Over the past five years, investors experienced two major market drawdowns even in the best ETFs. First was the Covid-19 pandemic bear market. Second was the 2022 bear market, when both the S&P 500 and long-term Treasury bonds lost more than 20% of their value at the same time.
With U.S. large-cap stocks at or near all-time highs, the idea of portfolio protection might not be at the front of one's mind. But that doesn't mean investors shouldn't be thinking about it.
That's one of the cornerstone ideas behind the Aptus ETF lineup. Aptus Founder and Chief Investment Officer JD Gardner says that his company's philosophy is founded on the idea of improving allocations. That's what ultimately helps the investor, while creating strategies to help make that shift without boosting risk.
Aptus offers six actively-managed ETFs. All are built around the notion of reducing portfolio volatility, minimizing downside risk and enhancing portfolio yield. Investors Business Daily asked Gardner to discuss the strategies behind the Aptus ETFs and how investors should approach using these within their own portfolios.
Best ETFs For Uncertainty
IBD: All of your ETFs use options or derivatives contracts in their investment strategy. How did you decide to go this route for your funds as opposed to using traditional equity or fixed income strategies?
JD Gardner: We think options-based strategies are needed to address both types of risk that worry us: longevity risk and drawdown risk.
Many are realizing that bonds may struggle to produce real returns and provide correlation benefits to portfolios. We'd rather own things like hedges that carry a cost to hold, but have a reliable correlation. Their presence should free up an allocation to more confidently hold risk assets.
Hedges inject convexity to portfolios and that convexity can pay off in the exact environment that worries clients. We don't hear clients worried about volatility. They worry about drawdown in our opinion. Options-based strategies, especially those that own hedges, can provide an allocation benefit with explicit protection against the risk that worries most investors.
Understanding The Lineup
IBD: The other sleeve of your fund lineup includes several managed risk products. How should investors augment stock and bond positions within their portfolios with funds designed to limit downside risk?
Gardner: These strategies are long volatility in the sense that they can benefit from left tail (way down) or right tail (way up) market environments. I'm biased and my team probably gets annoyed with me, but I'm as pro "long volatility" as any investor you'll find.
The presence of these types of strategies can shift allocations towards more beta, with the hedges protection in place. I think it's the best of both worlds. More beta translates to better right tail participation while hedges can chop off left tail participation.
The phrase we use internally is "better in the tails." The tails (big returns up or down) are where compounding happens. Every investor's financial picture improves with higher compounded returns. That's our objective. Create strategies that allow portfolios to perform better in both the good and bad tails.
Combining Stock And Bond Plays
IBD: The Aptus Defined Risk ETF uses a combination long investment-grade bonds and long stock options strategy that would appear designed to provide leveraged market exposure for every dollar invested. What sleeve of a portfolio do you see DRSK fitting into?
Gardner: DRSK was created as a bond replacement. Again, I'm biased, but I believe it's hard to find a direct comparison to this fund. It's best suited for tail-type environments, and the interest we are receiving is mainly due to the upside participation.
We are big fans of additional beta into portfolios. Specifically, equity beta. We view DRSK as a vehicle to get more equity upside into portfolios in a wrapper that can look more like bonds in an equity market sell-off. We've had an incredible run and I cannot speak highly enough about the team behind these strategies.
Best ETFs Take On More Assets
IBD: The Aptus Collared Investment Opportunity ETF is up to around $1.5 billion in assets. How have you gone about educating the investing public on how these products work and how they can benefit them?
Gardner: ACIO has benefited from a few things. The track record has obviously helped, as it's the poster child for expressing our more stocks, less bonds, risk neutral philosophy.
Where DRSK is different, we believe ACIO is a structurally-advantaged evolution of strategies that had already existed in the marketplace. We see wind in the sails of active ETFs and even more wind in the sails of options-based strategies.
We believe more investors and advisors are waking up to the fact that bonds cannot produce returns or manage risk like they'd hoped. Hedged equity stands to benefit from the volume of folks realizing this. We love the positioning of ACIO in this space as we've constantly improved this strategy, and the numbers speak to that. It should keep popping up on radars.
Finding Future Growth
IBD: Where do you envision the next big growth frontier is for your company?
Gardner: Our focus will continue to be on the options-based space. We think there's work to be done to drive efficiency and ease of access within that world. Our services business stands to benefit from how we partner with advisors and investors to tap into the options work we are doing.
IBD: What is the most underappreciated risk you see in the financial markets today?
Gardner: Too little risk-asset exposure. If you divide allocation between conservative assets (bonds) and risk assets (stocks), I think the biggest issue we see is the reliance on bonds and the illusion of safety they provide.
IBD: Any final thoughts on the state of the global economy and financial markets?
Gardner: As a nation, we are operating at substantial deficits. And our expectation is for federal debt to continue to expand. Just look at the expansion of debt in the last five years. It's increasing at an astonishing pace. New debt equals new money in the system. The outcome for stocks is not doom and gloom, it's that those assets move higher.
We believe a great hurdle rate for investors to maintain purchasing power is our deficit spending. Let's say that's 6% to 8%. What asset class gives you the best chance of compounding at that rate? Not bonds or cash in our opinion.
There's uncertainty, especially around this election year. Our firm belief is that the gap between returns only expands between "safe" assets and risk assets. Those that own risk assets will benefit, those that own 'safe' assets will have purchasing power erosion."
