Innovator Capital Management launched the first defined outcome, aka buffered, exchange-traded funds in 2018. Other firms have since gotten into the game with their own versions of this type of ETF, which seeks to reward investors with stock-marketlike gains while at the same time protecting against losses.
In the years since Innovator rolled out those first funds, other firms have entered the category, including First Trust (under the FT Cboe Vest brand), Pacer, TrueShares and Allianz Investment Management. Although they differ in the details, the funds are similar in structure to those in the Innovator lineup. Most of these funds are tied to either the S&P 500 Index or the SPDR S&P 500 ETF Trust (SPY).
Whether you call them defined outcome or buffered, the funds generally involve using so-called flexible exchange (FLEX) options. These options provide the buffer, or protection against losses, with exposure to a reference price index or the price performance of an ETF. There is also a cap on gains.
There are funds of this nature tied to the performance of the Nasdaq-100 Index, emerging markets, developed markets and even gold.
One “buyer beware” warning is that such funds must be held for their full outcome period to achieve their stated goals, largely because of how options work and their time value. For example, a fund that protects against a downturn of up to 10% may still experience a decline during the outcome period, even if the reference index/ETF is not down 10%.
However, the loss will still be less than that experienced by the reference index/ETF, and any gap between the stated goal of the fund and the fund’s actual performance will increasingly narrow as the fund nears the end of the outcome period.
Buffered offerings have grown so quickly that now about 150 ETFs offer buffered strategies or hold other ETFs that use buffered strategies. Those funds have nearly $17 billion in assets under management in total. So far in 2022, they’ve pulled in about $7.5 billion, and over the past three years, annual inflows have averaged $4.9 billion, according to ETF.com data.
Innovator is the issuer of nearly half of all those funds, with roughly 70 products currently trading and about $8.2 billion in assets. Meanwhile, the FT Cboe lineup includes roughly 40 funds representing more than $7.6 billion in assets. The remaining funds and assets are split among TrueShares, Allianz and Pacer.
The ETFs appear to be largely delivering on their stated goals, which may explain their rapid growth and popularity.
The $505 million Innovator U.S. Equity Power Buffer ETF – January (PJAN), the largest ETF in Innovator’s defined outcome lineup, is one example. The fund offers protection against the first 15% of losses in SPY before expenses—it has an expense ratio of 0.79%—with a reset date on Jan. 1. For the period Jan. 1, 2022 through Dec. 31, 2022, the fund also has a before-expenses upside cap on performance of 8.99%.
It’s pulled in roughly $255 million so far this year. And while it’s down 8.69% since Jan 1, SPY is down 21.21%, which is shown on the chart below. Essentially, PJAN is trading into the buffer range a bit more than one might expect with the 15% downside protection, but it’s down far less than the overall market. Even without holding one of these products for the entire outcome period, investors are still mitigating some losses.
Last year, PJAN returned 8.87%, while SPY delivered a return of 27%. For that period, the fund had a before-expenses cap of 9.75%. While PJAN investors gave up significant upside compared with SPY, they experienced less volatility.
Tweaks in a fund’s structure may make a difference in performance. For example, the TrueShares ETFs don’t have a cap or a fixed downside buffer, and they track the S&P 500 price index. The funds generally reduce participation in upside performance and have a downside buffer range of 8%-12%. The TrueShares Structured Outcome January ETF (JANZ) returned 16.4% during 2021. It's down roughly 13% year to date.
The methodology for the FT Cboe Vest ETFs involves different reset dates on or about the 15th of the month. During the Jan. 15, 2021 to Jan. 21, 2022 outcome period for the FT Cboe Vest U.S. Equity Buffer ETF (FJAN), which protects against a 10% downside loss in SPY, the fund returned 13.67% relative to a 16.58% return for its reference asset. It’s currently down more than 7% year to date.
Results are, of course, not guaranteed, and with different issuers offering their own twists on the methodology, investors must do their research. Still, for retirees and other investors focused on preserving capital, these funds may be an attractive alternative.
Contact Heather Bell at [email protected]