MASTERCLASS: Outlook for 2023
- 56 mins 26 secs
Two experts cover inflation expectations, how to navigate the higher interest rate environment, and whether investors should be bracing for a recession. They also explore innovative companies and some of the key themes shaping global markets as the transition to a more sustainable economy continues.Channel: MASTERCLASS
- Andy Braun, Senior Portfolio Manager - Impax Asset Management
- Tom O’Shea, Director of Investment Strategy - Innovator ETFs
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Jenna Dagenhart: Hello and welcome to this Asset TV 2023 Outlook Masterclass. We'll cover inflation expectations, how to navigate the higher interest rate environment, and whether investors should be bracing for a recession. We'll also explore innovative companies and some of the key themes at shaping global markets as the transition to a more sustainable economy continues. Joining us now we have Andy Braun, Senior Portfolio Manager at Impax Asset Management, and Tom O'Shea, Director of Investment Strategy at Innovator ETFs. Well, Andy and Tom, it's great to have you both with us.
Andy Braun: Thanks so much for having us, Jenna.
Tom O’Shea: Thanks, Jenna. Happy to be here.
Jenna Dagenhart: So, before we dive into what investors can expect in 2023 and beyond, I'd like to take a moment to give our audience a better sense of the work that you're doing at your respective firms. Andy, why don't you kick us off?
Andy Braun: Sure, will be happy to. Impax Asset Management as a firm is focused on investing in companies that we think will thrive as we transition to a more sustainable economy. I'm the Senior Portfolio Manager for the Impax large cap strategy focused on investing in US companies that are well positioned to benefit and drive the transition to a more sustainable economy.
I'm also on the investment committee for our sustainable allocation strategy that sets the allocations to various asset classes based on the risks and opportunities from each asset class, so stocks versus bonds and US versus international. We employ innovative sustainability tools both from a top down and a bottom up perspective to uncover advantage companies as this transition of the economy transforms.
Jenna Dagenhart: So, you're busy wearing many hats it sounds like. And Tom, Innovator has only been around since 2018. Could you talk a little bit more about the foundation of the firm and what it's known for?
Tom O’Shea: Definitely Jenna. So, Innovator, like you said, was only founded in 2018, but really the innovation goes back to 2003. It was formed and co-founded by Bruce Bond and John Southard, and anyone familiar with the ETF industry may recognize these names as these gentlemen are pioneers in the industry. Bruce and John, they co-founded PowerShares, which ended up being the fourth largest ETF provider in the world. And they were on the forefront back then too with passive index ETFs, actively managed ETFs and what's now known as Smart Beta ETFs.
A lot of people would argue that the ETF industry is saturated and matured, but I would say Bruce and John would disagree as they continue to innovate. They saw many advisors implementing annuities and different types of structured notes in their portfolios, because investors and advisors liked knowing the potential outcomes. But the drawbacks were high fees, inefficient taxes, and just not as easy as something as investing in a stock or an ETF. You'd have to re-up after these outcome periods.
So, Bruce and John were the first people to wrap a defined outcome in an ETF and eliminating all these negative drawbacks. They did it with simple option structures that, again, are just as tax efficient as any other ETF. So, although Innovator has a wide suite of ETFs, most advisors and clients really know us for our buffered ETFs. And just to give a quick example of what a buffered ETF is for people who are maybe unfamiliar with those type of structures, is I'll give PJAN, a ticker that we have as a quick example.
So, this is a US equity buffer ETF with a 15% buffer. The options that drive this are based on SPY, which is essentially the S&P 500. So, there are a couple scenarios that could happen, and there's an upside cap on PJAN's at 18.4%. So, in the event that markets go down 10% on the SPY, that 15% protection on PJAN will allow an investor to only have a 0% return.
If the markets of SPY go down 20%, the investor would only lose 5% because of that buffer. Now what happens on the upside when markets go up 10%, the investor captures all of that, but in the event that it goes above that 18.4% cap, the investor would only get that cap. So, investors really like this because they have a known defined outcome, and there's a lot of uncertainty in the markets today. We have two central bear markets that have happened since Innovator has come out, and our products have worked as intended and we expect a lot of uncertainty in the next year.
Again, we're the first company that has come up with these defined outcome buffered ETFs, and we've really seen a lot of other firms try to mimic what we've done. The assets under management have really grown from nine billion to 18 billion in 2022, and again, this is likely to continue in the next year.
Jenna Dagenhart: To your point, and we'll talk more about this today, it seems like the only certainty in 2023 is more uncertainty ahead. But Andy, what are some of the key themes that you're watching that you think will shape global markets in the year ahead?
Andy Braun: It's a great question. I reflect back to being asked this question at the beginning of last year when the global market environment was relatively serene and look at how the year 2022 ended up. So, there are a lot of things to worry about as we enter 2023. So, the overall backdrop is certainly more muted for economic growth. The World Bank just revised down global GDP to 1.7% for this year, and in fact, I think the consensus is now for negative GDP in the US. So, certainly a tougher backdrop.
Really the top three issues that we're thinking about as we go into 2023 from a macro perspective are certainly the direction of inflation, the direction of interest rates, and then the geopolitical impact on trade. And then of course, it's the unexpected themes that crop up during the year that will probably most impact markets during the year. So, we always have to keep our eyes wide open throughout the year for these themes to change and evolve.
With all that said, we really spend more time at Impax thinking about what the sustainability themes are likely to be and which are going to be durable over the next three years, five years, 10 years. Themes like resource efficiency, electrification of vehicles, clean water and healthcare innovation, those are themes that we think will span the duration of 2023 and beyond. So, that's really where we're spending a lot of our time thinking about the trends that are occurring now and will likely be durable over the intermediate term.
Jenna Dagenhart: And at the start of 2022, a few people would've expected four 75 basis point hikes by the Fed in the year to come. So, it's very tough to predict these things. But Tom, what do you expect from the Federal Reserve in 2023?
Tom O’Shea: Thanks, Jenna. We expect them to continue to elevate rates next year. Like you mentioned, they hiked at such a quick pace. We're up to four and a half and we think they're going to move up to about five and a quarter through mid-summer and then pause. We see what the Fed fund's futures or the market expectations of the policy rate is, and that's at about 5%. Then they actually expect rates to fall through interest rate cuts at the end of the year. One of the reasons that we don't think that will happen is just researching prior tightening cycles and Fed fund's futures has the tendency to underestimate the actual Fed funds rate during tightening cycles, and then during cutting cycles, they actually overestimate the Fed funds rate.
So, we really expect them to see what happens at five and a quarter. And then as we know, economic data, really what happens after tightening cycles occurs on delay. So, another factor we're considering with keeping elevated rates is the quantitative tightening. In the 14 years before the global financial crisis yields across the whole curve were much higher. And then they had quantitative easing following the global financial crisis, which just had a high sheer volume of treasuries and other assets purchased, which kept rates artificially low.
We're seeing the supply and demand dynamic shift with bonds requiring investor demand, and there's a potential for 60 billion of max runoff each month that would end up representing about 9% of the entire treasury market. This supply demand shift really leads us to believe that rates will remain elevated for the foreseeable future.
Jenna Dagenhart: Andy, how are you monitoring the trajectory of interest rates and the potential impact to the economy as growth moderates, and what are some of the social implications given that the Fed, for example, is calling for an increase in unemployment to 4.6% by the end of 2023, which is just over a point higher than where we are now?
Andy Braun: It's a good question. So, we think the interest rate increases will impact the economy. Typically, they do on a lag of six to 12 months. So, we really don't think we've seen the full impact of the higher rates on the real economy yet, and that's before further likely increases by the Fed at the beginning of 2023. From our perspective, the Fed really only became restrictive in their policy around mid-year 2022. So, there's a little bit of a ways to go where we'll see that forward impact on the economy continued to provide a drag. So, what we've seen certainly so far is a lot of the speculative froth is now out of the market. So, a lot of the companies that really relied on very low interest rates for survival, those companies have taken it on the chin. Really the next leg is how typical companies deal with this economic weakness.
So, we've seen PMI's in the US now fall below 50 in November, so certainly signaling some elements of economic contraction as we speak, and we think that will likely continue, certainly through the first half of 2023. To your question around unemployment, the current levels of unemployment at 3½% generally considered to be over full employment. So, we and others are expecting a reversion to occur. It's taken a little bit longer to start, so the last tick on unemployment was at a record low. So, certainly the direction is likely to be higher. It's taken a little bit longer to achieve liftoff.
I'm not particularly concerned about the effects on the economy really until unemployment reaches higher than 5%. Though we can get a lot of interesting intel from a company specific standpoint as we watch how companies deal with their human capital and deal with the issues around potential layoffs. So, so far we've seen that focused on technology companies and more speculative areas of the economy that really benefited from the free money. What we'll see now is really how companies treat employees during stressful times. We saw a little bit of that during COVID, and companies that treat their employees well, really provides a good window into their human capital policies and provide interesting dichotomy as to which companies we're interested in and which we want to avoid.
Jenna Dagenhart: And Tom, do you think that a recession is unavoidable at this point, or is a soft landing still in the cards? I mean it's very hard to achieve a soft landing, but it has been done in 1966, for example.
Tom O’Shea: Yeah, sure. We reviewed a couple soft landing scenarios and based on our research, we think it's definitely possible. I mean anything is possible, right? But we think it's unlikely. We think what happened during COVID is still having knock on effects to what's happening now. And you look back to the lockdown and it prevented everybody from traveling, spending all our disposable income at restaurants. I've seen more Amazon boxes than I needed to in an entire lifetime, but I would say generally the majority of US built up excess savings.
On the employment side, we saw people lose their jobs, unfortunately, and what's going on now outside of technology in some financial companies, it seems that, at least anecdotally, people are more reluctant to fire employees because of how difficult it is to hire that top talent or the expenses associated with training people that are coming back on. So, we have these two factors with a strong labor market, we have consumer spending strong also due to that strong labor market. So, it'll really be a delicate balance of if the Fed can tighten at a rate that won't completely make everybody crazy while keeping a lid on inflation. Again, we expect a recession, but it is possible.
Jenna Dagenhart: And to your point about the labor market too, Tom, I mean it's been such a difficult environment for a hiring given the number of job openings per person seeking employment. It's just a very strange labor market that we find ourselves in.
Tom O’Shea: Yeah, definitely. Labor market and the consumer spending are really two key pieces of the puzzle, in our opinion, of what's happening with the inflation situation. We had CPIP last summer around 9%, and a lot of people are wondering, "Hey, when is inflation going to get back down to that 2% target?" And we reviewed all developed market economies from 1980 to 2020, and when core inflation has exceeded 5%, we saw a large range of how long it took to bring that 5% down to that 2%. And that's been from about three to 30 years.
So, now we have the Fed hiking at the fastest rate in modern history. It is moving at the fastest pace ever. So, it is possible that maybe the rate comes down to 2% quicker than those three years on the short side. But even if that does happen, we expect those restrictive rates to remain, because they're hyper aware of what happened in the 1970s and 1980s and don't want to repeat those mistakes of those Fed officials who cut rates too soon and saw inflation come back out of the bottle.
For that reason, we really think that the Fed's going to raise rates to that five and a quarter I mentioned previously, and then wait and make sure inflation is contained a little bit. Now we can maybe consider cutting rates or spurring some more growth back into the economy.
Jenna Dagenhart: Yeah. Powell wants to have his face in the history books next to Volcker, not certain other Fed officials, I'm sure. Andy, what are some opportunities for companies created by the rising cost of living and all this inflation that we were just discussing?
Andy Braun: So, we think vast investments of capital are needed to meet the demands of aging societies and to address inequalities brought to the fore from the recent COVID-19 experience. So, we think this should provide opportunities for companies that help meet basic needs, help broaden economic participation and generally improve quality of life. So, examples of meeting basic needs, clean water certainly is essential for the broad population. Food service distribution provides necessary efficiencies to large populations.
From a broadening economic participation perspective, we're really looking for companies to help get marginalized populations access to jobs, education, finance and information they need to achieve financial independence. And then on the improving quality of life standpoint, we're really looking to healthcare companies to provide innovative solutions that make the sector more efficient while widening patient access. It's been a real issue and we're hoping that corporations can lead the way in improving quality of life in that way.
Jenna Dagenhart: And to quickly follow up on that, could you elaborate on how these products and services also solve social challenges?
Andy Braun: Sure. I'll give one example. Certainly given the rising cost of living and inflation, the retirement gap is significant and growing worldwide. So, in an inflationary environment, companies really need to help people plan ahead for retirement. So, those companies that are well positioned to benefit from that theme should be well positioned to ease the social challenges upcoming from this rapidly aging population.
Jenna Dagenhart: And Tom, I know I'm asking you to look into your crystal ball a little bit here, but what do you expect from the S&P 500 this year after the really challenging year that we just saw?
Tom O’Shea: Sure. As Andy mentioned earlier on this webinar, a lot of the risks that were going on in 2022 are still occurring in 2023. Tightening Fed, high inflation, potentially lower consumer demand due to this tightening. For these reasons, we expect muted returns on the S&P 500. Going back to my discussion on interest rates, we expect those to be elevated, and interest rates have historically explained about 40% of the variability in price to earnings ratios. So, without any expansion from the PE ratio, what's going to happen with earnings, right?
Earnings, we don't expect a meaningful growth either. We have the headwinds due to higher borrowing costs and lower consumer demand, and just kind of being historically aware of what's happened in the back half of tightening cycles. Looking back at the last 11 tightening cycles of which there's data for the tenure, it's increased 100% of the time. Now who knows if we're in the back half of the tightening cycle. I think most people would say we probably are. So, just historically speaking, we expect interest rates to remain higher.
And then in 11 of those 13 prior tightening cycles where we have more data for PE ratios, in only two of those previous cycles had valuations increased and they increased at only 2%. So, we're not seeing expansion from PE ratios, we are unlikely to see growth from an earnings perspective. We think it'll be really challenging to have higher than low single digit type returns on the S&P 500.
Jenna Dagenhart: Andy, I'd love to hear you weigh in as well.
Andy Braun: Yeah, not especially different from Tom's thoughts here. Our central case for the S&P 500 is also roughly flat with some pretty fat tails and a lot of volatility during the year. We've done our scenario analysis recently with an upside case and a downside case as well. We'd say the downside case moderately outweighs the upside case in terms of probability of outcomes. So, if we step back, valuations on the S&P certainly more attractive than they were at this time last year, probably three or four points cheaper.
That's balanced by the fact that the cost of debt is now 200 basis points higher. And, as Tom mentioned, the trajectory of earnings is certainly weakening here. And the full impact of the economic weakness, as I mentioned, has yet to be fully felt by companies. So, on the flip side, a positive would be that a Fed pivot, a signal that we're at peak interest rates, that certainly would be well received by the US large cap companies that we look at. That being said, it does sound like it's a bit premature to bake that in for the first half, certainly of 2023.
So, given that flattish outlook, we really think the emphasis will be on stock selection will be really important. It will pay to be nimble and take advantage of whatever volatility the market gives us throughout the year.
Jenna Dagenhart: Would you say the market is bottom, Tom?
Tom O’Shea: We don't think so. Anybody who follows the financial news, reads Wall Street Journal, Financial Times, watches Bloomberg all day, they've probably heard the statement a billion times that the market has never bottomed before a recession, and we're really historically focused. So, based on history, we would say that no, the market has not bottomed. Recessions occur. And I think Andy mentioned some of these stats before that recessions occur on average about seven months after the last interest rate hike with a range of five months before that last hike and 18 months after that last hike.
Right now the S&P 500 is up about 9%, maybe a little more after today from the October 2022 bottom. And investors are trying to get ahead of the Fed either moving at a slower pace or pausing, looking at inflation going down. So, we expect a lot of volatility next year and we won't be surprised in any way by an extended bear market rally. We've done a lot of research looking at these type of bear market rallies. In rallies of 5% or more have occurred in every single bear market going back to 1928, in all but two of 21 of these bear markets.
Rallies of 10% or more, which we're looking at about right now, have taken place in all but nine. So, looking back at those 5% plus rallies, that has occurred on average seven times, seven, before a market bottom. So, this would be no surprise if the market drops further than that, believe it's October 12th. These substantial head fakes were demonstrated in the global financial crisis. For example, in the spring of '08, the Fed began cutting rates and the S&P rose about 12%. What happened next? The markets fell about 50% in the next 10 months.
Jenna Dagenhart: That's an important lesson to remember. And Andy, as the transition to a more sustainable economy continues, what are some of the material risks and opportunities that investors should be aware of?
Andy Braun: Yeah, we spend a lot of time thinking about that. Maybe I'll start with the risks. One of the biggest ones is around the energy transition. So, renewable fuels are getting much more cost competitive at a rapid rate. So, the statistics that we've seen recently is that solar and wind generation in Europe is now approaching a third of the cost of natural gas, so much more cost competitive that really could provide stranded asset risk for traditional energy companies. So, that's a very large risk as we transition to a more sustainable economy.
Also from a supply chain standpoint, we've seen really big changes in the last few years around the complexity and companies trying to simplify supply chains. So, certainly industries like apparel manufacturers with pretty complex and long supply chains, we think those remain risky areas to invest in as we transition to a more sustainable economy. On the flip side, we're seeing lots of opportunities as well. From a social standpoint, we're seeing companies focus on inclusion in all of its forms. Diverse representation we found promotes better and less risky decision-making generally.
So, that's certainly a step in the right direction that we're seeing happen. And then just generally sustainability related opportunities come in a lot of different forms. We focus on a number of different themes, but I'll call out six right now. Resource efficiency, electrification of vehicles, the evolution of the cloud, clean water, access to finance and healthcare innovation. We think those are areas of opportunity that we think will really benefit as we transition to a more sustainable economy.
Jenna Dagenhart: And any lessons learned from 2022, Andy, that you're taking with you into the new year about the sustainable investments and trends, given the year that we just had?
Andy Braun: Yeah, certainly 2022 showed a rebound from traditional energy. In fact, energy was the single largest performing sector. That being said, with higher energy prices, this provides more incentive for companies to think about becoming more sustainable and having alternative energy sources. So, in the future, this actually might be a blessing in disguise for the acceleration of the transition to a more sustainable economy from the standpoint of cleaner energy.
Jenna Dagenhart: And for a consumer looking at purchasing a vehicle, for example, in 2022, those gas prices may have swayed them to make the move to electric for some.
Andy Braun: That's right. And then certainly the supply chain issues that we grappled with during the last two years seem to be easing a little bit in spots. So, certainly in the auto sector, we're expecting some better, more efficient production this year, which combined with perhaps a little bit weaker demand should allow for those prices to come in a little bit, making at least one area of the economy a little bit more affordable going forward.
Jenna Dagenhart: And Tom, turning to you, how should investors position portfolios based on your expectations for financial markets?
Tom O’Shea: Yeah, definitely. Well, regardless of market environment, risk management in portfolios is essential. Especially next year with the amount of uncertainty going on, investors really need to be honed in on what risks they are taking and what potential rewards lie ahead. Innovator, we are really known for creating these great products like the buffered one I mentioned prior. But we really have a strong portfolio solutions group, and we believe every asset should serve a purpose in someone's portfolio.
And we have a lot of experience combining our buffer type products with traditional equity and fixed income investments. Kind of going back to my prior example of our PJAN, P-J-A-N ticker, which is our 15% US equity buffer ETF. The reason we think investors will really like positioning their portfolios in this is due to the wide range of S&P 500 targets this year. I know I mentioned that we have low single digit return expectations. Andy was saying they personally think the S&P 500 will be flat-ish, but since 2009, there has not been this amount of wide dispersion of the S&P 500 targets from the collection of Wall Street firms.
So, PJAN has that 15% buffer on the downside in the event that we have the recession and kind of doom and gloom that a lot of people are forecasting, but in the event that we're wrong, there's an upside potential to that cap of 18.4%. One other ETF that investors should really be thinking about is our accelerated product. And I know accelerated products may make some people nervous, but our accelerated product is a lot different. It has no leverage at all and is based on basic option structure. So, the ticker in question that I'm referring to is called XDSQ, and again, it seeks to provide double the upside participation of SPY up to a cap over a quarterly outcome period.
So, this also targets a one-to-one downside in the event that SPY declines. We think this is a really good opportunity because, like I mentioned, there's an on average seven rallies of about 5% these bear market head fakes during these drawdowns, and this could be a potential opportunity to hedge against low returns again over this quarterly outcome period.
Jenna Dagenhart: And given this inflationary higher interest rate environment that we've been discussing, Andy, what are some innovative companies with pricing power and growing niches with the potential to shine?
Andy Braun: It's a great question. We really think 2023 and beyond will see companies that are leaders in their field that have pricing power that operate in oligopolies. Those should be the companies that really are able to navigate a more difficult investment backdrop. So, I'll give a few examples that are current holdings in the Impax large cap strategy. The first one is a company called Prologis, it's an industrial REIT company. And they are unique in that when their leases roll over, they've estimated a 62% pricing opportunity to upgrade lease rents when those leases roll, which typically occur every five years.
So, we think they have enormous pricing power to exert if needed and as time goes on, so they seem like they're in a unique position. Another company I'll focus on is Visa, which operates in a very tight oligopoly. We think they're a real leader in getting more people on the financial digital grid really continue to benefit from the digitization of payments that have gone on for a very long time. So, really benefit from this transition to a more sustainable economy and benefit generally from higher inflation. So, we think they're well positioned to take advantage of a difficult environment with pricing power.
And then the third one is UPS, which is really a bottoms up idea for us. They are focusing much more on yield per package rather than just sheer volume. And they certainly also operate in an oligopolistic industry. And we think their senior management is really doing the right thing to focus on pricing and their unique network as opposed to being a commodity oriented provider. They certainly are not.
Jenna Dagenhart: And on the flip side of that, Andy, any areas that you're staying away from in this kind of environment?
Andy Braun: I think we generally stay away from commoditized markets where companies are price takers instead of price setters. We think those companies certainly had their moment in the sun last year, but we think on average these are companies that don't earn their cost of capital, that don't have real franchise value, and typically have their competitive advantage competed away very quickly. So, we're really focused on those leaders that are going to participate in this transition. And companies that are exposed in various ways have higher than average sustainability risks, or financial risks for that matter, are companies that we tend to avoid.
Jenna Dagenhart: And to follow up on that, and turning to you, Tom, how are you monitoring risks and making sure that you're staying out of areas that could potentially keep investors up at night given this environment?
Tom O’Shea: That really goes back to our portfolio solutions group and just the nature of a lot of our products. Being in a product like a buffered ETF really lets people sleep at night, especially people towards the end of their getting near retirement or people in retirement. We like to say, "Hey, we don't want to make your nest egg twice, let's preserve that." So, a lot of our buffered products, they kind of help us and they help you keep that nest egg. You have the upside potential, but you have downside protection as well. We have a product that is one of our more conservative products and it's called BALT, and it's a bond alternative is what people like to call it.
And it's also known as the Innovator Defined Wealth Shield. And this is, again, one of our more conservative products and has a 20% quarterly buffer on the SPY, and its latest upside cap was 2.6%. And just to demonstrate the power of BALT, I just want to go through what happened last year in the equity and fixed income markets. So, equity and fixed income markets were sharing the same exact risks. We had the S&P 500 go down 18%. We had the Bloomberg aggregate bond index go down 13%. That is the first time we've ever seen double digit negative returns from US equities and aggregate bonds like that. Both the S&P 500 and the AG had the first three quarters negative.
And so what happened with BALT, what was BALT's return? They have that 20% quarterly buffer. So, even though the SPY was down three consecutive quarters, BALT essentially locked in 0%, 0% and 0%. One of those quarters, the S&P 500 was down, I want to say about 16%, but those that were invested in BALT kept their nest egg safe in that environment. In the fourth quarter, we finally saw an increase in both the S&P 500 or SPY and the aggregate bond index. But like I said, those indexes both finished down 18% and 13% respectively while BALT clipped that cap that I mentioned and finished up 2.5% for the year.
So, you just need a couple positive quarters here and there to keep your returns positive. We see a lot of advisors and clients take this BALT and slot it into the fixed income sleeve of portfolios, and historically it has the potential to improve return per unit of risk. By being invested on options on the SPY, you're less exposed to interest rate risk that may happen in typical fixed income investments and you remove a lot of that credit risk as well.
Jenna Dagenhart: Yeah, 2.5% return is pretty attractive when you stack it up against a negative 18% and 13% return. Now, Tom, does Innovator have any new products scheduled to release this year? What's in the pipeline?
Tom O’Shea: One of my favorite parts of working at Innovator is just the ideas that are constantly flowing in the hallways. Before I talk about some of our new products that are going on this year, I'd like to talk about our latest product that we released last year. And this product is a lot different than some of the buffered ETFs that I spoke about earlier in this webinar. And this ticker is called IGTR, which stands for Innovator Gradient Tactical Rotation Strategy. And Innovator really liked this strategy that Gradient out of Minnesota was putting together, and they were running this strategy out of a separately managed account since 2013.
So, Innovator, we partnered with them to put this in the ETF wrapper, and this seeks to get long-term capital appreciation over the S&P BMI index and it's actually performed quite well compared to the S&P 500 too. I know a lot of people are probably thinking, "I don't really care about the S&P 500 BMI index, I'm looking at S&P 500." So, it's got really solid performance compared to that. But back to the strategy, it's a momentum-based strategy that looks at three regions. The US developed XUS in emerging markets. It looks at each of these three regions and decides which one has the highest sustained price momentum and chooses that region.
From that region it looks at three sub-indexes. So, you have the high beta or momentum index, the actual index itself, and then the low volatility index. Okay, out of those three sub-indexes, which one has the highest sustained price momentum, and you would allocate entirely to that sub-index. But in the event that there is no sustained price momentum out of these regions or sub-indexes, the strategy shifts entirely to cash. So, in years like last year, once the price momentum kind of fell out from all the regions as globally stocks struggled, the product moved into cash and we saw great outperformance. It's really, really great ability when bear markets happen so often.
Another strategy that we're releasing in April of this year is called our Barrier ETFs. And one benefit of working with so many advisors is we hear their questions, we hear what their clients are worried about, and especially before this latest tightening cycle, "Where can I get yield?" "Where's the best way to get yield?" "Do you have any yield products?" And that's exactly what these barrier ETFs are. They're designed to produce a high level of income at known levels before you invest in the product. So, we're releasing a 20% barrier and a 40% barrier. Again, this is launching in April. So, similar that I did with PJAN, I just want to walk through an example so everyone understands how the barrier product works.
For just purely example purposes, say somebody invests in the 40% barrier at the beginning of an outcome period. So, they're invested, they know their income. And again, this is for example purposes, you invest the money, we'll say that the investment goes into treasuries and the options that are sold end up being 10% income that you'll receive. If the S&P 500 falls 30%, an investor would earn that 10% income. If the market gains 30%. Again, that investor earns that 10% income. What happens when anything is greater than that negative 40%, you get the 10% income.
In the event that the market actually falls below to say 45%, the barrier is breached and you take on the 45% of losses, but you're still kind of hedged a little bit because you receive that income and then you'd end up down around 35%. So, the reason we think this will be a really popular product because it generates good income and can potentially compete with high yield and other bond products and may fit in in that less risk asset portion of the portfolio. But just looking at prior statistics on 12 month returns of the S&P 500, when the S&P 500 returns are negative over a 12-month period, they've fallen below that negative 40% barrier only 0.6% of the time. I think this will be a really good opportunity next year.
Jenna Dagenhart: And Andy, you mentioned resource efficiency earlier. I want to spend a little bit more time on that. How can resource efficiency ultimately impact the bottom line, and are there any companies that you've identified that are doing this well?
Andy Braun: Yeah, Jenna, we think resource efficiency is one of the most exciting sustainability theme. We see a lot of stories focused on resource efficiency in the industrial sector. Companies that provide innovative solutions to environmental problems and save customers money are very likely to win in the marketplace. So, I'll give you one example. Energy use in buildings is the biggest source of energy related emissions. It's about 40% of global emissions is driven from energy use in buildings. So, it's a really important and knotty issue that we need to solve if we're going to make any progress on limiting CO2 emissions.
So, companies that really can directly help decarbonize buildings and provide energy related cost savings are companies that we're really attracted to. One company that we've owned for quite a while in the Impax large cap strategy is a company called Trane Technologies. They provide really innovative solutions and decarbonize solutions for buildings as well as refrigerated transportation solutions. So, we think they're squarely in the bullseye of where the world needs to go in terms of limiting greenhouse gas emissions. So, we think in addition to saving their customers money and help them hit their targets, they should have a long runway of growth ahead of them as companies retrofit and add new technology within buildings to help limit greenhouse gases going forward.
Jenna Dagenhart: And Tom, at the portfolio level, how have investors used your products?
Tom O’Shea: So, with just the sheer volume of advisors that we speak with, it really runs the gamut. When we first started, a lot of advisors said, "Hey, I want to ratchet down risk. Let's cut out maybe a 10 to 30% sleeve and put in buffer products. So, really protect on the downside." But now that we're really evolving, coming out with more and more products besides these buffered products, we're really looking at the full suite of investors portfolios. Rather than having that dedicated sleeve, we're looking at all the assets and making sure we understand the underlying assets and what are they intended to do.
For example, we received a portfolio the other day that was really interested in applying some both BALT, which I mentioned and 15% power buffer, but they also had items in there like low volatility strategy. So, we want to make sure we're not just putting our products in there just for the sake of doing it. We want to take a consultative approach and say, "Okay, these two assets are doing the same thing, which one would be better?" So, we look at history and do some back testing and say, "Okay, is our product better? Let's implement it. If not, hey, this low vol strategy is doing what it's intended."
So, that's one big portion is using that portfolio solution and portfolio construction to see where they fit. But again, everyone has different needs, different investment policy statements. A lot of investors have investment policy statements that require international investments, right? Emerging markets or developed XUS equities. And that's been a drag on a portfolio for quite some time. Swapping out some of that exposure for our 15% emerging market buffer or our 15% international buffer has really made a lot of advisors happy, because it has that 15% buffer if those equities continue to struggle outside the US. But again, there's that upside cap where you can still gain in the event those equities kind of turn it around outside the US.
Jenna Dagenhart: What about sustainable investments, Andy? What are some of the ways that investors can integrate sustainable investments into their portfolios?
Andy Braun: Yeah, so we really think at this point sustainable investments like those offered by Impax are really rapidly migrating towards the mainstream. We think sustainable investing is just good investing at this point. People that ignore sustainability when looking at investments really do so at their peril. So, we're really excited about this transition that's occurred and is occurring, certainly has occurred very quickly in Europe and the US is starting to catch up. So, the Impax large cap strategy that I'm on the portfolio management team, really is designed to be a core equity holding.
So, the portfolio managers on the team have a really keen focus on valuation, really makes it well positioned and well suited to perform across multiple market backdrops. We really think of it as an all-weather portfolio. And some sustainability oriented portfolios have tended to drift towards growth stock investing, and it's hard to tell the difference. I think ours is a little bit more down the middle in terms of a core holding, and I think that is designed so that it can perform well in a number of different backdrops. In addition, the impact sustainable allocation strategy where I'm on the investment committee, that's really designed to be a one-stop shop for investors who want exposure to a range of asset classes using our sustainability framework with just one investment. So, a really easy plug and play type solution for advisors and investors who want to invest sustainably.
Jenna Dagenhart: To your point, you wouldn't ignore other material risks to the portfolio, so why ignore material sustainability risks as well?
Andy Braun: Exactly. What we've seen in our work is that sometimes sustainability oriented challenges crop up before financial challenges crop up. So, really helpful to have a finger on the pulse of a lot of different inputs. And we think some of the tools that we have employed from a top down perspective, just the industries that are well positioned. And then within each industry, the companies that are better positioned from an ESG standpoint, from a sustainability standpoint, from a controversy standpoint, we try to uncover those early so we can get ahead of that and feel like sustainability equals financial outcomes a lot of the time. So yeah, we're really excited to have a wide range of tools at our disposal that should help outperform over time.
Jenna Dagenhart: And are clients using your products in a tactical manner, Tom? Are there any tactical opportunities that you see next year?
Tom O’Shea: Yeah, so a couple of our products come to mind when I think about tactical moves, again, bringing up BALT again, it's one of our more popular products just because of how dynamic it is. I mentioned you slot it into the fixed income sleeve of a portfolio, maybe remove some of that interest rate risk that clients would face in traditional fixed income products. Remove some of that credit risk that you might face in fixed income products.
But another use for BALT is a cash proxy. So, with inflation so high, you're probably happier if you would've been in cash versus equities or fixed income last year. But even so, that level of prices increased is cutting into your spending power. Those that believe that the markets have fallen a lot and they won't fall another 20%, a lot of them are putting their money in BALT thinking, "Hey, even if it's a small upside cap for the quarter, that's getting a little bit of my spending power back, but also it's not going to completely kill me if the markets tank," like some people are thinking.
So, that's one of the main tactical moves that we see some investors making. And another one, the accelerated products come to mind. I know I mentioned previously a ticker that seeks to double the return of the SPY up to a cap for a quarterly outcome period. But we also have a product with the ticker XBJA that seeks to provide double the return of the SPY to a cap of 18.8%. And the difference here is this is over a one-year time period. An added feature of this product is that it has a 9% buffer on the downside. So, for those looking to hedge potentially with low returns, they may think that XBJA is a good place to be, and in the event that markets go down less than 9%, your return will be zero, not considering management fees. And in the event that there's maybe low single digit returns, you could potentially outpace the S&P 500.
The final product that comes to mind, and I know I mentioned this one briefly, is our emerging market 15% buffer. China has been in the headlines a ton with some of the strictest COVID lockdowns. I know personally I've seen some really crazy videos on the internet, on Twitter, and they're finally easing those restrictions and it also appears that they're easing regulations for some of their tech and finance companies. So, I look back to what happened in the US equity markets when COVID-19 was running and the economy was open, it seemed like everybody opened their computer every day, "How many people are hospitalized?" "What are the fatalities?" And it seemed like the markets kind of followed and saw that volatility.
Well, there may be opportunity in emerging markets next year with that finally being open. Maybe towards the back half of the year it might raise if they kind of figure that out and it gets sorted. But that 15% buffer will kind of help a little bit on the downside in the event that maybe that takes a little bit longer for those economies to stabilize.
Jenna Dagenhart: And as we wrap up this panel discussion, Andy, any final thoughts that you'd like to leave with our viewers about your outlook?
Andy Braun: Yeah, so as we mentioned at the outset, could be a challenging year for the equity markets. That being said, it pays to be nimble and it pays to focus on the long term trends and themes that we think are going to be really exciting trends and themes over the next three, five, 10 years. And if you're laser focused on those, we'll likely have pretty good outcomes over time. So, despite a little bit of caution near term, we're really excited about the long-term opportunities investing in a sustainable manner like we do at Impax. So, thanks so much for having me, Jenna. I really appreciate it.
Jenna Dagenhart: Absolutely. And Tom, I'll give you the final word if there's anything you'd like to leave with our viewers.
Tom O’Shea: Great. Thanks, Jenna. I would just say that there's a lot of uncertainty ahead in 2023, and timing the market is one of the most difficult things to do, ask any investor out there. Mistakes can easily be made. So, having a risk measured approach and solid portfolio construction is a great way to protect yourself. A lot of Innovator's products can do that. So, if anyone's interested in seeing how we would construct a portfolio with some of our buffered products or others, we'd be happy to help you manage risk in the future.
Jenna Dagenhart: Well, Andy and Tom, really appreciate you joining us. And thank you to everyone watching this 2023 Outlook Masterclass. Once again, I was joined by Andy Braun, Senior Portfolio Manager at Impax Asset Management, and Tom O'Shea, Director of Investment Strategy at Innovator ETFs. And I'm Jenna Dagenhart with Asset TV.