Managing downside risk in portfolios has been a big theme this year as we navigate uncertainty in the face of a presidential election, the expectation of rate cuts as Federal Reserve monetary policy shifts, and geopolitical tensions across the globe. Buffer ETFs, as a category, have risen to that challenge.
These ETFs deliver easy-to-implement portfolio protection and tail risk hedging. They also offer market participation and capital preservation in single-ticker solutions across time horizons.
As my colleague Kirsten Chang noted this week, buffer ETFs — as derivatives-reliant ETF strategies — have grown significantly in number as investor appetite feeds demand. Several product providers are now in this space, bringing to market innovative solutions for the risk-aware investor, and filings for new products in this category are still trickling in.
While it’s easy to implement portfolio protection with ETFs, it’s certainly not an effort where a one-size solution fits all. In a recent webcast we did with the team at Innovator ETFs, we were reminded of just that as we dove into some of these strategies. Due diligence is important because the details make all the difference on outcomes in this category.
Innovator is a pioneer in the Buffer ETF category. The firm’s most widely known family of funds, the Defined Outcome ETFs (such as BOCT), are in many ways poster children for Buffer ETFs as a category. But Innovator has recently introduced another segment to buffer investing: the Managed Floor ETFs (such as SFLR).
Managing Floors vs. Defining Outcomes
On the surface, these newer strategies are also in the business of delivering peace of mind to investors concerned about downside risk, much like their predecessors. But they aren’t like defined outcome ETFs in at least three key ways:
- Investor experience on the downside
- Upside market participation
- Importance of time horizon
About the Downside
Managed Floor ETFs aren’t the same as Defined Outcome ETFs. They both swim in the Buffer ETF pond, but they are very different fish.
If you recall, Defined Outcome ETFs offer an initial downside protection layer, which varies by fund and strategy type, but let’s say that fund XYZ protects against the first 10% decline in an equity benchmark — say, the S&P 500.
If you invest in that Defined Outcome ETF, you aren’t vulnerable at all to that first 10% decline (in this example), and will only start to feel the pain if the market drops lower, beyond that initial layer of protection.
Managed Floor ETFs offer, essentially, the opposite of that experience. These funds (also depending on the strategy) let you feel that initial downside pain — say, 10% decline in the S&P 500. But they will protect your investment in declines that go beyond that initial drop — the remainder potential 90% market decline.
Neither the Defined Outcome ETF nor the Managed Floor ETF downside “band” of exposure versus protection is bulletproof or tied to a rigid number — say 10% — because they depend on market volatility and its impact on the options contracts. But they offer a dependable range of expected protection: the first on that initial drawdown, the latter on the drawdown that may follow.
About the Upside
Upside market capture is also different across these two types of Buffer ETFs. Defined Outcome, by definition, sets out to define the experience and offer a certain range of expected downside protection and upside capture, which is achieved through its options strategy. That means these funds have upside caps.
Managed Floor ETFs don’t cap the upside. Market participation on the upside depends, again, a lot on volatility, but it can go as far as it will go, tracking the equity benchmark’s performance. That said, these ETFs’ laddered options strategy powering up these portfolios has, historically, seen 70%-80% upside participation as a general rule of thumb, according to Innovator.
About the Time Horizon
One other key difference between Defined Outcome and Managed Floor ETFs is the importance of time frames. Buffer ETFs are commonly built on an options strategy that resets every 12 months, at which point the downside protection and upside capture targets get set.
Investors looking to experience the downside protection and upside capture specifically as stated on the reset date need only buy the ETF on that first day and revisit that position 12 months later. If you enter or exit the position outside of the bookend dates, your experience varies as the market moves.
Managed Floor ETFs don’t work like that because they achieve their buffer experience through a laddered options strategy consisting of quarterly laddered put options and biweekly laddered call options that are rolling constantly. There’s no entry or exit point set on a calendar or a trade.
Because Managed Floor ETFs aren’t tied to time horizons, they may offer a better fit for a core type of strategy that can be part of a portfolio at any time — to quote Innovator, “evergreen.” By comparison, Defined Outcome ETFs offer a more precise experience across a precise time frame.
Look Under the Hood
Defined Outcome ETFs and Managed Floor ETFs aren’t the only types of downside-protection-type of ETFs, but they are a good example of how different ETFs — even competing in the same category — can offer very different results, which, in this case, can actually be complementary to some extent.
Other providers, such as Calamos, offer something else with their Structured Protection ETFs offering 100% downside protection along with an upside cap set over a 12-month period (such as CPSM.) Allianz, FT Vest, iShares are also all providers bringing product to this space.
As an investor and as an advisor, there’s no shortcut to due diligence when it comes to finding the right ETF for a specific investment goal. Buffer ETFs are no exception — downside bands, upside participation, time horizon all matter and are all packaged in different ways across different products. (Find here a list of products.)
At VettaFi, we host a lot of educational (CE-credit) webcasts looking to help with that never-ending due diligence effort. In fact, for a deeper discussion on Managed Floor ETFs, please check the replay of our recent conversation here.
For more educational webcasts, you can also check out our Webcast Page, where a simple sign-up will open a library of content to you that taps into a wide range of firms, speakers, and expertise across an even wider range of topics and themes. Join us as we learn about markets and work diligently to keep up with product development, trends, and ideas in investing.
For more information, please visit VettaFi.com | ETF Trends.
