Personal Finance
Buffer exchange-traded funds (ETFs) are an intriguing investment instrument that’s grown in popularity of late. Indeed, if you’re a more conservative investor looking to protect against potential downside risk, such ETFs may be worth checking out.
Like many instruments, which aim to trim away market risks while maintaining some amount of exposure to equities (think covered-call ETFs, which make use of options strategies to boost yield via premium income), it’s worth understanding the inner workings and what one will need to give up for the perk of protection to the downside. Indeed, there’s no such thing as a free lunch!
So, what’s the trade-off with buffer ETFs?
Like covered-call ETFs, you’re basically “capping” your upside potential. But instead of for premium income, you’re limiting your downside to a certain percentage. Indeed, it would be ideal if all downside risks were to be eliminated entirely, but in the case of buffer ETFs, do understand the opportunity costs you’ll need to pay to eliminate such risks.
More downside protection typically comes at the cost of less upside potential. So, if the bull market continues strong (let’s say the S&P 500 is in for another year of 20% gains or more), going with a max buffer ETF would lead to the least ideal outcome.
At times, it can make more sense to mitigate just “some” of the downside risks so that you have a risk/reward that you’re most comfortable with.
Buffer ETFs aren’t new, but they’re growing in popularity
While buffer ETFs may be new to some, they’re not really novel on Wall Street. However, with BlackRock (NYSE:BLK) and various other big names in ETFs jumping onto the scene to meet the sudden uptick in retail investor demand, the class of ETFs is worth exploring, especially if you’re looking for alternatives to selling stocks and buying bonds.
Of course, there’s more than one way to reduce risk if you fear a sell-off in stocks. One way is to increase your bond and cash exposure. For those who still want exposure to stocks, though, buffer ETFs may be more their cup of tea.
As always, understand these instruments (options strategies and new terminology like “caps” and “buffers” can be confusing to some) and the added fees you’ll need to pay (buffer ETFs tend to be pricier than their non-buffered index counterparts) before picking up shares.
In this piece, we’ll check out two intriguing buffer ETFs to see which, if any, are worth a spot in your portfolio.
iShares Large Cap Max Buffer ETF (MAXJ)
First, we have the iShares Large Cap Max Buffer Jun ETF (MAXJ), a buffer ETF that provides the greatest (100%) downside protection. It boasts a year-long hedge period and is a great fit for ultra-conservative
While max buffer and full protection seem ideal for conservative investors, do note that the upside cap could be incredibly low depending on when the investor picks up shares (unless you buy in June, it’s at some point within a hedge period). In fact, it’s about on par with longer-duration Treasury ETFs, which boast a yield of around 3.6%.
If you value predictability, don’t see much in the way of returns for stocks moving forward, are okay with the relatively large 0.53% expense ratio, and are content with the 3.35% remaining cap through the outcome period, which resets every June.
iShares Large Cap Deep Buffer ETF (IVVB)
For investors seeking a bit more upside and far less downside protection, the iShares Large Cap Deep Buffer ETF (IVVB) may be a better pick. Unlike the MAXJ, which, as its name suggests, provides maximum protection, the IVVB provides partial protection, typically in the range of 5-20%. The expense ratio is similar to the MAXJ but with greater return potential in up markets. At writing, the remaining hedge period is 67 days, with just 2.9% worth of cap but an impressive 15.7% buffer.
Indeed, investors looking to pick up at the start of the next hedge period can expect a starting cap of around 5.5%, with a buffer close to 15%. For those wishing to stay invested in stocks (by way of the S&P 500), while having the ability to side-step a potentially looming market correction (think a 10-15% drawdown), the IVVB may be a stellar option for you. However, if you’re looking to defend against a more vicious meltdown, the more conservative MAXJ may offer better mileage.
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