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The Stock ETF That Can’t Lose Money

No-loss ETF

As teased in today’s intro, you may wonder how to invest in stocks and guarantee no money will be lost?

It’s nuanced but not that complicated, despite sounding like financial witchcraft.

In fact, a class of Wall Street investment products known as “buffer funds” — types of ETFs promising to reduce losses — has become quite popular this year.

To use the jargon, these are “defined-outcome” funds since investors accept a cap on how much they can earn to protect against a certain level of losses.

For the Innovator Equity Defined Protection ETF (ticker: TJUL), the investment fund takes this approach to its logical extreme, promising a defined outcome with no possibility of loss.

How does it work? Good question.

 

The nitty gritty

Firstly, TJUL — the can’t-lose ETF — takes about 80% of its money and buys an S&P 500 index fund. Pretty straightforward so far.

Next, things get slightly wonkier and invoke stock options, which I wrote about two weeks ago. At the core of the strategy are ‘at-the-money put’ options.

In this case, consider them insurance contracts guaranteeing you the right to sell your investment, no matter what happens, at the current market price.

If the stock market sells off, you have a contract saying you can sell your stocks at their price before the sell-off, protecting you from any downside.

Such an insurance contract isn’t free, nor is it cheap. The fund must find a way to pay for this insurance contract, preferably without charging customers higher fees.

 

Paying for insurance

TJUL’s solution is, again, not all that complicated. They pony up the money to buy portfolio insurance in two ways: Taking away all of the fund’s dividends and selling ‘out-of-the-money call’ options.

The first point there is easy enough. The ETF’s 80% investment in the plain ol’ S&P 500 earns dividends like any other investment in the S&P 500, and that money is used to partially pay for portfolio insurance.

The second point requires a bit more context. If TJUL could actually promise the upside of stock investing with no losses, it would be the financial equivalent of alchemy. Rather than turning lead to gold, the fund has a tradeoff, capping how much you can earn when the stock market rises.

 

Max gains

For TJUL, the cap is 16% — if the S&P 500 goes up 20%, TJUL will only raise 16%, no further. Without getting too complicated, they do this by selling call options (the opposite of put options), which gives them the funds to buy the insurance that gives TJUL no downside.

It’s savvy, interesting, and makes for great marketing (who doesn’t want to invest with no downside!), but it’s not voodoo.

If you were to invest in TJUL, you’d accept two real tradeoffs to ensure you don’t lose money: No dividends and a max 16% gain over two years.

Who’s this for?

For the average investor, TJUL is a novel but unhelpful tool. To retirees, it may have a better pitch, allowing investors to preserve their wealth with some upside potential they may not get from owning bonds.

There’s one other wrinkle: TJUL can only guarantee a “defined outcome” over a limited period (two years) and only if you invest in the ETF on its first day of trading.

After day 1, the potential gains and losses shift, so the defined outcome of a precisely no-loss ETF is guaranteed only for a moment in time.

Still, the ETF fundamentally offers a capped downside and upside, but the numbers won’t be as clean as a guarantee of no loss and a max gain of 16%.

And as ETFs come, it’s not particularly cheap, with an annual fee of 0.79% of your investment, which directly subtracts from your returns.

But compared to other low-and-no-risk products marketed to retirees, like fixed annuities, TJUL and other buffer funds are reasonably compelling, offering lower fees, promising upside, and liquidity (ETFs can be bought and sold almost instantly on stock exchanges.)

 

The real downside

Not to dissuade you from diving into buffer funds like TJUL, though, consider this from Matt Levine of Bloomberg: “If you buy stocks, you get not only the price return but also the dividends; the S&P 500 has about a 1.5% dividend yield, and (2) if you don’t buy stocks, you get a 4.75% yield on Treasuries…

If stocks are down, this trade is worse than just buying Treasuries, and if stocks are up, this trade is worse than just buying stocks, and if stocks are flat, this trade is worse than any mix of buying stocks and buying Treasuries.”

As I said, this isn’t voodoo. The tradeoffs are real, and TJUL investors very much aren’t having their cake while eating it, too. The lure of no-risk investing is nonetheless intuitively appealing and marketing gold.

 

Dive deeper

For more, listen to this podcast on Trillions interviewing TJUL’s creators.

See you next time!

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