Buffer ETFs: Luring Investors Into Pricey Protection
The latest darlings of financial advisors, are growing in popularity and may not be suitable for every investor.
Amid financial markets' chatter about strategies involving cryptocurrencies and artificial intelligence, overlooking the quiet force of buffer ETFs may have been easy.
According to etf.com data, the more than 200 buffer ETFs combined manage nearly $46 billion. That’s up from $200 million in total assets in 2018, and up from $35 billion at the start of the year.
It is perhaps ironic that this category of ETFs that offers varying degrees of downside protection in exchange for a cap on upside performance is benefitting from the higher-profile performance and volatility taking place in financial markets.
Buffer ETFs employ options strategies to replicate the performance of a designated index while also providing the buffers on each end to give investors a sense of calm. Financial advisors and ETF issuers love these products because they help keep nervous investors from fleeing to the sidelines when markets get scary.
From that perspective, buffer ETFs are doing their job. But one can’t help but wonder where the balance is when it comes to paying higher fees for less volatility.
Buffer ETFs Pit Price Against Protection
No matter how they are pitched to investors, buffer ETFs are essentially carving out a lane in the mid-range of an index’s run over a predetermined period, typically 12 months.
Similar to a bond, a buffer ETF has a full life cycle and to benefit from the buffers, investors need to stick it out for the entire ride. Ideally, it’s easy for investors to stay put in buffer ETFs because the strategy snips off the extreme highs and lows.
Most financial advisors say the strategies are best suited to investors in or near retirement or otherwise extremely nervous about market volatility.
But with an average expense ratio in the range of 78 basis points, investors and financial advisors should be asking themselves if the price is worth a smoother indexed experience.
For now, there doesn’t appear to be anything standing in the way of more innovation in the buffer ETF space. There are already versions offering 100% downside protection, which makes one wonder if someone who is that nervous belongs in equities at all.