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Buffer ETFs Provide Comfort At A High Cost , Advisors Say
These vehicles can make lots of sense for those fearing market volatility .
By Ben Mattlin
IN OCTOBER 2020 , THE SECURITIES AND EXchange Commission enacted rule 18f-4 , removing regulatory barriers preventing exchange-traded funds from using derivatives to enhance returns . Asset managers quickly sprang into action , launching a still-expanding catalog of so-called buffer ETFs and related products that use derivatives to generate extra dividend income or protect against losses .
Risk-averse investors who don ’ t want to totally lose out on equity performance have been diving in , in droves . According to data tracker FactSet , these ETFs have attracted more than $ 31 billion of new money over the past 12 months , bringing their total assets to almost $ 120 billion .
But what do advisors think of these products ? “ They can help clients stay invested for the long term without being as concerned with short-term volatility ,” says Rob Swanke , senior investment research analyst at Commonwealth Financial Network in Waltham , Mass . “ The defined outcomes help give clients a bit more comfort with the level of risk they are taking .”
These ETFs work by holding a basket of securities while simultaneously selling ( sometimes called “ writing ”) call options on those securities to a third party at a predetermined “ strike price ” that ’ s above the current price of the assets , advisors explain . The options have an expiration date . If the asset appreciates before that date , the third-party buyer gets it for a bargain , but if it loses value the option can simply expire . Either way , the option buyer must pay an up-front premium that becomes an extra dividend for the ETF holder no matter what happens to the underlying asset .
Many of these ETFs are buffer funds that use options to cap investor gains in exchange for limiting potential losses . Others are known as “ equity premium income ” ETFs , which offer a higher degree of upside potential but less or even no downside protection . “ Their popularity is really around being able to define the acceptable losses for a portfolio ,” Swanke says .
But this kind of “ defined outcome ” comes at a cost , detractors say . For example , the Calamos S & P 500 Structured Alt Protection ETF , which tracks that broad market benchmark but caps gains at 9.8 % while providing 100 % downside protection , carries an annual fee of 0.69 %. That ’ s much higher than the fee for a passive S & P 500 ETF , though it ’ s fairly typical for actively managed ETFs , industry watchers say .
The JPMorgan Equity Premium Income ETF , which invests in a basket of large-cap U . S . stocks , returned roughly 10.5 % over the past 12 months as of early July . It lagged the S & P 500 by roughly 14 percentage points , but it generated dividends of roughly 8 %. Its annual fee is 0.35 %.
Swanke acknowledges these products are expensive . “ So you really need to weigh how much of these you need . If clients aren ’ t very concerned with short-term fluctuations of the market , then there really isn ’ t a need to spend the extra cost for these products .”
Still , many investors are concerned that markets are too rich continued on page 58
SEPTEMBER 2024 | FINANCIAL ADVISOR MAGAZINE | 45