We believe that Uncapped structured outcome products offer a better return profile over the long run and make investing easier by removing difficult decisions for investors when compared to capped products. Overall, the potential advantages of the uncapped structure becomes apparent when you consider how these funds can trade in up and down markets.
Capped Products Trail in Up Markets
When we think about these products, it is important to remember that investors can buy or sell at any time, not just at the end of a period so how they are performing relative to expectations matter intra period. This means that HOW they reach their expected outcome matters as much as the actual outcome.
In a capped structure, the cap is created by selling a Call at the level that is defined as the cap. It is far out of the money when that cap is established. When the market goes up, it gets closer and closer to being in the money. In other words, it may become more valuable as a short position that weighs down performance. For investors, this means that a capped product may trail far behind an up market waiting for the period to end to realize gains up to the cap.
In contrast, the uncapped product does not have any additional options on the upside. As the market moves up, it trades closer and closer to the expected outcome in terms of participation rate. For investors, that means that they are poised to achieve almost all of their expected gains in an up market as they occur.
One of the potential benefits of these ETFs is liquidity. You can trade them intra period either to get out of the position or trade into the latest reset. If the market is up and you decide you want to reset your cap, a trade into the most recent month will reset the cap and buffer at the current level. You may be concerned that the market has moved too far too fast or that there is a new risk that wasn’t there when you made your initial investment. Whatever the reason, capped product investors must make a tough decision with no good outcomes. Do you sell and reset your buffer/cap? If the market is up, you have to give up the gains that you have not realized yet because the structure is trailing the market as we described earlier. If the market keeps running, you just face the same tough decision again and again. You continue to trail the market in real time.
With the uncapped TrueShares Structured Outcome product, you don’t face this quandary. If you want to step up your buffer, just sell your position and buy the front month. At that point, you will already have realized most of your expected outcome.
When the market moves up big, a capped structure could get left behind waiting to realize the expected outcome. You may have to wait the whole year while the market is running.
Resetting in a Down Market
The dilemma is even worse for capped products when the market is down. The capped and uncapped structures are very similar in their downside performance and face the same issue with realizing the buffer over time. Investors must wait to realize the full buffer at the end of the period. Both structures can have option positions down about 10%, and as the market moves down, you have to wait for the end of the period for the full benefit of the buffer to be realized. The difference between capped and uncapped here is if you decide to reset the buffer in a capped product, you lower your cap.
If the market is down and you reset in a capped product, you lower your cap. If the market bounces, investors in a capped product run into their cap sooner and so they participate less in the recovery. Some of the biggest upside moves happen in off market sell offs, so participation in those bounces are crucial for long term returns in investor portfolios. Resetting with a cap CAPS your recovery in the worst way.
Conversely, investors in TrueShares Uncapped Structure can trade to reset their buffer, as well, but since your upside is uncapped you would potentially just ride with a slightly different participation rate. That means you can reset your buffer and get additional downside mitigation without severely impacting your upside participation on any market bounce or recovery.
In a capped structure, when you are down and you reset your buffer, you lower the cap below where it was initially. You are lowering how much you can participate in the recovery!
A common question we get is why we chose 10% as the buffer? There was a lot of thought and reasoning that went into that decision, but it really boils down to that being the sweet spot where we get a buffer that is significant, but don’t give up too much upside participation. Historically, the participation rate at a 10% buffer works out to being in the 70-85% range almost 83% of the time since 2008 (1). That is a significant participation rate that keeps the position on the upside as close to equity as we can make it while keeping a significant buffer in place. And if we increase the buffer to 20%, we reduce the participation rate significantly, in our minds, it is better to just reassess the appropriate amount of equity exposure to maintain.
Learn more about TrueShares Structured Outcome ETFs at www.truesharesetfs.com/products.
1 – Source: TrueMark Investments, based on data from Bloomberg
Upside participation over an investment period is subject to options pricing. Due to the cost of the options used by the fund, the correlation of the fund’s performance to that of the S&P 500 Price Index will be less than if the fund invested directly in the S&P 500 Price Index without using options, and could be substantially less. While upside participation is uncapped (no absolute upper limit), an investor in the TrueShares Structured Outcome ETFs should expect to experience a rate of market return less than 100% of actual broad market results. Each Fund’s current expected participation rate can be found at https://truesharesetfs.com/products.
The TrueShares Structured Outcome ETFS have characteristics unlike many other traditional investment products and may not be suitable for all investors. You should only consider an investment in the Fund if you fully understand the inherent risks, which can be found in the prospectus.
TrueShares Structured Outcome ETFS are designed to seek to achieve the investment strategy for investments made on the Initial Investment Day and held until the last day of the Investment Period. Investors purchasing shares in the fund after its 12-month investment period has begun or selling share prior to the end of the investment period, may experience very different results than the fund’s stated investment objective. These periods begin at either the fund’s inception date or at each subsequent “Initial Investment Day”. Following the initial investment period after fund inception, each subsequent investment period will begin each year on the first day of the month the fund was incepted (subsequent “Initial Investment Days”). Fund management will target a 10% downside buffer, with expectations that it will generally fall between 8-12%. The Fund is not designed to protect against declines of more than 8-12% in the level of the S&P 500 Price Index, and there can be no guarantee that the Fund will be successful in implementing the buffer protect options strategy to avoid the first 8-12% decline.
The Fund invests in options, which involves leverage, meaning that a small investment in options could have a substantial impact on the performance of the Fund. The Fund may invest in FLEX Options issued and guaranteed for settlement by the OCC. The Fund bears the risk that the OCC will be unable or unwilling to perform its obligations under the FLEX Options contracts. Additionally, FLEX Options may be illiquid, and in such cases, the Fund may have difficulty closing out certain FLEX Options positions at desired times and prices. As the options the Fund invests in derive their performance from the S&P 500 Price Index, the Fund is subject to the equity market risk associated with the index. The ETF’s portfolio is more volatile than broad market averages.
Investments involve risk, including potential loss of principal. The Fund employs a buffered strategy in an attempt to buffer against losses in the S&P 500 Price Index over the course of a 1-year period. There is no guarantee the Fund will be successful in this strategy, and investors may experience losses beyond targeted levels. In the event an investor purchases Shares after the date on which the options were entered into or sells Shares prior to the expiration of the options, the buffer that the Fund seeks to provide may not be available and there may be limited to no upside potential. The Fund does not provide principal protection and an investor may experience significant losses on its investment, including the loss of its entire investment.