We recently bought into BJAN, which is a defined outcome ETF. This ETF is unique in that it offers a buffer against market losses and a cap in market gains. Specifically, BJAN protects investors against the first 9% in losses in the S&P 500. But the upside is capped at 13.30% of the S&P 500. This means that if the S&P 500 falls 15% for the year 2020, BJAN will only decline by 6%. And if the S&P 500 were to rise by 20% in 2020, BJAN would only gain 13.30%. Here is a chart for illustrative purposes (source: BJAN fact sheet):
Why we’re buying BJAN
After the S&P 500 went up 30% last year, we find BJAN’s current 13.30% cap attractive. The following two tables, from Schaeffer’s, help give context to why we find the potential 13.30% return appealing. The first shows S&P 500 returns for the last 30 years following a new all-time high (as of June 2019):
Note that the average 1-year return is 10% compared to an average anytime return of 8.87%. BJAN’s cap gives modest upside compared to that average (13% vs 10%). The second table shows the S&P 500 returns since 1954 after closing within 1% of an all-time high (as of April 2019):
The 1-year returns are a little bit better here at 11.87%. But still, BJAN’s cap is higher and above that average. In addition, according to Bespoke, the S&P 500 averages a yearly return of 6.58% the year after a 20% rally. That’s below the long-run average of 7.58%. So based on the numbers and the current market environment, we deem BJAN’s potential upside to be above average. Of course, if the S&P 500 goes up 30% again this year, BJAN will be a huge underperformer.
Risk vs Reward
We think the market has higher risk vs reward right now and do not expect another 30% rally this year. But even so, we’re not over-investing to BJAN. It’s simply taking up a small allocation in some of our more conservative portfolios. BJAN is also a great replacement hold for new money to start the year. This is because BJAN will not decline as much as the S&P 500 in the event of a broader market pullback. You can visualize this from the following illustration:
For example, if the S&P 500 declined by 5% in the next two months, we’d expect BJAN to be down roughly 3%. At that time, we could consider swapping out of BJAN and into the S&P 500. The benefit of that would be that we save 2% in market losses. We’d also be able to get rid of any upside cap in the event of a bounce-back rally. It’s worth noting here that, over the last 40 years, the average intra-year decline in the S&P 500 is 13.80% (from JPM Asset Management):
To be clear, the S&P 500 vs BJAN pullback example is strictly hypothetical and does not account for factors like liquidity. But, we use it nonetheless to help explain our reasoning in favor of BJAN. Regardless, based on our own research and conversations we’ve had with the creators of BJAN, it’s logical to assume BJAN will be down less than the broader market during a market drawdown.
Keep in mind, BJAN is a defined outcome ETF with a 1-year period. This means that in order to realize the effect of BJAN’s buffer and cap you must hold for the entire outcome period. The good news is that the outcome period just started on January 2, and the S&P 500 is basically flat so far. So you could theoretically buy in this week and be assured the stated buffer and cap referenced earlier. But remember, BJAN will trade as its own ETF with its own price. And even though its buffer and cap are based on the S&P 500, it will have some tracking error on a day-to-day basis. It will typically be down a little less than the index on down days. And up a little less than the index on up days.
So BJAN is an attractive ETF for the conservative buy and hold investor who is worried the market might be in for a rocky year. Or if you just don’t think stocks will be up much more than 15% on the year. It’s also a nice option to use for putting spare cash to work while waiting for a more attractive entry point into the broader market. We personally are not using BJAN as a total replacement for large-cap exposure. But we have been doing things like allocating 15% to our normal large-cap basket and then allocating 5-10% to BJAN. We think it’s an innovative ETF and we’re excited to see how its performance factors into our portfolios this year.
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