Exchange-traded funds, or ETFs, are a type of investment vehicle that offer access to different themes and industries, and they’re one of the most popular asset classes available today. In 2019, ETF inflows totaled $326 billion, and that figure has already been surpassed as of September 2020. In fact, ETF inflows right now are only $144 billion short of 2017’s record $476.1 billion.

Part of the reason for this popularity is the sheer variety of ETFs available. Whatever an investor is looking to buy into, there is likely an ETF for it. One theme that has been getting increasing attention lately are ETFs designed to buffer against portfolio risk, or Buffer ETFs. (They are also sometimes referred to as Defined Outcome ETFs, Structured ETFs, or Target Outcome ETFs.)

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While these have appeal for risk-averse investors in good times (even before the COVID-19 pandemic, buffered ETFs were gaining in popularity), they have even more appeal now. After all, if there was ever a year that investors were worried about risk, it’s 2020. 

In early 2020, nearly $1 billion flowed into Defined Outcome products offered by Innovator Capital Management. In other words, buffer ETFs are catching on in the COVID-stricken economy.

Here’s what investors should know about buffer ETFs and why you should consider them as part of a diversified investment portfolio. 

What are buffer ETFs?

Buffer ETFs were launched in August 2018 by Innovator Capital Management, but since then the segment has grown to nearly $1.38 billion in assets. 

In August 2020, buffer ETFs alone experienced a net inflow of $159 million. That same month, other types of U.S. stock funds saw outflows of $19.8 billion. These numbers indicate that these ETFs have a specific appeal in today’s economy. 

Buffered ETFs are designed to provide investors “some level of participation in the upside of a risk-asset, while giving…some level of downside protection.” But, there is a price for the downside protection, or “buffer.” Investors pay a price for reduced risk.

Buffer ETFs have four primary features: (1)market index, (2)upside cap, (3)downside buffer, and (4) outcome period. The index is the point from which caps and downside buffers are measured. The downside buffer is typically a specific percentage, 10%, 15% and 30% (from -5 to -35%). The price for the downside buffer is essentially the amount of the upside cap, or gains that investors preclude their investments from. 

Essentially, investors are buying a specific percentage level of insurance on their investment to avoid major losses.

The outcome period is the agreed length of the investment term. Many buffer ETFs require that an investor hold each fund for a specified period of time, often one year. While these ETFs can be held longer than that, new terms are set after each designated outcome period ends.


How popular are buffer ETFs?

In April 2019, Innovator Capital Management’s S&P 500 Buffer ETF series was awarded the most innovative new ETFat the ETF.com Industry Awards. And it didn’t stop there. 

According to Innovator, the entity that initially launched buffer ETFs, “if interest rates returned to December 2018 levels, 20-year Treasury bonds could see a decline of more than 40%.” 

So, Innovator kept innovating, launching the Innovator 20+ Year Treasury Bond 9 Buffer ETF – July (TBJL) and Innovator 20+ Year Treasury Bond 5 Buffer ETF – July (TFJL) in late summer 2020. These are somewhat similar to the iShares 20+ Year Treasury Bond ETF, which launched in 2002, although the iShares is not a buffer ETF.


Why invest in buffered ETFs?

It’s an “off moment” for the global economy, to say the least. We are in the midst of a pandemic induced recession and seeing sustained low interest rates. Yes, global markets are increasingly connected, making it unclear where growth will come from next.

Many investors simply don’t have the appetite for risk that the economy seems to demand in its current state. For those less willing to take on risk in volatile markets, they are also missing out on opportunity for any gains. Buffer ETFs offer an attractive alternative, particularly for those investors who don’t have the time to wait out the ups and downs, such as those approaching retirement. 

But, even for such a new segment of the ETF market, there are already many different buffer ETFs to choose from. A search on Magnifi suggests that interested investors have a number of options to consider.

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