The interest in buffer ETFs or defined outcome ETFs among advisors has been increasing and many financial services firms are moving quickly to meet the demand.
A buffer ETF protects the initial investment against a certain percentage of loss. To accommodate that buffer, the funds have a cap that limits the amount of upside potential for the fund. The funds typically have a one-year duration. Advisors have been pushing for such funds as of late, motivating several firms to introduce their own versions.
Wheaton, Ill-based Innovator ETFs launched the first version of the product in 2018. It initially rolled out three buffer ETFs, but since then its lineup has expanded to more than 100 with varying buffer sizes, including a 100% buffer that the firm introduced last year.
“You can buy these and know exactly what you’re going to get on the upside, on the downside, and especially with markets selling off, now that becomes even more valuable when uncertainty is rising,” said Graham Day, chief investment officer at Innovator.
About 74 buffered ETFs have already launched this year, according to Morningstar. That has surpassed the 71 that launched last year and far better than 14 that launched the year before, Morningstar said.
One firm that has been getting aggressive in the space is PGIM, the global investment management business of Prudential Financial. Earlier this year the Newark, N.J.-based firm announced the launch of two series of buffer ETFs. One was the PGIM U.S. Large-Cap Buffer 12 ETF series and the other was the PGIM U.S. Large-Cap Buffer 20 ETF series. The former has a 12% buffer complemented with an almost 16% cap, while the latter has a 20% buffer with a slightly more than 12% cap.
Originally, the firm was going to release a new fund every month for a year, but the increased demand prompted PGIM to release all 24 of its buffer ETFs by mid-June, according to Matt Collins, head of ETFs and vice president at PGIM Investments.
“What we found is that there are these sets of power users out there that have a very clear strategy on how to use defined outcome ETFs and they want to bounce around between months depending on where the market is,” he said.
Other firms are looking to stand out in an already crowded field. Naperville, Ill.-based Calamos announced the launch of 12 Structured Protection ETFs that have 100% protection, according to Matt Kaufman, senior vice president and head of ETFs at Calamos.
“We did not want to be just another buffer ETF issuer [because] there’s enough of those in the market,” he said. “We wanted to build what we thought the new thing was and where we thought the market was heading with rates higher.”
The funds offer capital protected exposures to the S&P 500, Nasdaq-100 and Russell 2000 benchmarks. Since the funds have a 100% protection they come with slightly higher caps, Kaufman noted.
The first ETF rolled out in May based on the S&P 500 with a 9.8% cap. The Nasdaq version released in June with an 10.2% cap followed by the Russell a month later with an 11.2% cap. Going forward a new S&P will launch monthly and the other two will launch quarterly for the next year, Kaufman explained.
Other firms have also taken their first steps into the buffer ETF space, including New York-based Blackrock, which launched the iShares Large Cap Max Buffer Jun ETF (MAXJ), in June. It is the first in a series of four ETFs, which will be released quarterly, that tracks the share price return of the iShares Core S&P 500 ETF, its underlying ETF, according to the firm.
Boston-based Fidelity introduced its own option-based ETFs in April, according to Michael Scarsciotti, senior vice president and head of Investment Specialists at Fidelity. Option-based ETFs use options contracts like a buffer but do not seek a defined outcome.
The firm launched the Fidelity Dynamic Buffered Equity ETF (FBUF), the Fidelity Hedged Equity ETF (FHEQ), and the Fidelity Yield Enhanced Equity ETF (FYEE). The hedged equity ETF looks to protect against any sudden and meaningful market drawdowns.
The enhanced equity ETF delivers positive distribution yield through harvesting options that originated through covered call writing, and the buffered brings together both call-writing and put-buying overlays and creates what Fidelity referred to as a “collar” overlay, the company said.
“For our advisors in many cases, their clients have specific outcomes that they want to achieve and rather than always sticking to the modern portfolio answer theory, we want to make sure that advisors have choice,” Scarsciotti said.
Day believes more firms will offer products that are not tied to the S&P 500 in the small cap space. He also expects to see the products available on more platforms.
“There is a tremendous market for products that can give investors some upside exposure but with downside protection so I feel as if we’re just getting started,” he said.