may maintain positions and securities discussed in this podcast.