With the S&P 500 Index up nearly 9% as of mid-April, advisors we heard from at VettaFi have a mixture of client priorities focused on investments. According to responses to a question asked during a recent webcast, just 38% of advisors choose capital growth as their top priority, but a combined 43% choose either to minimize drawdowns or volatility. Limiting taxes or generating income were selected less frequently.
While defined outcome ETFs have been gaining traction in recent years because they protected the downside during times of uncertainty, we think there’s still education needed, as these products can potentially be a solution for clients who want to see capital growth but still reduce drawdowns and volatility.
Defined outcome ETFs are typically made up of a package of options securities to gain exposure to a reference asset (like the S&P 500) while creating a predetermined downside buffer and an upside cap. Such hedging can help advisors and end clients have greater control of the potential gains or losses achieved in a defined period, which is typically a year. The products can be used to meet a client’s risk appetite while providing still meaningful returns.
After each outcome period ends, the upside caps are reset, but investors do not need to sell the ETF, which would create capital gains. Rather, these ETFs can be used strategically in a long-term asset allocation strategy.
The products which make the most sense to me are those that recently started or are about to start their outcome period, as an investor has more room to take advantage of the buffers. While a few firms offer these ETFs — and with similar tickers — and they all use the S&P 500 as their reference asset, it is important to understand that the risk mitigation and reward potential of each is unique.
For example, the (PAPR ), which has $575 million in assets, had a starting cap of a 14.9% gain and starting buffer of a 15% loss, though it shifted to a current remaining cap of 14.1% and a buffer of 15.3%, as of April 17. The S&P 500 Index was up 1.2% since its reset date of March 31, 2023. PAPR has a net expense ratio of 0.79%.
The (FAPR ), which has $290 million in assets, will have an upside cap of between 17.9% and 20% and a downside buffer of 10% when the target outcome period resets on April 24, 2023. Investors that buy the ETF before will have only limited benefits. FAPR has a net expense ratio of 0.85%.
Meanwhile, the (APRT ), which has $35 million in assets, had a starting cap of 18.9% and a buffer of 10% on April 1, though this has shifted to 17.8% and 10.1%, respectively, as of mid-April. APRT has a net expense ratio of 0.74%. The ETF was reset on April 1.
Each of these firms offers ETFs with outcome periods that begin in other months and that have other buffers than those described above. Because for many clients, losing less money during times of market volatility matters more to them potentially gaining more money.
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