New ETFs Bet Investors Are Way Too Careful — Even When Buying Bitcoin — Heard on the Street — WSJ

By Jon SindreuIrrationally exuberant investors who lose their shirts get a lot of attention. But there is another way to manage your money poorly: taking so little risk that you end up with little reward.Enter the Calamos Bitcoin Structured Alt Protection ETF, which started trading under the "CBOJ" ticker last Wednesday. The fund uses a combination of safe investments and options on other bitcoin vehicles to guarantee that initial backers won't lose any money over the following year, despite investing in one of the most speculative assets in existence. The flip side is that it also limits the maximum returns they will receive over this period at 11.65%.Since 2016, there have been 23 occasions in which bitcoin has risen more than that in a single day. Its average annual volatility has been 86%.Calamos frames this as an advantage, since the chances of hitting the maximum are high, but there is an equally big probability that the cryptocurrency will tumble and never again come close to its recent $100,000 mark. So CBOJ's return could easily be zero minus its 0.69% fee, which seems to make it a poor alternative to cash. Right now, some bank deposits return 4.5%.Arguably, this also defeats the whole purpose of allocating money to bitcoin, which is to have a shot at outsize gains at the cost of big potential losses.This exchange-traded fund ultimately joins an illustrious tradition of investments that exploit loss aversion. Chief among them are the structured products that have become wildly popular among individual investors since the 2000s. "Principal-protected notes," for example, mix a zero-coupon bond with options that provide upside if some underlying index trades within a certain range.As with most investment products, these functionalities are nowadays being placed into ETF wrappers, referred to as "buffer" or "defined outcome" ETFs. Earlier this month, PGIM launched one linked to the S&P 500 with 100% downside protection and a one-year return cap of 7%. This is similar to what is offered by an analogous ETF released by Calamos in January.An analysis of monthly historical data underscores how much investors may be giving up: The S&P 500 has beaten those returns 57% of the time. In 42% of cases, it has more than doubled them.Of course, past probabilities are a poor guide to the immediate future, whereas the options used to set the caps on these products should allegedly reflect the risk that, say, today's S&P 500 is more expensive than average, or that bitcoin has few real-world uses and could suddenly become worthless. Indeed, the traditional argument to sell structured products was that investors didn't have access to derivatives to fine-tune their portfolios.The problem is that most studies, including a well-cited 2011 paper by Brian Henderson and Neil Pearson, found no value in adding structured products to portfolios after accounting for the high fees charged by issuer banks. And complexity can be an issue for the unsophisticated: Those who buy structured ETFs after launch, for instance, must remember that the terms shift with market prices. CBOJ's downside protection has gone from 100% to 100.03% as a result of bitcoin falling over the past week.Why, then, is the promise of not losing capital so mesmerizing? Research by psychologists Daniel Kahneman and Amos Tversky famously found that many people decline betting on a coin flip when they have a 50% chance to win $150 and a 50% chance to lose $100. While apparently irrational, the psychological hit from actual losses far outweighs that of missing out on larger winnings.To be sure, it is still a good thing that structured products are increasingly migrating into safer, liquid ETFs with fees below 1%, rather than the roughly 3% charged by banks. Perhaps this will turn out to be enough to make some buffer ETFs a useful part of expert investors' tool kits.And there are other rationales behind Calamos's bitcoin offerings. One is tax efficiency. Also, CBOJ is to be the first of a series of three ETFs, one of which has a more crypto-like profile — losses capped at 20% and a maximum return of around 50%. Crucially, these vehicles are a tool for financial advisers to push bitcoin to the fearful, or to allow newly made crypto millionaires to diversify, said Matt Kaufman, head of ETFs at Calamos.Most investors, though, are better off following classic portfolio theory and diversifying with cash and vanilla market trackers. Laying all the risk on the table only to sweep it away with the same hand is an odd approach at best.Write to Jon Sindreu at [email protected]