As this year’s bruising stock selloff wiped about $1 trillion from the US exchange-traded fund industry, the same turmoil was powering one young breed of fund to its most-explosive growth yet.
Assets in so-called buffer ETFs -- which cushion losses in return for a cap on gains -- have surged 80% to $16 billion so far in 2022, according to data compiled by Bloomberg. They’ve drawn total net inflows of $8 billion in the span, almost triple the amount in all of last year.
Buffer funds use options to protect against a certain amount of losses over a time period, but will also simultaneously limit gains.
For example, the Innovator US Equity Power Buffer ETF - October (ticker POCT) seeks to buffer against the first 15% of losses in the SPDR S&P 500 ETF Trust (SPY) in each annual period starting in October. The cap on gains varies each year, but for the current one that began earlier this month, they’ll be limited at around 20%.
Stocks have been rattled by the Federal Reserve’s rapid pace of rate hikes to tamp down inflation. Investors’ rush toward buffer funds shows a pivot from previous years in which they were less willing to give up potential gains for greater protection.
“It always used to be, ‘you know what, I don’t want to miss out on the upside,’” said Athanasios Psarofagis, ETF analyst at Bloomberg Intelligence. “Now I feel like the sentiment has completely flopped: ‘I’m willing to give up some of the upside because the downside right now is so much more important to me.’”
Innovator, one of the biggest issuers of buffer funds, has seen investment advisors gravitate toward their products because bonds -- the assets that had been typically used for protection -- have tumbled lately alongside stocks, according to Chief Investment Officer Graham Day.
Its buffer funds have also grown more attractive because the issuer can set higher caps on gains when there are higher interest rates and increased stock volatility, due to the way Innovator manages the funds through buying and selling options, Day said.
Other types of ETFs that aim to tame wild swings haven’t experienced the booming growth that buffer funds have. Low-volatility ETFs, which seek to invest in stocks that won’t move around too much, have seen assets grow about 2% this year.
Low-volatility ETFs don’t have the guarantee that buffer funds do to protect against a certain amount of losses, said Psarofagis. The holdings of low-volatility ETFs can also vary significantly depending on the discretion of the fund’s portfolio manager, whereas buffer funds all generally follow the same strategy and are “a little bit more straightforward.”
The difficulty in using buffer funds, though, is timing. If investors get in as stocks start tumbling, then they’ll benefit from smaller losses. Take the Innovator S&P 500 Ultra Buffer ETF - September (PSEP), which seeks to buffer against the first 15% of losses in SPY in each annual period starting in September.
For the year starting last September, SPY fell a little over 12%, while PSEP only dropped 0.8%.
But if investors get in just as markets are about to rebound, then they could lose out on major gains. For the year starting September 2020, when stocks enjoyed a bull run off the pandemic bottom, SPY rose about 29%, while PSEP gained nearly 11%.
Investors also must stay invested for the entire time span that the fund targets, typically a year, to experience the protection the fund aims for, said Amrita Nandakumar, president of Vident Investment Advisory. In addition, buffer ETFs don’t pay out dividends to investors as an equity fund would, she said.
Innovator’s Day, however, sees continued interest in using buffer funds to smooth out wild swings.
“We would argue that these help advisors mitigate market timing risk because the alternative is you are just pulling your money out” when the market grows volatile, Day said. “We’re helping advisors keep their clients invested and protected, as opposed to them just pulling out and putting the money under the mattress and then missing out.”
Bloomberg News provided this article. For more articles like this please visit
bloomberg.com.
Read more articles by Elaine Chen
