Talk Your Book: The Next Generation of Income Strategies
Animal Spirits Podcast
The episode explores the rapid growth and mechanics of structured income ETFs, specifically focusing on auto-callable and stability notes. G
Key takeaways
- Auto-callable notes function similarly to insurance, where investors earn a premium for bearing downside risk.
- Janus Henderson's JELM and JELH ETFs target high income by utilizing 25 to 30 individual equities.
Main topics
- Auto-callable mechanics
- Stability notes and gap risk
Notable quotes
Anything that can be ETFed will be ETFed.
Conclusion
This episode provides a technical deep dive into how new derivative-ba
Transcript preview
Speaker 1 (0:00) Today's Animal Spirits Talk Your Book is brought to you by Janice Henderson Investors. Go to JaniceHenderson.com to learn more about their whole suite of structured income ETFs with JaniceHenderson.com. Speaker 2 (0:11) Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast. Speaker 1 (0:40) Welcome to Animal Spirits with Michael and Ben. Michael, I feel like on these Talk Your Book episodes, we bring some knowledge to the table, but I also feel like we are learning along with some of these. Sometimes we come in bald. One of the things that we've learned, I think, a lot in the last couple of years is how structured products work. And this isn't like an area of expertise for you and I. We were not coming up in the structured product world. And these auto-callable ETFs. and the option income ETFs have just exploded. I will admit the auto callable idea was kind of a blind spot for me. This is not something that I think many investors had ever heard of before or used. And it's a very interesting way to sort of transform your equity exposure. Speaker 5 (1:24) There is a reason why this category has exploded. I'm pretty sure I said on the show today, we'll record this intro, I guess a week after the recording, but we got to do a rebrand. Imagine what this category can do if it was named something that actually had a hook. This means auto-callable means nothing to anybody. And yet, I don't know how fast it took to get this to a billion dollars, but what's the ceiling on this? How about automatic income? 50, 100? Yeah, that works. Well, automatic is tricky for compliance. I don't know. We'll go to the lab. Speaker 1 (1:57) Auto income? Okay. So we talked with Mike Laughlin, who's the executive director and ETF. client product specialist at Janice Henderson. We've talked to Mike before. It's always good to talk to someone who's in the weeds on this stuff because you and I just pepper him with questions and to learn more about how these things work. And it's pretty interesting stuff. And this is stuff where I think before you go into something like this, you really do have to understand how these things work. Speaker 5 (2:19) Yeah, there's a lot of moving parts. Speaker 1 (2:21) Yeah, there really are. So here's our talk with Michael Laughlin from Janice Henderson. Speaker 1 (2:27) Mike, Speaker 4 (2:27) welcome back to the show. Great to be here, Michael. Ben, love the opportunity. Appreciate it. Speaker 5 (2:31) So I was talking earlier with somebody in my office, a colleague of mine, and we were talking about the evolution of our industry and our business. And on the asset management side specifically, 2010's area was kind of boring. And it seems like this is the roaring 20s, both inside the wealth management industry. on our side, on the REA side, in terms of everything that's happening with technology, but also on the asset management side. I mean, this is absolutely the roaring 20s. One of the areas that we're going to get into today is the structured product market, which is something that I'm sure there is some sort of regulatory change, code, whatever, that allowed these products to go into the wrapper. And they've made a massive dent in... I actually saw that Vanguard's share of the overall ETF market has stopped going up for the first time ever. And part of the reason is because of products like these and others. That was a long introduction, but why have structured products in particular gotten so popular? Speaker 4 (3:37) Well, let's hope 2029 ends differently than 1929. One working mental model I have for our industry is that anything that can be ETFed will be ETFed. And I think this is the current leading edge of product development, if you will. The ETF wrapper itself is a technology and that technology has improved over time. And as it improves, it allows more and more parts of the market to be incorporated into the wrapper. And so structured notes are an example of that. The structured note market itself is 40 years old. However, being able to incorporate it into an ETF is new. I think advisors and clients value structured notes because investing is inherently an emotional and uncertain activity. And anything that can provide definition around investing, and in some ways, that's what these structured products are structuring, is defined risk and outcomes, is something that people inherently are gravitating towards. Traditionally, advisors did these as one-off notes, which was great for those clients, but it is operationally intensive for an advisor. It was something that was typically done in brokerage, typically only done for larger clients. And we think bringing it into the ETF wrapper is going to allow advisors to reduce that operational burden, use it in more places across their book. Speaker 1 (4:56) The outcome you get from these strategies is, I think, pretty easy to understand for people to grasp, right? You could get some sort of yield from something. You could get downside protection. You could get sort of a, you know, you got a collar on this side and a collar on this side. So it's just maybe more. defined outcomes. So people understand, I think, what you get. But I think what goes into these strategies and products is a lot harder for people to understand. So maybe you could just tell us from a broad general perspective, what actually goes in? Because I know that there's a lot of paperwork for doing these products when you're dealing with options and swaps. It's a lot of behind the scenes stuff that has to happen for these things to work. Speaker 4 (5:33) It's Speaker 1 (5:33) a Speaker 4 (5:33) lot of behind the scenes and it's a lot of ongoing monitoring from an advisor's perspective as these different structures. And it depends on what type of note we're talking about. On the growth side, you have buffered notes that then became very, very popular buffered ETFs. Now we're seeing more of the income notes, something like an auto callable or a stability note that are making their way into the ETF wrappers today. But the underlying physical notes are operationally intensive for both advisors and actually asset managers. One of the reasons, at least in the products that we have launched or are launching, we've been sort of replicating those exposures actually through swap rather than actually owning the physical note. But there is a lot of complexity in operational pipes and plumbing that go into this. And I think that's as those things get better over time, it's what unlocks more and more asset classes for broader wrappers like the ETF. Speaker 5 (6:22) So the auto callable category is relatively new to the ETF market, and it's huge. Like, I don't know how many billions of dollars it is already, but I got to tell you, not that you have anything to do with this, it could use a rebrand. How is anybody supposed to know what an auto callable anything means? And please explain yourself. Speaker 4 (6:41) Yeah, the language for sure is not friendly, maybe even unfriendly. I think though, if I was to sort of boil it down in the simplest way, there are investors who really want protection from severe market declines and uncertainty. And auto callable investors are basically taking the other side of that. To use maybe an apropos analogy here, it's like insurance in a way. If you're a homeowner, you have homeowner's insurance. You pay a premium to an insurance company because there's a risk that you don't want to bear, which is the risk of your house, say, burning down. Most years, your house doesn't burn down. And at the end of the year, you're not unhappy that you paid that premium. You're happy that your house didn't burn down. But the insurance company is... earning that return, earning that premium for bearing the risk that you do not want, right? Because as an individual, having your house, in many cases, a home is somebody's largest asset. Having your house burned down is catastrophic, both personally and financially. And so you basically offload that risk to an insurance company who earns a premium. And almost by definition, you overpay for that, right? The insurance companies... earning a profit, you're overpaying for the probability-weighted outcome of your house burning down, but you're okay with that because the outcome is so severe. I think thinking of this like insurance is pretty helpful. This is income that is not duration. It's not credit. It's not dividend. It's not illiquidity. It's almost like it's underwriting income, if that helps and makes sense. It does. Speaker 1 (8:15) So let me try to explain it. Let me know if I'm on the right path here. It's essentially the risk of these auto callables is the tail risk, right? So there's some sort of downside barrier, whatever it is, 40%, 50%, whatever your number is. And I'm guessing the lower the drawdown level, the higher the payout is going to be or the higher the... But it's... So let's say you did an auto callable and the downside is 50 % losses. If the stock market were to fall greater than 50%, that's when the risks kicks in for these strategies, correct? That's Speaker 4 (8:43) exactly right. Speaker 1 (8:43) The big risk. Speaker 4 (8:44) Yes. So functionally, you can think of the structured notes as a package of options. And so in an auto callable, as an investor in the auto callable, the income comes from basically selling two main options here. The first is you're basically selling an at the money call. And that's where the term auto callable comes from. Because if the market goes up over a specific time period, that position, that structured note is basically called away from you. And then the other thing that you have sold is exactly what you described, Ben. It is a barrier or a down in input. And so if you struck your barrier at minus 50, and let's say the underlying asset goes down 49.99%, well, you're fine. If it breaches the barrier, though, now you're knocked in basically back to $1 on that. And so that's why it's different than a buffer in that way. It's different than just a short put in that way. It is a... true contingent barrier put option. And that's roughly the structure of an auto callable. Speaker 1 (9:44) Because that risk exists, you don't want to own just one of these, right? You want to own a bunch of them at different time series. It's essentially like you're building out a private equity or venture capital portfolio where you want different vintage years or vintage weeks or months, however you explain it. Speaker 4 (9:59) Exactly. And that's a benefit of the ETF