Innovator Capital Management takes a unique approach to exchange-traded funds (ETFs), crafting strategies that offer downside protection while maintaining upside potential. The monthly launched funds in its suite of Equity Defined Protection ETFs offer a 100% buffer to help advisors manage equity market risk.
A new entry in the August series of this group is the Innovator Equity Defined Protection ETF (ticker: ZAUG). Tim Urbanowicz, Chief Investment Strategist for Innovator, recently joined Wealth Advisor Managing Editor Scott Martin to share insights into this groundbreaking ETF and how it’s changing the game for investors and advisors alike.
Understanding ZAUG: The 100% Downside Protection ETF
According to Urbanowicz, the ZAUG ETF strategy “provides 100% principal protection and then also upside exposure on the S&P 500 over the year to the first 8.82% of gains. So, it’s really a way to protect against losses but also gets some equity exposure in the portfolio.”
This combination of features addresses a crucial concern for many advisors, especially in light of recent market volatility. Acknowledging a pullback from recent market highs, Urbanowicz notes that many clients are still concerned: “The market has had such a good run. This is a way to keep clients invested in equities but give them peace of mind to know that if the market does go down—we start to pull back from these all-time highs—we still have a 100% buffer against any losses that might occur.”
Target Audience: Retirees and Near-Retirees
While the ZAUG ETF can benefit a wide range of investors, it can be particularly well-suited for older clients, especially those in or nearing retirement. For advisors, Urbanowicz says, the fund represents “a good way you don’t have to take them down to a 20/80 portfolio. You can really maintain that equity exposure.”
This approach recognizes that today’s retirees often have different needs and risk tolerances compared to previous generations. They may be hesitant about traditional fixed-income allocations, especially in the current interest rate environment. The ZAUG ETF offers an alternative that allows for continued equity exposure while mitigating downside risk.
The Mechanics: Options and Precision
Unlike some hybrid solutions that combine equities and fixed income, Innovator’s ZAUG strategy uses options to achieve its objectives. “We hold a portfolio of options, and that gives us the ability to provide a level of precision in the portfolio,” Urbanowicz explains.
This approach is designed to deliver exact outcomes within defined parameters. “The options allow us to construct a portfolio of precision where we know that if the market goes down anything over a year, we’re going to be fully protected, less the expense ratio of the strategy. And then on the way up, we know precisely the upside exposure that we’re going to have,” he explains.
Potential Returns and Portfolio Placement
The ZAUG ETF offers upside potential of up to 8.82% over the course of a year, which aligns well with average annual equity returns. However, the real strength of this ETF lies in its versatility within a portfolio.
Urbanowicz suggests, “Obviously, for more conservative clients, you can use it as their equity sleeve, but for the majority of advisors that we work with, they’re thinking about this as a way to really increase return expectations in what we call bucket one. So, cash that their clients need over the next year.”
This positioning allows advisors to potentially enhance returns on what would traditionally be very low-yield allocations. “This is a way to not just hold savings accounts, not just hold CDs, money markets,” he adds. “This is a way to actually still get some upside in that bucket one as opposed to just defaulting to the risk-free rate and calling it a day.”
The strategy can also be applied to specific financial goals. “Client wants to buy a house in a year, two years. They don’t want to take on the full risk of the equity market, but they still want some upside. Let’s use this ZAUG to fill the hole with 100% protection. We still have that equity-like upside,” he explains.
Tax Advantages
Beyond its investment characteristics, the ZAUG ETF also offers potential tax advantages. “We would never anticipate any distributions being paid out along the way,” Urbanowicz notes. “There are no dividends either. You, as the advisor, control when you pay taxes per clients, and as long as you hold over a year, when you sell, you’re able to take a long-term gain.”
This tax treatment can be particularly beneficial for high-net-worth individuals and high earners, who might otherwise face significant tax burdens on interest from savings accounts, CDs, or bonds. “Your high-net-worth individuals, your high earners, they’re getting whacked at 30–40% tax rate. That’s a big difference,” he points out.
Monthly Series and Continuous Holding
The ZAUG ETF is part of a series of monthly ETFs offered by Innovator Capital Management. Each month, a new series is launched with a ticker that incorporates the month’s abbreviation (for example, ZSEP for September). This allows investors to enter the strategy at any point during the year.
One of the key advantages of this structure is its simplicity for long-term holding. Urbanowicz explains, “The nice thing about this is underneath the hood, when that year is up, all that we’re doing is simply rolling the options package to buy a new cap and a new buffer at that time. So, the only thing that’s going to change for the advisor, for the client, is that new upside cap we’re able to achieve for them at that time.”
The tax advantages of this automatic rolling process are clear. “If you want to hold this for the next 10 years, you can do that. And with the ETF structure, that’s not going to be a taxable event for the investor,” he notes.
The Value of Defined Outcomes
At the core of the ZAUG ETF and similar Innovator strategies is the concept of defined outcomes. This approach addresses a fundamental concern for many advisors and the clients: uncertainty.
As Urbanowicz explains, Innovator’s funds directly address this anxiety. “When we talk to advisors, their clients, more than anything else, hate unknowns. What the buffer allows us to do is remove a lot of those unknowns by providing the defined outcome point to point. We know what’s going to happen.”
This level of certainty sets these strategies apart from traditional risk management approaches, he believes. “We don’t have to worry about is our bond position going to zig when the equity zags. We know that this is going to have the protection that we state up-front. We know the upside.”
The result is a potentially smoother investment experience. “What we’ve seen over time is it takes the volatility of the portfolio down, which everybody loves,” he notes.
A Tool for Client Acquisition and Retention
For advisors, the ZAUG ETF and similar strategies can serve as powerful tools for client acquisition and retention. Urbanowicz shares a personal anecdote: “I started out in the business 14, 15 years ago. I was sitting in front of a prospect that had $1 million sitting in a checking account, called him for months straight, tried to get a meeting with him. Finally took the meeting. He’s scared to death of getting into the market. What do we show him? We show him the bond fund that has very low volatility. He’s like, yeah, I’ve seen this a hundred times. No thanks.”
In contrast, the defined outcome strategies offer something novel and compelling. “To be able to show him something he’s probably never seen before, at least in the structure of the low-cost, no-lockup surrender charges in the ETF world. This is a differentiator that can help advisors bring in new business as well,” Urbanowicz states.
These strategies can also serve as alternatives to products that some advisors may not offer, such as certain types of annuities, he adds.
Key Takeaways
The ZAUG ETF and similar defined outcome strategies from Innovator Capital Management represent a significant innovation in the ETF space. By offering downside protection coupled with upside potential, these solutions address key concerns for many advisors, particularly those with clients nearing or in retirement.
The Innovator ETFs provide a new tool for portfolio construction, potentially enhancing returns on traditionally low-yield allocations while managing risk. The defined outcome approach offers a level of certainty that can be particularly appealing in uncertain market conditions.
As with any investment strategy, advisors must thoroughly understand these products and how they fit into a client’s overall financial plan. However, for those seeking innovative solutions to balance risk and return, the ZAUG ETF and its counterparts may well be worth a closer look.
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Additional Resources
- Contact Innovator Capital Management
- Innovator Equity Defined Protection ETFs Overview
- ZAUG ETF Summary
- ZAUG ETF Fact Sheet
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Disclosures
The Funds face numerous market trading risks, including active markets risk, authorized participation concentration risk, buffered loss risk, cap change risk, capped upside return risk, correlation risk, liquidity risk, management risk, market maker risk, market risk, non-diversification risk, operation risk, options risk, trading issues risk, upside participation risk and valuation risk. For a detailed list of fund risks see the prospectus.
There is no guarantee the Fund will be successful in providing the sought-after protection. If the Outcome Period has begun and the Underlying ETF has increased in value, any appreciation of the Fund by virtue of increases in the Underlying ETF since the commencement of the Outcome Period will not be protected by the Buffer, and an investor could experience losses until the Underlying ETF returns to the original price at the commencement of the Outcome Period.
Fund shareholders are subject to an upside return cap (the “Cap”) that represents the maximum percentage return an investor can achieve from an investment in the funds’ for the Outcome Period, before fees and expenses. If the Outcome Period has begun and the Fund has increased in value to a level near to the Cap, an investor purchasing at that price has little or no ability to achieve gains but remains vulnerable to downside risks. Additionally, the Cap may rise or fall from one Outcome Period to the next. The Cap, and the Fund’s position relative to it, should be considered before investing in the Fund. The Fund’s website, www.innovatoretfs.com, provides important Fund information as well information relating to the potential outcomes of an investment in a Fund on a daily basis.
These Funds are designed to provide point-to-point exposure to the price return of the Reference Asset via a basket of Flex Options. As a result, the ETFs are not expected to move directly in line with the Reference Asset during the interim period.
FLEX Options Risk The Fund will utilize FLEX Options issued and guaranteed for settlement by the Options Clearing Corporation (OCC). In the unlikely event that the OCC becomes insolvent or is otherwise unable to meet its settlement obligations, the Fund could suffer significant losses. Additionally, FLEX Options may be less liquid than standard options. In a less liquid market for the FLEX Options, the Fund may have difficulty closing out certain FLEX Options positions at desired times and prices. The values of FLEX Options do not increase or decrease at the same rate as the reference asset and may vary due to factors other than the price of reference asset.
Investing involves risk. Principal loss is possible. All rights reserved. Innovator ETFs are distributed by Foreside Fund Services, LLC.
The Fund’s investment objectives, risks, charges and expenses should be considered carefully before investing. The prospectus and summary prospectus contain this and other important information, and it may be obtained at innovatoretfs.com. Read it carefully before investing.
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