Mullooly Asset Management
Fiduciary Fee-Only Financial Planner | Investment Advisor in Wall, NJ
Mullooly Asset Management
New ETF Strategy Sparks Immediate Interest
Can actively managed ETFs that use derivatives really offer the perfect balance of income generation and market protection, or do they come with hidden risks that could jeopardize your investments? This week, we explore the emerging world of these high-stakes financial products, which have attracted a staggering $31 billion in just one year. We'll share personal stories and hard-learned lessons, stressing why thorough research and caution are crucial before diving into such complex strategies. While these ETFs seem to be tailored for current market demands, they might not be suitable for everyone or adaptable to future conditions.
In our deep dive into risk management strategies, we dissect the mechanics of buffer funds and their role in smoothing out market volatility. You'll learn how these products trade off downside protection for capped upside returns and why understanding this dynamic is essential for long-term success. We'll connect the dots from the 2008 financial crisis to present-day sentiments and discuss how upcoming events, like elections, could sway investor behavior. Our goal is to equip you with the knowledge needed to make informed decisions and understand the full implications of incorporating these financial tools into your investment portfolio.
Welcome. Welcome everyone to the 481st episode of the Malooly Asset Management Podcast. I am Tom Malooly and in this podcast we have a conversation that we recorded recently between Brendan Malooly, tim Malooly and myself regarding an article that was in the Wall Street Journal recently. The headline and we'll link to this in the show note the headline for the article is these hot new funds are boomer candy for retirees, and 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 12 months and we're recording this in mid-2024, over the past 12 months, these types of new actively managed exchange-traded funds have raised $31 billion in the past year.
Speaker 1:So someone is selling these funds to investors, and investors seem to have an appetite for them, but some analysts have, as mentioned in the article, questioned whether these strategies even work at all.
Speaker 1: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 12 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 into our podcast.
Speaker 2:Welcome back to the Malooly Asset Management Podcast. This is episode number 481. Thanks for listening. I'm Tim Malooly here today with Brendan and Tom. We're going to dive right in.
Speaker 3:Maybe just as like a preface to this conversation. I feel like it's I feel like it's important to remember that, like any of these things that we talk about, like these, 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 Right. And that is not the fault of the product.
Speaker 2:Yeah, I was going to say that, like I don't blame, that's important.
Speaker 3:Yeah, that's just that's my take and I don't want to end up like arguing with you guys on the podcast about like, whether these things are good or bad. I don't think like it's not that they just are.
Speaker 2:Yeah, they're just a thing, it's a thing that like there are and it's not those, it's not the people's fault to like that are creating these funds.
Speaker 3:They're not doing it maliciously, they're creating a product for 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. I feel like sometimes in the past we just like bring an article, use it as a straw man and just like don't just punch and it's, that's stupid. I don't think. I don't think it's helpful to anyone who was.
Speaker 1:So just we don't like something doesn't mean that they're not that there is a use case for it. Yeah, clearly there's a demand For it because they're selling, they're putting billions and billions $31 billion into it, I think but I also think it goes back to things that happen in our line of work. These things are not clearly explained to people.
Speaker 3:I don't think that happens as much as the good advisors want to tell people sometimes. They're like some bad advisor sold you this. Let me save you. I'm Superman.
Speaker 1:Yeah, come on, all right, 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've seen it happen to me and I know that I'm doing my best, so I'd like to give other people in our profession the benefit of the doubt in most
Speaker 3:cases because I don't think that they're out there like trying to steal people's money.
Speaker 2:It's just like why would they do that?
Speaker 3:like, not like people aren't doing this to be criminals yeah in 99 out of 100 cases no, there are obviously like exceptions to what I'm saying, but it's like, come on yeah, there's a there's a demand for something like this.
Speaker 1:These fund companies have created a product that fits that so good, just know, going in what, you know totally what the risks are. Anyway, I, I just yeah.
Speaker 3:I just Particularly useful to people to be like, hey, bad advisors are selling these and beware. And it's just like, all right, that's not helpful.
Speaker 1:Some of these ETFs are option writing. Yeah, they're all options.
Speaker 2:Yeah.
Speaker 3:They're writing calls.
Speaker 1:They're writing options. Yeah, they're writing calls. They're writing calls against this. I got blown up in 1986 and 1987 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 funds got whacked pretty bad and I got a very quick lesson on how these things can not 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? Then I had to basically carry that message back to my new clients. I really wound up getting a very costly education going through that process.
Speaker 4:So now when.
Speaker 1:I see actively managed ETFs and they're writing options against them, I get a little worried. I'm like, okay, I'm getting flashbacks to 1987. I don't know if this is going to be such a good idea. I don't know if it's going to provide a happy ending for clients. I will say that that factors into part of my decision matrix, 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.
Speaker 3:I think that the more complex a product gets, the more outlier cases there are when you're thinking through the cons. So I agree with that, but again, I don't feel like that's being misrepresented. It's just people not doing their homework when they put money into these things.
Speaker 1:That is the point.
Speaker 3:And the risk that you're talking about exists, whether it's a mutual fund, an ETF or you're doing the options yourself like an idiot Right about. Exists, whether it's a mutual fund, an etf or you're doing the options yourself like an idiot. So right, we, we definitely agree on you know. I mean, like these strategies aren't new, the new part is that they're in an etf wrapper.
Speaker 3:Now right, that's the new part yeah, people have been doing covered calls and you're buying, and it's a straddle when you're talking about the buffer fund like that's. That's all we're talking about here. You sold, you bought a put at the money and you sold one 10% down and you're protected in the interim. You're going to lose the rest of it if it goes down further.
Speaker 2:I'm not saying I like these funds.
Speaker 3:I'm just saying it's.
Speaker 2:Yeah, I don't really have that much of an opinion on them. My only opinion is that I think that they're unnecessary.
Speaker 3:Yeah, I'm not going to use them. If you want less risk, you can use them, and I think that's the point that we're trying to convey in the episode is that it's like it's not magic.
Speaker 2:They're not good, bad or anything. I think they're just an unnecessary, more expensive way to do it, when you could really just right-size the amount of money that you have in stocks versus bonds, versus cash in the market.
Speaker 3:Those are the three S pluses that you need to own, and the rest of them, like there are other ones, there are alternatives. That's why they're talking about chunky fees.
Speaker 2:You know like you're going to pay more money to have this done for you in an ETF and you could do it for less Right and potentially.
Speaker 3:You're going to 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 magical third thing, right.
Speaker 1:I forget if it was Charlie Munger or Warren Buffett who said if you can't explain this to a fourth grader, it's too complicated. And that's really I mean. I wrote on the back.
Speaker 1:I mean it's complicated. Yeah, it's hard to explain. Yeah, getting back to what we were saying earlier about some people want to just selectively remember certain things that they heard when this was being presented to them and then they want to know, like, well, the S&P is up whatever, but we're not. Qqq is up whatever, but we're not. It puts the advisor in a very defensive position and you don't know if it's the client not listening or just not sinking in or hard to define.
Speaker 2:I think that that happens and it would happen with these funds, and it happens with what we put clients in as well, though it's a strategy, and usually the timing of when you select the strategy matters a lot, and so these particular funds were huge last year.
Speaker 3:Yeah, because the year before that the market was down.
Speaker 3:So we're talking about hedging strategies, just like doing trend following. Got big after 08 and then it was not helpful for another decade afterwards. 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 do the thing that you want to have had in the past. But maybe when you're getting into it, you're focused on the downsides. You're implementing a new strategy to hedge volatility because the downside is what scared you and you're actually not asking questions about what the opposing thing is.
Speaker 4:What am I giving up by?
Speaker 3: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 then 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.
Speaker 3: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 is a pro and a con to every single strategy that you can implement Sometimes people don't want to hear it or it's just not that interesting to them because it's their finances or whatever, and so yeah, sometimes you have to revisit the conversation and be like yeah, so what we did when we, when we implemented this strategy is we hedged our downside because we were we were worried about that at the moment.
Speaker 3:However, the opposing end of that is, we also capped our upside.
Speaker 2:Right. 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 100% in the market. But these funds in this article do the same thing. It's just like you get capped at 10% and if the market goes up 23%, you get 10% and then people are like why am I capped? And it's like, well, you wanted the downside protection, so here's the trade-off.
Speaker 3:I have a pretty deep understanding of market history and kind of like the bell curve of returns, and it's not a normal curve. It has fat tails 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 tails in a lot of cases and the upside tails. But the returns always include the downside tails as well, and so when you shrink that opportunity set, it's going to have a major impact on the returns that you realize as an investor. And that just is what it is. There's no way around it.
Speaker 2:Anything that you do to reduce the volatility of your portfolio will reduce your returns, right, no matter what yeah, yeah, whether it's uh, 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 plus 10 percent, like, or plus 15 percent or whatever it is. You were kind of you're kind of implementing that yourself. If you're not using these funds and you're you just don't have like, if you have a 60 40 portfolio, you shouldn't expect 100 of the stock market returns. You should expect less than that. Maybe like, like, just ballpark like 60 percent, maybe a little more than that. You know it depends on what you're doing with the other 40 percent.
Speaker 1:But and we're not trashing these exchange traded funds because you can get the same approach, the same type of uh strategy in a mutual fund, in an ann annuity. They're all out there.
Speaker 3:The buffer fund product is really similar to what you see in an equity indexed annuity in terms of the defined outcomes 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 equity indexed annuity.
Speaker 2:I was going to say they're cheaper.
Speaker 3:Well, they're cheaper. Well, they're cheaper, that's a good point.
Speaker 2:They're not as cheap as not using a buffer fund or just implementing they're also more liquid.
Speaker 3:Yeah, you can like actually get your money. However, I don't know. Grant us all with that because, like these are ETFs, so you can trade them whenever the market's open. But if you 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 almost certainly not going to get the outcome that you signed up for, so maybe liquid.
Speaker 3:I don't know, maybe the surrender charge on the annuity doesn't end up being too 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 they're going to be selling it early because things have gone well.
Speaker 1:In those situations, having a surrender charge, I think, stops most people from bailing out at a bad point for sure.
Speaker 2:I mean, that's what they're there for, kind of. I feel like these funds, like what they were talking about in the article you mentioned they were popular last year, coming off of 22. 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 a corrections do, like we can't keep going up, up and up and up and while that's true, we don't know when the next correction is going to happen, but there is a stress and volatility inducing event happening later this year that people seem to be worried about. 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 enticing to some folks right now. So maybe the timing of an article like this kind of highlighting these funds.
Speaker 3:I'd rather see people taking an approach like that and consider these sort of strategies and de-risking in you're almost describing like a counter cyclical fashion. That's better than wanting to buy this, like on January 1st of 23, after the market drops 20 plus percent in a calendar year. That's the worst possible time to be considering a de-risk.
Speaker 2:At least they're preemptively considering it before the market's gone down.
Speaker 3:Yeah, like if somebody is 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 just having less market exposure if their plan can bear having less market exposure, then I think that's probably a good signal that they have too much at risk. And again, the financial plan and how it's designed to work is probably going to be the driving factor there.
Speaker 1:If it's something they're not comfortable with on a personal level, I think to tee up something that you just said, in that these products do seem to come out right after the perfect time to have them. Part of that comes from the investor demand them. Part of that comes from the investor demand. You know the market's going down in 2022. Gee, I wish we had something that could help buffer that. But then they also have to.
Speaker 1:These fund firms have to decide is there enough interest demand for something like this? Then they have to register the product with the SEC. All of these things take time, and so when these products do 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 21st Century Fund, which was all internet stocks. They launched it in February of 2000. This was after the NASDAQ had risen 55% in the fourth quarter of 1999. And it was just a few weeks before the internet bubble completely popped. Poor timing, that's a great example.
Speaker 1:So yeah a lot of times these products come out right after when you it would have been great to own.
Speaker 4:Right.
Speaker 2:When there's a demand for it.
Speaker 3:Well, yeah, there needs to be 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 I guess it's up to us to consider whether it's such a good time to be doing that or if it's something we can stick with over a full market cycle or not Because, even if you missed, time to purchase and you buy it after you would have needed it.
Speaker 3: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 part of your portfolio moving forward. But I think you need to understand the shortcomings and when it's going to 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 funds from the article.
Speaker 2:Like you mentioned before, they have like a specific timeframe that you need to hold these things for. So if you want to, but you're you know if someone's purchasing this, just as a you know, a couple of month hedge here while we wait for the dust to settle after the election, Like that's not, that's not the reason to do it, so I wanted to make that point as well.
Speaker 3:There's literally no strategy that's going to accomplish that Exactly, yeah, I mean that's whether you're talking about buying one of these or like swinging or anything else you're going to lose.
Speaker 1:if that's your approach to anything along investing Along the same lines, the idea that these two times inverse, or these 2X leverage funds and triple X leverage funds. When these things came out now 15 years ago, they were hotter than sliced bread, but over time these leveraged funds were two times, whatever the index did that particular day. And when the numbers started coming out and getting circulated at the end of 2010 and into 2011, people were realizing, hey, this triple leveraged fund actually did worse than just buying the index itself 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 they were going, I thought this was going to work.
Speaker 2:They work as they're designed to work. It's just whether or not you understand how it works.
Speaker 3:Yeah, we're talking about something that's kind of like saying like a particular kind of car is like a like bad, like a like saying like a a particular car brand creates more accidents. Like cars don't create accidents, people create accidents. So the way that the vehicle is being used is the problem, not how the product was designed.
Speaker 2:Right, unless it's a self-driving car, brendan, I think that's a good place to wrap up. Thanks for listening to episode 481 of the Malooly Asset Management Podcast. We'll catch you on the next episode.
Speaker 4:Tom Malooly is an investment advisor representative with Malooly Asset Management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not necessarily reflect the opinions of Malooly Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Malooly Asset Management may maintain positions and securities discussed in this podcast.