Inside ETFs: What's the best hedge for your portfolio?

When markets fall, everyone wants a parachute. But will these funds actually open? This is Inside ETFs and we're exploring the search for shelter. For much of this year, the ETF story has been simple. Money in and markets up. More than $1 trillion has flowed into US-listed ETFs this year. But are we starting to see the first cracks? Last week, investors pulled $3.7 billion. A rare outflow as the AI trade came under pressure. So attention is turning to option-based and buffer ETFs designed to cushion downfalls. But will they deliver the protection that investors are counting on? Let's ask JD Gardner, founder and CIO of Aptis Capital Advisors. So JD, your growth strategy is built on the idea that more stocks and fewer bonds can drive better long-term outcomes. So with AI momentum fading, does that thesis still hold? I would say that thesis still holds. That's our strong conviction. The one thing that I'd point out that kind of underpins our conviction is when you think about other ways to protect against potential risk in stock markets, people tend to think of bonds. And we would argue that bonds are a diversifier versus options-based strategies. There's a known correlation with hedges. And we'd much prefer known correlation rather than hoping that a diversifier helps us. And we obviously think stocks will compound at a faster rate than fixed income. Let's talk about those options strategy. Your funds use covered calls on individual stocks to enhance income and liquidity. But in volatile markets, can the income stream become uneven? Special investors are giving up some upside. Selling a call is a shortfall strategy. And it's inherently dangerous because we think equity markets tend to rise. And so the way that we think about selling calls are you can only make the premium you sell. And so we tend to be very quick, very short tenors in what we sell and very quick to monetize. So we don't want to get in the way of rising equity markets, which ultimately we think that's what's going to happen. The old Wall Street rule is buy low and sell high. But investors today seem willing to pay up for what's working. So are high valuations becoming less of a warning sign for your strategies and more of a reflection of investor conviction? The big thing to us that we think most investors need to really consider is their asset allocation. Meaning, hey, what do I have in cash, stocks and bonds? We think that's a much more important decision than do I own growth or AI or value. Like we don't really play the factor games as much or the sector games. Our conviction lives that stocks will perform better than bonds. Therefore, we want to own much more of them. And the options based strategies allow us to own more of what folks think of the volatile asset with confidence, because we know the options are there to protect. Well, you do have a bond alternative strategy. It uses a ladder of investment grade corporate bonds. So investors are chasing higher yields. What happens if corporate balance sheets start to weaken? Is that a hidden risk when earnings season comes around? Our exposure and de-risk our flagship bond fund is really the investment grade corporate bonds. So we stick to investment grade. And we think that insulates us somewhat from credit spreads having issues. But the big thing with that strategy and we're kind of a broken record over here, but it's 95 percent, 90 to 95 percent investment grade corporate bonds. But then there's an option strategy that's tacked onto that. That's really where that deserves most of the attention rather than the bonds. The bonds are just kind of they just serve to give us the asset class exposure. So let's talk about buffering ETFs. They offer downside protection, but they also cap upside. So does your quarterly reset change that equation? There's path dependency in any kind of buffer. And that means, hey, if you timing risk is what that means. And so there's the market and issuers are really innovating in the space to reduce that path dependency. And our approach to it is we have quarterly buffers. We think the mechanics of our buffer is more attractive than the other options out there. But the quarterly buffers is kind of the first leg. Hey, we've we've given you four different options. But then we also have laddered buffers where, you know, it's a single fund that owns all four of the quarterlies. And we think that goes a long way at reducing path dependency and kind of it mitigates some of the issues. But I think the pros far outweigh the cons in the defined outcome space. If and this is a big if, but if you're funding these defined outcome strategies with the right asset exposure, we think the funding should come from things like fixed income and cash rather than equities. So finally, JD, there is a view that buffer ETFs are just fear being packaged into a product and expensive insurance policy. So what do you say to those who believe investors are paying too much for a peace of mind? That was some of our thinking in the space is, hey, we can put together a better structure with better outcomes and better outcomes to us means higher caps. So anytime you're going to protect a certain amount of, you know, exposure, you're going to probably give up some of the upside. And so if you're thinking about like a 15 percent buffer or even a deeper buffer, the most critical question is, well, what is my cap? And to us, the obvious way to solve for higher caps was to lower expense ratios. And that's that's kind of one of the things that we hope we are kind of, you know, generating in this market. There's tons of demand for defined outcome, and we think the price point should be lower. So we're trying to solve that problem for investors because we would agree some of the existing and most of the kind of incumbents in the space. It's pretty expensive exposure considering what the structure is. That was JD Gardner from Optus Capital Advisors. Don't forget, you can watch more videos on Reuters dot com.