MW Tips for investors considering 'buffer' ETFs to protect against stock-market selloffs
By Isabel Wang
Buffer ETFs can hedge against market selloffs - but investors could lose out on upside if they hold them for the long term as gains are not guaranteed, notes one analyst
Hello! This is MarketWatch reporter Isabel Wang bringing you this week's ETF Wrap. Recent volatility in the U.S. stock market has put "buffer" ETFs back in the spotlight, as investors flocked into these funds in the hope that they could limit their downside risk and help navigate stormy conditions.
Please send tips or feedback to isabel.wang@marketwatch.com or to my colleague Christine Idzelis at christine.idzelis@marketwatch.com. You can also follow me on X at @Isabelxwang and find Christine at @CIdzelis.
Sign up here for our weekly ETF Wrap.
The spike in stock-market volatility over the past week may have been a jackpot for at least one group of investors: those flocking into so-called buffer exchange-traded funds for protection against market downside.
"Investors have piled into buffer ETFs in a way that we've never seen. We've seen over $1 billion flow into the buffer ETF category over the last month," said Tim Urbanowitz, head of research at Innovator Capital Management.
"It just highlights a lot of the uncertainty that investors are feeling around the presidential election and the potential for a recession, and they want that peace of mind - knowing that they have 100% of their principal protected [by investing in some of the buffer ETFs]," he added.
U.S. stocks have tumbled in August after the unwinding of Japanese yen $(USDJPY.FOREX)$ carry trade and fears of a weakening U.S. economy, with a global market rout on Monday sending Wall Street to its worst day since 2022.
The Innovator Equity Defined Protection ETF TJUL, with $252 million under management, was off 0.8% over the past week, while the S&P 500 SPX has fallen over 4% and the Nasdaq Composite COMP has tumbled nearly 6% in the same period, according to FactSet data.
What are buffer ETFs?
Buffer ETFs, or defined-outcome ETFs, emerged years ago for investors looking to manage market volatility. They have become particularly prominent since last summer, when Innovator Capital Management launched TJUL - the "first-of-its-kind" fund that provides investors 100% protection against market losses, as well as potential gains, with a cap over a two-year timeframe.
Last month, BlackRock $(BLK)$, the world's largest asset manager, also launched a buffer fund - the iShares Large Cap Max Buffer Jun ETF MAXJ - that seeks to offer a 100% downside hedge to risk-averse investors looking to tap the stock market.
Opinion: Nervous about stocks? These ETFs promise market gains and plunge protection
Buffer ETFs usually overlay an option-based hedging strategy to an equity portfolio or a stock index in order to limit or cap the losses it could face. Funds like TJUL and MAXJ offer full downside protection on the S&P 500 over a defined period, while others provide only partial protection in exchange for more potential upside.
A way to play offense and defense at the same time
Buffer ETFs are designed as a defensive play against painful meltdowns in the stock market, but Urbanowitz said some of his clients have used the funds as an opportunity to "capitalize on the selloff and add equity exposure while still making sure they're in full control of the risk of their portfolios.
"They are looking to play offense and defense at the exact same time," he told MarketWatch via phone on Wednesday.
As an ETF with a two-year lifespan, TJUL has advanced nearly 8% over the past year. However, elevated interest rates suggest investors can also get some decent payouts on Treasury bills, CDs and annuities.
The yield on the 2-year Treasury note BX:TMUBMUSD02Y rose 7 basis points to 4.074% as of early afternoon Thursday, according to FactSet data.
But unlike CDs or annuities, buffer ETFs are liquid. Investors can get out of them anytime they want without paying a surrender penalty.
"TJUL [over the past year] has pretty much doubled what investors could have gotten in a T-bill," Urbanowitz said. "So investors have that flexibility that if things go well out of the gates, they can capitalize; if things go south, they still have that principal protection in place."
How much do buffer ETFs cost?
Of course, having that absolute downside protection has a price.
The average expense ratio for all U.S.-listed buffer ETFs is 0.77%, according to Aniket Ullal, head of ETF data and analytics at CFRA Research. That compares with a less than 0.1% expense ratio for the SPDR S&P 500 ETF Trust SPY and 0.2% for the Invesco QQQ Trust Series I QQQ, according to FactSet data.
Another concern is that while these ETFs can hedge against a market selloff, investors may lose out on upside if they hold them for the long term, as gains are not guaranteed.
"The opportunity cost is the highest when the markets are going up, because most of these products are not going to keep up with the market due to their limit on upside returns," Ullal told MarketWatch in a phone interview on Thursday.
"These products are designed for market environments where the investor has a view that the market is either going sideways or could potentially decline," Ullal said. "They allow investors to stay investing in equities because one risk investors have faced in the past is when markets go down, they exit equities - and then they don't time the re-entry properly, so they lose out on the rebound."
Opinion: In a stock-market meltdown, this retirement-account trick can save you thousands in taxes
Buffer ETFs may particularly speak to retirees or people who are getting close to their retirement, because these investors normally cannot afford a big drawdown in the stock market and are willing to give up some upside.
"Some clients need to live off their investment account for the next 20 to 30 years; they can't afford to stomach a 20% drawdown," said Urbanowitz. "But they also don't necessarily need the 20% return in the stock market ... so these strategies really give them a way to do that without putting their goals of retirement at risk."
As usual, here's your look at the top- and bottom-performing ETFs over the past week through Wednesday.
The good...
Top performers %Performance United States Natural Gas Fund LP 5.9 Invesco DB Agriculture Fund 3.5 iShares MSCI Brazil ETF 1.9 Simplify Short Term Treasury Futures Strategy ETF 1.5 SPDR Bloomberg International Treasury Bond ETF 1.5 Source: FactSet data through Wednesday, Aug. 7. Start date Aug. 1. Excludes ETNs and leveraged products. Includes NYSE-, Nasdaq- and Cboe-traded ETFs of $500 million or greater.
... and the bad
Bottom performers %Performance Grayscale Ethereum Trust -24.9 iShares Ethereum Trust ETF -24.9 Grayscale Ethereum Mini Trust -24.8 YieldMax COIN Option Income Strategy ETF -19.4 YieldMax TSLA Option Income Strategy ETF -17.2 Source: FactSet data
New ETFs
J.P. Morgan Asset Management on Thursday announced the launch of three new active ETFs which incorporate data science for their portfolio construction: JPMorgan Fundamental Data Science Large Core ETF LCDS, JPMorgan Fundamental Data Science Mid Core ETF MCDS and JPMorgan Fundamental Data Science Small Core ETF SCDS. Advisors Asset Management on Tuesday announced the launch of three active ETFs in partnership with Brentview Investment Management and Sawgrass Asset Management: the AAM Brentview Dividend Growth ETF BDIV, AAM Sawgrass U.S. Large Cap Quality Growth ETF SAWG and AAM Sawgrass U.S. Small Cap Quality Growth ETF SAWS. Tortoise Capital Advisors on Tuesday announced its plans to merge three of its closed-end funds into a newly formed active ETF, Tortoise Power and Energy Infrastructure ETF. The fund aims to invest primarily in fixed-income and dividend-paying equity securities of power- and energy-infrastructure companies, the firm said in a press release.
Weekly ETF Reads
Amazon's stock selloff enticed Cathie Wood's ETFs to start buying (MarketWatch) 3 Good ETFs When Interest Rates Fall (MorningStar)Why Chasing Volatility With a VIX ETF Is Trickier Than It Seems (Investopedia) These 4 ETFs Won the Market Sell-Off Monday (VettaFi)
-Isabel Wang
This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
August 08, 2024 14:05 ET (18:05 GMT)
Copyright (c) 2024 Dow Jones & Company, Inc.
Comments