Stay informed with free updates
Simply sign up to the Exchange traded funds myFT Digest — delivered directly to your inbox.
The first fund tracking a popular type of structured product launched in the US on Wednesday, in the latest sign that increasingly complex financial instruments are being packaged into stock market vehicles that can be bought and sold by retail investors.
So-called autocallables offer buyers a stream of payments, unless stock markets drop below a certain level, at which point investors suffer losses. They typically require a minimum investment of $250,000, and boomed in popularity in the wake of the global financial crisis as banks and financial advisers marketed them to wealthy clients hungry for steady income.
Calamos Investments has packaged autocallables into an ETF that can be bought or sold for as little as $1. The new fund, which is backed by JPMorgan, looks set to be the first of a flurry of similar ETF launches as providers continue their push to bring often complex derivatives-based investment strategies to small investors. Innovator Capital Management and First Trust have also filed to launch rival ETFs to Calamos’s offering.
“This is very much in keeping with the trend we have seen play out in the ETF space,” said Ben Johnson, head of client solutions, asset management at Morningstar.
“ETFs are taking market share not just from traditional funds but from all forms of financial products”, including futures and structured products, Johnson added.
US-listed derivative income and defined outcome ETFs — encompassing strategies such as covered calls and buffer products — surged in volume from $3.5bn in assets at the end of 2019 to $179bn, according to Morningstar.
Sales of US structured products — pre-packaged investment strategies linked to the performance of underlying assets such as equities and often involving derivatives — are dominated by autocallables. The latter accounted for $104bn of an overall $157bn of issuance last year, according to data provider Structured Retail Products.
Autocallables are designed to generate a similar income stream to high-yield bonds. They are often linked to major stock indices, such as the S&P 500, and have a fixed term — commonly three years — along with a series of observation dates, usually every three or six months.
At each observation date, if the index is above a specified level, the product is “autocalled”: the investor receives their original principal plus the promised annualised coupon, and the product is closed.
However, if the index falls below the key level on every observation date and at maturity, the investor may face a capital loss.
Autocallables have a “final protection barrier” — often set at 60 per cent of the initial index level. If, at maturity, the index is above this level, the investor gets their full principal back, but no coupons. If the index ends up below the barrier the investor would suffer a loss in line with the index, again without any coupons.
The Calamos Autocallable Income ETF will hold a basket of 52-plus autocallable notes issued weekly and tied to an index linked to the S&P 500.
Each note will pay a coupon for every month that this index is above 60 per cent of its starting level. Each note will be called after a year if the index is above the 60 per cent mark, with investors receiving the full principal and coupons, and replaced with a new note.
If not, it will remain active either until it does reach the 60 per cent threshold and is called or it reaches its five-year maturity. At that point, if the index sits at, say, 50 per cent, investors would get half their money back.
Coupons will rise and fall in tandem with market volatility. They currently sit at 14.7 per cent. The fund charges an annual fee of 0.74 per cent, above the 0.51 per cent average asset-weighted cost of US derivative income ETFs, according to Morningstar.
Elisabeth Kashner, director of global fund analytics at FactSet, said “structured outcome ETFs may well be directed towards retirees, who are super sensitive to capital preservation and who rely on their portfolios to generate income”.
However Kashner feared it would be a “tall order” for advisers to explain autocallables to clients, while in a severe downturn the downside protection and coupon payments can disappear. Such an outcome “will be more devastating to investors who might believe they’re buying something bond-like”, she said.
