Derivative-Based Strategies Take Center Stage at Asset Allocation Summit

Hosted by TMX VettaFi Head of Research Todd Rosenbluth, the discussion synthesized the thoughts of the ETF industry. It brought together industry pioneers to consider the rapid evolution and growing acceptance of derivative-based strategies. Joining Rosenbluth were:

• Direxion Investments: Edward Egilinsky, managing director, head of global sales/distribution & alternatives
• JP Morgan Asset Management: Matt Bensen, portfolio manager
• Tuttle Capital Management: Matthew Turtle, CEO & CIO
• Tidal Financial Group: Ryan Bader, SVP of capital markets

Once thought of as niche products, ETFs with derivative-based strategies have gained wide acceptance among both institutional and retail investors. For the latter, they’ve essentially become building blocks for modern portfolios.

Egilinsky has witnessed this firsthand. Direxion has pioneered the leveraged-inverse ETF product space, which uses derivatives via swaps and futures contracts, since 2008. The industry has reached level of comfort with the ETF wrapper, paving a smoother path to complex strategies using derivatives.

“I think the key is education with Direxion, when it comes to leveraged and inverse,” said Egilinsky, noting that Direxion has “seen a pickup in inverse products with markets at highs. However, when you look at the leveraged-inverse space, its preponderance is leveraged bullishness.”

Single-stocks ETFs are some of the most highly sought after products as of late. Direxion has been leading the charge with funds like the Direxion Daily TSLA Bull 2X Shares (TSLL A-) and Direxion Daily TSLA Bear 1X Shares (TSLS ), which have been their most popular offerings to date.

“If somebody wants to express a bullish view with leverage, the one advantage with an ETF is that there’s no margin necessary,” Egilinsky added.

Likewise, Tuttle Capital has inverse funds like the Tuttle Capital Daily 2X Inverse Regional Banks ETF (SKRE B+) to play bearish views. However, Tuttle also sees more traders gravitating to the bullish view.

“We certainly see, to Ed’s point, way more assets, way more people holding the long side,” Tuttle said. “They rent the short side.”

The growth of these products represent a shift in how investors access the market. In the case of Tidal Financial Group, they have the Yieldmax and Defiance ETF suites to bridge the gap between tactical institutional strategies and retail investors. These suites can achieve income (discussed further below), capital appreciation, or both.

See More: Opportunities in Direxion’s Leveraged-Inverse Suite

In the current higher-for-longer rate environment, income is a topical theme. To help solve this income dilemma, Tuttle Capital has ETFs like the TappAlpha Innovation 100 Growth & Daily Income ETF (TDAQ ) to help with income diversification.

Additionally, firms are innovating with tax-efficient structures and tactical overlays. For example, Bensen discussed the J.P. Morgan Nasdaq Equity Premium Income ETF (JEPQ A+) and the recently launched J.P. Morgan Nasdaq Equity Premium Yield ETF (ROCQ). Bensen explained that ROCQ is designed to provide similar exposure to JEPQ while potentially allowing investors to defer taxes through return of capital (ROC) distributions, reiterating that tax treatment is a key differentiator.

“As the industry has evolved, we’ve seen others use return of capital in their distributions, which can effectively push back and defer your taxes,” Bensen said.

See More: J.P. Morgan Expands Options ETF Lineup With New ROC Duo

The recurring theme across all panelists was the absolute necessity of education. Because these products utilize complex underpinnings like futures and swaps, the risks are magnified.

In the case of Direxion’s leveraged-inverse products, it’s easy to become enamored, given their profit-making potential. However, a profitable trade in concept can go awry quickly during execution. As such, education is imperative.

“You need to do your homework and know what’s under the hood, no matter what type of derivative you’re considering to invest in,” Egilinsky stressed. “In our case, it’s high risk, high reward. People have to realize that.”

Additionally, Bader echoed this sentiment. He suggested that understanding the strategy’s operational nuances such as daily rebalancing is key to successful utilization.

“I don’t expect every advisor, individual investor, to really read the full prospectus by any means, but absolutely understanding the strategy is key,” Bader confirmed.

As the 60/40 portfolio evolves, derivative-based ETFs are filling the needs of investors in today’s uncertain market environment. From tactical tools for capital appreciation or to open up avenues for income, these funds serve a variety of purposes.

Whether it’s to enhance a core portfolio or utilize managed futures to hedge against geopolitical shocks, the strategies have moved to the front of the advisor’s toolkit. And they’re not going anywhere.

“I think derivative products are here to stay,” said Bader.

To watch the webinar in its entirety, click here.

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