Defining Outcomes During A Downturn: Is It Time To Buffer?

Investors continue to make use of ETFs that offer a buffer as a means of protecting against downside risks in the year ahead, with demand for ETFs that provide such a buffer growing in popularity every year.  

‍

It is worth noting that buffer ETFs, which are included in defined outcome funds, offer investors the opportunity to participate in the broad market without losing control over upside risks - protection usually paid for by a cap on potential gains. 

‍

It's all about risk management today as stocks and bonds are expected to drop in 2022, according to Graham Day, SVP and chief investment officer at Innovator ETFs.  

‍

In exchange for the certainty that you will have a known level of buffers that will protect you from loss, you trade unlimited upside. 

‍

An example of one of Innovator’s products, the Equity Power Buffer (PNOV), uses options in the Equity Power Buffer (PNOV) to track the SPDR S&P 500 ETF Trust (SPY) and provides protection against the first 15% of losses if the SPDR S&P 500 ETF Trust (SPY) suffers a decline. An annual rebalancing is conducted on this fund and it starts with a capitalization of 20.51%.  

‍

Innovator Defined Wealth Shield ETF (BALT) is the more conservative option for investors looking to take their first steps into defined outcome ETFs, according to Day. In addition to providing a 20% buffer against equity markets every three months, the product also carries an upside potential that could be realized. 

‍

“When the market has corrected, we have really seen BALT guard investors against losses every time the market has corrected the 20% buffer,” Day said. “We have also observed that investors have been able to participate in those gains when the market has had some upside recovery.” 

‍

Despite the fact that these funds tend to perform best when the market is down or sideways, Todd Sohn, an analyst at Strategas Securities and expert in ETFs, warns that there are inherent problems with the funds if the trading landscape changes.

‍

"Any investment comes with risks," Sohn told Trade Algo Monday. "If the market were to go on a tear here, you would lose out on upside potential if the market were to go on a tear." 

‍

Nevertheless, Sohn explained that in recent years there has been a spike in market volatility that has been specifically designed to favor buffer ETFs as a countermeasure to those concerns.  

‍

During the second quarter of 2018, there was a 20% correction; the Covid crash. In 2017, there was a 20% correction at one point. It's not uncommon to see us down a lot at one point in the past year or two. This might be a good place to start if you are near retirement, or if you're a novice investor, and you're scared to invest given what's happened in the market. 

‍

A recent study by Innovator ETFs found that, in the past two years, the number of defined outcome funds has increased significantly, increasing to 158 funds. Also, major issuers have become increasingly interested in these funds. Since the launch of the JPMorgan Equity Premium Income ETF in 2020, assets of the JEPI ETF have surpassed $21 billion, and BlackRock has submitted two similar structured-outcome ETFs, and both are currently under construction.  

‍

In a few years, everyone followed Cathie Wood and her team and started following options-related strategies to get an income from the equity market a few years ago. Now, you're seeing options-related strategies to get income from the equity market a few years ago. 

‍