The market volatility and widespread uncertainty on the global economic outlook has created a more defensive attitude in most investors. The result has been a rise in popularity for defined outcome ETFs, designed to limit losses and maximise returns.

“In today’s market, we think it’s critical to understand where returns are coming from and where they could come from,” says JD Gardner, Founder and Portfolio Manager of Aptus Capital Advisors, which has USD1.6 to 2 billion under management, and is the issuer of the Aptus Defined Risk ETF, DRSK, a fixed income solution designed as a bond replacement, but being utilised in multiple ways, which was launched in 2018.

Gardner says that if the return stream comes from yield plus growth plus valuation change, his ETF is specifically designed to help shift portfolios to higher probability return drivers.

DRSK is designed as a bond replacement allowing investors to gain more than they risk, with some 90 per cent of the fund in investment-grade corporate funds and 5 per cent designed to achieve growth exposure through buying 3-6 per cent near the money call options to limit downside risk. 

These options offer investors asymmetry, Gardner says. The fund uses 10-20 diversified names to give optionality, not relying on the index, but spreading the risk and return across multiple return drivers.

Aptus launched in 2013 and had its first ETF in 2016. The firm offers ETFs, model portfolios and OCIO services. Its ETFs have some USD700 million in assets.

The firm has core hedged equity products and core equity products with a tilt towards providing income generation, applying what the firm calls its ‘drawdown patrol’ to avoid a drawdown.

“2020 has been a wild year but good for us as our effective risk management shows the power of what are doing under the hood,” Gardner says. Year to date their defined risk fund is up over 13 percent while peak to trough the firm’s equity funds have seen a drawdown which was less than half of the market’s.

“Everything we do we always want to be long volatility,” he says. “If volatility rises, we want something that can benefit from that.”

DRSK might be just two years old, but as Gardner says, it has experienced a decade of volatility. The ETF does not have fixed A to B points for its outcome to be defined as such. Gardner says: “It’s hard, in our opinion, to give a firm number of defined outcome when you enter a market like we saw in February or March – in the middle between point A and point B, a whole lot can happen.”

Word is out that defined outcome or buffered ETFs could overtake the annuity market in the US and Gardner thinks that could happen. “A lot of those defined outcome ETFs have a lot of powerful messaging behind them, but there are still some structural inefficiencies with them that we don’t have to deal with,” he says.

This actively managed ETF has a management fee of 0.69 per cent and an acquired fund fee of 0.07 per cent.

“Everybody is focused on income right now,” he says. “But anything with a yield of more than 5-6 percent has a very good chance that you are taking on a load more risk than you intended to. We look at yield but we have equity built in so we solve a lot of the issues at the portfolio construction level.”

The classic 60/40 portfolio has 40 per cent in an asset class that can’t do anything for the investor, Gardner says. “We created DRSK as a place for the 40 per cent that’s traditionally devoted towards bonds. This allows your potential for return to improve without absorbing the volatility risk associated with owning more stocks.”