HOW TO PLAY IT

risk of their products.”

One culprit in this process is the nearly universal habit of measuring risk by a single number, the variance in the month-to-month moves in an asset’s price. Variance adds up the squares of the distances stock prices move from their starting point. Berns cares about the cubes. Arcane? Not at all. Look only at variance, and you’re going to love a strategy that combines a lot of small gains with the occasional big loss.

That’s what you get, for example, in a junk bond fund or a fund that enhances its monthly income by writing call options. Stuff like this sells because it deludes investors into thinking they can enjoy low risk and enhanced income at the same time.

The calculation with the cubes, which statisticians call “skewness,” puts a red flag on such strategies. It favors the mirror image of return patterns: many small sacrifices in return for an occasional big payoff. A positive skew is what you get in the $449 million Simplify U.S. Equity Plus Downside Convexity ETF, which owns puts that don’t do much in a mere correction, of the sort stocks have had this year, but would kick into high gear in a crash. That pattern is right for certain investors, the ones who can handle a 20% decline but not a 50% decline.

Says Berns: “We sculpt return distributions. Options are the scalpel.”

Simplify’s ETFs cost more than plain old index funds but a lot less than private hedge funds offering customized return distributions. The rate hedge ETF has a fee of 0.5% a year; the hedged equity fund, 0.53%; the downside convexity fund, 0.28%.

“The ETF is a better mousetrap [than a hedge fund],” Kim says. “It’s cheaper. It’s more transparent. It’s more tax-efficient.”

Kim’s 23-employee firm is not yet in the black, but he expects that it soon will be. “ETFs are like a movie studio,” he says. “You’re looking for a blockbuster to fund the business.” He won’t admit to praying for a catastrophic bear market in stocks or bonds, one much worse than what we’ve had, but such an event would probably deliver that blockbuster.

“IF YOU AVOID LARGE LOSSES WITH A STRONG DEFENSE, THE WINNINGS WILL HAVE EVERY OPPORTUNITY TO TAKE CARE OF THEMSELVES.” —Charles Ellis