Buffer ETFs protect against the downside while capping the upside. We examine them closely to see if they are worth it.
Topics covered include:
- How buffer ETFs are structured and some current examples
- How buffer ETFs have performed over the past five years
- What are the risks of buffer ETFs
- How loss aversion and narrow framing contribute to the popularity of buffer ETFs
- Are buffer ETFs worth it and what are some alternative strategies that could be used instead
Show Notes
BlackRock Enters Booming Market for Stock ETFs With a 100% Hedge by Emily Graffeo—Bloomberg
New Stock ETF Offers 100% Hedge as Buffer Funds Nab $46 Billion by Emily Graffeo—Bloomberg
Monetizing Loss Aversion for Fun and Profit—Paul Kedrosky
Prospect Theory: An Analysis of Decision Under Risk by Daniel Kahneman and Amos Tversk—ECONOMETRICA
Episode Sponsors
Become a Better Investor With Our Investing Checklist
Become a Better Investor With Our Investing Checklist
Master successful investing with our Checklist and get expert weekly insights to help you build your wealth with confidence.
Investments Mentioned
Innovator U.S. Equity Ultra Buffer ETF – January Series (UJAN)
Innovator U.S. Equity Ultra Buffer ETF – June Series (UJUN)
iShares Large Cap Max Buffer Jun ETF (MAXJ)
Innovator U.S. Equity Accelerated 9 Buffer ETF (XBJL)
SPDR S&P 500 ETF Trust (SPY)
Related Episodes
460: Should You Be Invested 100% in Stocks Before and During Retirement? A Recent Study Says Yes.
451: How Much Should You Invest in Stocks? The Art of Position Sizing in a Volatile Market
394: How to Get Better at Risk Taking
321: How to Analyze Complex Investments
Transcript
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 485. It’s titled “Should you Invest in Defined Outcome Buffer ETFs?”
One of the things that we do at Money for the Rest of Us is monitor new investment products that may help us in managing our investment portfolios. Hopefully generate higher returns, at lower risk.
Over five years ago, in Plus episode 240 we looked at one of these new investment products. We’ll often do those more detailed, maybe technical discussions in our Plus episodes that we release to members of our Money for the Rest of Us Plus community, just because sometimes it works better to get in the weeds in those episodes.
How Buffer ETFs Are Structured
So this was a brand new product, it was called the Innovators S&P 500 Ultra Buffer ETF. It was the January series, and it had the ticker UJAN. This was, as far as I’m aware, the first buffer or defined outcome ETF released. A defined outcome exchange-traded fund, also known as a buffer ETF—it’s a publicly-traded security. It has a fixed maturity date, in that the time period or the outcome period is set. The ETF will provide exposure to an equity market index. It could be the S&P 500, it could be an ETF that tracks the S&P 500, or the NASDAQ 100. You get exposure to that index, the upside, up to a cap, but you also get some protection on the downside, and that’s the downside buffer.
So there’s two components to these defined outcome ETFs. There’s the return buffer, that protects investors from losses up to some levels, and there are many variations on how these buffers work. For example, the innovator US Equity Ultra Buffer ETF (UJUN), it’s offering a buffer to investors against losses of a -5% to -35%. So the investor will suffer the first 5% of losses, and then nothing beyond that until the losses in the S&P 500 exceed 35%.
Now, this is for the outcome period. This ETF, the most recent outcome is June 1st, 2024, through May 31st, 2025. At that point, existing investors will roll into the new outcome period, which would be from June 1st, 2025, through May 31st, 2026.
Now, Innovator has a number of different months. The first one we looked at was the January series; they have a June series. And each of those—there’s a certain buffer that they’re willing to protect. But in order to get that protection, that insurance, there’s a give-up. And the give-up is the cap. So these defined outcome ETFs are essentially a combination of owning insurance for downside protection, that is financed by selling insurance, by capping the upside return.
For example, the Innovator US Equity Ultra Buffer ETF (UJUN), for this current outcome period, the cap is 14.3%, which means investors will earn the first 14.3% price return or price appreciation on the SPDR S&P 500 ETF—which is the underlying ETF being tracked—but anything above that they wouldn’t be able to participate, because the ETF sponsor, in structuring these ETFs, uses flex options. And these are customizable options that are guaranteed by the options clearing corporation, but they’re very specific for this outcome period. So much protection on the downside, versus a cap on the upside.
Outcome-based ETFs have become incredibly popular. Total assets have grown to $46 billion. They’ve tripled the asset size since October 2022 according to Bloomberg Intelligence. That’s about as much invested in these outcome-based buffer ETFs as there are invested in the new spot Bitcoin ETFs.
iShares, one of the largest ETF providers in the world, if not the, largest just announced their first buffer ETF. It’s the iShares large-cap max buffer June ETF (MAXJ). The outcome period is July 1st, 2024, through June 30th, 2025. That’s the one-year period. They’re offering 100% protection on the downside. So any losses below the starting price, but the cap is lower; the upside cap is 10.6%. Any price appreciation above that, the investor wouldn’t participate.
That in a nutshell was how these are structured.
As a Money For the Rest of Us Plus member, you are able to listen to the podcast in an ad-free format and have access to the written transcript for each week’s episode. For listeners with hearing or other impairments that would like access to transcripts please send an email to team@moneyfortherestofus.com Learn More About Plus Membership »
