Investors who are concerned about the stock market crashAnd those who don’t mind limiting potential upside gains may want to consider a new breed of exchange-traded funds called defined-outcome ETFs.
The funds, also called cushioned ETFs, use options to mitigate losses in exchange for limiting some gains, creating guardrails on an investor’s performance. Since their debut about four years ago, assets in the funds totaled about $13.6 billion in mid-July and received $5.4 billion in 2022, according to Bloomberg data provided by the Innovator ETF.
ETFs protect against a preset amount of loss. Most set loss protection at about the first 10%, 15%, or 30% of the market decline, and are designed to be held for a full 12 months, although, like all ETFs, they can be bought or sold at any time .
For example, him
Innovator US Equity Power Buffer ETF–July
(ticker: PJUL) protected against the first 15% of losses in the
ETF (SPY) for the 12 months ended June 30, 2022. Lost just 0.8%, reflecting the fund’s expense ratio of 0.79%. During that time, the S&P ETF fell 11.87%.
A similar ETF,
FT Cboe Vest US Equity Buffer ETF–June
(FJUN) from First Trust, protected investors against the first 10% of losses in the SPDR S&P 500 ETF for the 12 months ended June 17. It noted losses of 2.7% (including 0.85% charges), compared to the S&P’s loss of 11.8%.
Dave Alison, president of Prosperity Capital Advisors, which uses hedged ETFs as a bond alternative to create portfolio drag, says these ETFs offered loss protection for clients when Federal Reserve interest rate hikes caused the fall in stocks and bonds. “They’ve done exactly what they should be doing on the portfolio,” he says.
There are 149 Defined Outcome ETFs available. They follow important indices, such as the
S&P 500,
the
Nasdaq 100,
or the
MSCI EAFE.
The top five issuers are Innovator ETF, First Trust ETF, Allianz, Pacer, and True Shares, with the top two holding the vast majority of market share.
| Editor | exchange traded fund | Heart | Earnings Period Downside Buffer¹ | Earnings period upside limit¹ | Remaining buffer² | Remaining limit² | Total return³ | expense ratio |
|---|---|---|---|---|---|---|---|---|
| Innovative | US Equity Power Damper-July | PJUL | -fifteen% | 17.42% | -16.0% | 14.81% | 2.2% | 0.79% |
| first trust | FT Cboe Vest US Equity Buffer-July | FJUL | -10 | 21.30 | -11.5 | 19.90 | 1.1 | 0.85 |
| state street | SDPR S&P 500 Trust | TO SPY | N/A | N/A | N/A | N/A | 5.5 | 0.09 |
¹The results period for Innovator is from 07/01/22 to 06/30/23. ¹The results period for First Trust is from 7/18/22 to 7/21/23. ² Limit/remaining cushion as of 7/26/22. ³Return as of 7/26/22; The return of SPY is a return of one month. N/A=not applicable
Sources: Innovative ETF; first trust; Morning Star
Most issuers offer a monthly series of Defined Return ETFs, with the return period typically beginning on the first trading day of each month, although some do offer quarterly products. Funds do not expire: After the 12-month period ends, they are reset wherever the underlying index is trading at that time.
Although each issuer has its own methodology, they all use call and put options to establish position and offset losses in the index they track. Because hedging is often expensive, funds sell higher-priced calls to finance the trade. In return, the gains are limited and the handicap is defined. (Put options give holders the right, but not the obligation, to sell a stock at a fixed price at a specified time, while call options give holders the right, but not the obligation, to buy ).
While ETFs can be bought or sold at any time, to receive the advertised limit and reserve when the ETF is reset, investors must hold the fund for the entire outcome period, which is typically one year from the day the ETF is reset. the result period begins. says Bruce Bond, CEO of Innovator ETFs, who pioneered the strategy.
Once the ETF begins trading, the fund’s daily return will change to reflect market movement and keep the cap and buffer safety measures constant. For example, for the period July 1, 2022 to June 30, 2023, Innovator set US Equity Power Buffer’s July down buffer at 15% and its up limit at 17.42. %, based on the price of the SPDR S&P 500 in July. 1.
Three weeks after trading, as the S&P 500 rallied, the cap was lowered to 14.7%, but the margin was expanded to 16.4%, to stay in line with the original earnings period value.
The fund’s return on July 21 was 2.2%, which is what investors would receive if they sold on that day, while the S&P ETF’s return was 5.5%. There are two reasons for the performance difference, Bond says: the expense ratio and the slight lag that options have when keeping up with the benchmark asset.
There are simpler ways that retail investors can try to hedge against stock market swings, such as low-volatility stock ETFs, says Aniket Ullal, head of ETF data and analytics at CFRA Research. While he’s a fan of defined results strategies, he says it takes time to understand how they work.
Defined Outcome ETFs are Similar to Other Risk Management Products as structured notes, which are securities issued by financial institutions linked to an underlying index or other benchmark. Daniel Milan, managing partner at Cornerstone Financial Services, which uses backed ETFs and other structured products in its portfolio, says these ETFs give retail investors access to strategies long used by financial advisors and institutions in an easy-to-use vehicle. . ETFs provide more flexibility as they can be easily bought or sold and users benefit from the tax efficiency inherent in ETFs.
“Now they can go into their E*Trade account and type in a ticker symbol and buy it,” he says.
There are some caveats. ETFs are significantly more expensive than the S&P 500 ETF or the Nasdaq-based one.
ETF (QQQ), which cost 0.09% and 0.20% annually, respectively. However, Hagen Pruemm, a financial adviser at SIS Financial Group, says that if individual investors were to create these option trades on their own, it would be a lot more work and a lot more expensive. He uses these ETFs as a way to reduce volatility in stock portfolios.
The biggest caveat is the fund’s upside caps; in strong bull markets, like 2021, they will underperform. That is seen in the return of the
Innovator US Equity Buffer ETF–January
(BJAN), which had a result period from January 1, 2021 to December 31, 2021. This fund had a drawdown margin of 15% and a cap of 15%. Its return was 14%, net of fees, versus the S&P 500 ETF Trust’s 27% return in 2021.
“The thing that really comes down to this is people saying in this environment, ‘Okay, I’m willing to give up the perks.’ And then, three years later, they’re like, ‘How come you got me into something that was beyond me?’ Milan says.
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