It's part of a move to broaden access to retail investors
by Denitsa Tsekova and Yiqin Shen
Move over, buffer funds. Forget those income-enhanced strategies. Leverage? Who needs it. Wall Street has found another derivatives-powered bet to stuff inside an ETF: The single-stock autocallable.
That’s the latest gambit from independent issuer GraniteShares, which filed for more than 30 such products last week. The move is a fresh escalation of a recent trend of making complex investments easily available to any investor, and part of a race to offer exchange-traded funds with ever-higher yields.
An autocallable is a type of structured product that can pay hefty returns provided an underlying asset is within a certain trading range at regular observation dates. If the asset has climbed out of the range, the note gets “auto-called” and the investor gets their capital back. If the asset has dropped out of the range when the note expires, the investor faces losses.
Autocallables are the driving force behind an ongoing boom in structured notes, which are increasingly in demand from wealthy American investors, often as a way to keep earning good returns while limiting potential downside. But the strategies weren’t available in ETF form until this year, when Calamos launched a fund based on notes tied to broad indexes.
GraniteShares will go a step further by targeting autocallables on individual names. That’s a thriving part of the structured-product ecosystem, where many notes have been written on the Magnificent Seven stocks, in particular. The planned ETFs would be tied to companies including Strategy Inc., Robinhood Markets Inc. and Apple Inc.
The potential for yields is significant. Index-based autocallable ETFs already target coupons of more than 14%, and products linked to individual securities could theoretically offer even higher payouts. But to critics, it’s the latest example of Wall Street giving easy access to strategies that likely only sophisticated investors properly understand.
“These things are very complex, exotic derivatives,” said Benn Eifert, managing partner at volatility hedge fund QVR Advisors. “They provide this very high yield, but then also have a pretty high chance of hitting knockout barriers and terminating at a loss depending on where the barriers are.”
Issuers, who can collect hefty fees on more elaborate funds, argue they are just leveling the playing field, offering everyone a chance to use strategies normally reserved for the wealthy. They also point out the ETFs can be useful tools for those already dealing with structured notes.
“The target market is financial advisors who already use these products in structured-note form who want to migrate to a better wrapper in the ETF,” said Will Rhind, founder and CEO of GraniteShares. “Investors are already familiar with arguably more complex structures like buffered ETFs and other ETF strategies that utilize options to provide downside protection, generate yields or to hedge tail risks.”
The first ETF of this kind was the Calamos Autocallable Income ETF (ticker CAIE), which surpassed $300 million about three months after its June launch. CAIE uses swap agreements to get exposure to the MerQube US Large-Cap Vol Advantage Autocallable Index, which tracks a hypothetical portfolio of synthetic autocallables.
While not a direct proxy for performance, the index has gained about 14% annually over the past 10 years. It’s lagging the S&P 500 by a small margin over the stretch, but hugely outperforming the 1.9% return from bonds. Calamos, which charges a 0.74% fee on CAIE, is already planning a second fund based on the Nasdaq 100.
“Our goal was to deliver the autocallable strategy in a way that spread out your risk,” said Matt Kaufman, head of ETFs at Calamos. “If you frame autocallables like bonds tied to the equity market it’s a lot easier to make sense of them.”
The broader universe of derivative-income ETFs has hit about $120 billion assets, according to estimates from Bloomberg Intelligence. That marks growth of 255% since the beginning of 2023.
The new derivative-income category may come with tax advantages compared with other strategies. For example, because CAIE uses total-return swaps to mirror the performance of the index, most of its monthly distributions can be classified as return of capital rather than ordinary income, according to Bloomberg Intelligence.
Several issuers have been rushing to tap demand for autocallable exposure. Innovator Capital Management launched two such ETFs in September, just as issuer REX Shares filed for its own version.
“It’s explicitly part of the derivative-income craze,” said Charlie McElligott, managing director of cross-asset strategy at Nomura. “It’s been an easy pitch to create demand in these products, which are spinning off income but with equities underlying exposure, which gives you price appreciation as well.”
Copyright Bloomberg News
