Stay Invested, Hedge Downside Risks Using ETFs with Built-In Buffers

Investors seeking an alternative investment strategy to hedge against further risks can consider defined outcome exchange traded funds as these strategies can solve many of the problems with existing buffered structures and can be utilized to build better portfolios.

On the recent webcast, Implementing the Only ETFs with Built-In Buffers, Bruce Bond, Co-Founder and CEO, Innovator ETFs, highlighted the ongoing demand for downside risk mitigation, with $3.2 trillion in hedge funds and $1 trillion in equity-linked structured products, but he argued that solutions available to investors today notably products issued by insurance companies and banks, often fail to deliver downside protection and are delivered in sub-optimal investment wrappers.

For instance, bonds may not provide the downside buffer investors are historically accustomed to with credit risk exposures. Hedge funds are expensive, have spotty track records over the last market cycle and come with high minimums. Shorting the market typically come with high carry costs, limited upside exposure and requires the ability to time the markets well.

On the other hand, investors can look to Innovator’s Defined Outcome ETFs, which come with no credit risk, intra-day liquidity, no surrender fees, access on an exchange, no commissions and lower fees. Specifically, Innovator ETFs has come out with a suite of Defined Outcome ETF strategies with a build-in buffer to help investors hedge against risks ahead, depending on one’s level of risk aversion.

For example, its April series includes the Innovator S&P 500 BUFFER ETF (BAPR), Innovator S&P 500 POWER BUFFER ETF (PAPR) and Innovator S&P 500 ULTRA BUFFER ETF (UAPR), which have a 9%, 15% and 30% buffer, respectively. The April series joins Innovator’s other Defined Outcome ETFs, including the October series of Innovator S&P 500 Buffer ETF (Cboe: BOCT), Innovator S&P 500 Power Buffer ETF (Cboe: POCT) and Innovator S&P 500 Ultra Buffer ETF (Cboe: UOCT).

The July series includes Innovator S&P 500 Buffer ETF (CBOE: BJUL), Innovator S&P 500 Power Buffer ETF (CBOE: PJUL) and Innovator S&P 500 Ultra Buffer ETF (CBOE: UJUL).

The January series includes the Innovator S&P 500 Buffer ETF (BJAN), Innovator S&P 500 Power Buffer ETF (PJAN) and Innovator S&P 500 Ultra Buffer ETF (UJAN).

Finally, the June series includes the Innovator S&P 500 Buffer ETF (BJUN), Innovator S&P 500 Power Buffer ETF (PJUN) and Innovator S&P 500 Power Buffer ETF (UJUN).

Additionally, the more recently launched Innovator MSCI Emerging Markets Power Buffer ETF (EJUL) and Innovator MSCI EAFE Power Buffer ETF (IJUL) provide exposure to international emerging and developed markets up to a cap with downside buffer levels of 15% over a one-year outcome period.

Graham Day, Vice President of Product and Research, Innovator ETFs, pointed out that international equities have underperformed over 1-, 5-, 10- and 15-year time frames on both a price and total return basis. Nevertheless, global markets exhibit varying rolling returns, with emerging markets offering higher returns in low return U.S. markets and vice versa. Looking ahead, Day projected MSCI Emerging Markets and MSCI EAFE indices to generate higher 10-year expected returns and volatility, compared to U.S. large cap stocks.

Nevertheless, downside risks remain and may be growing as we head deeper into the later stages of an economic cycle, along with rising global geopolitical and economic risks.

Consequently, investors may look to Innovator’s buffer strategies to mitigate risks and still maintain upside potential. Day explained that the Defined Outcome ETFs provide market exposure with a built-in downside buffer. The ETFs start with a synthetic 1 to 1 exposure to the target market. They would then include a put spread to provide targeted buffers of 9%, 15% or 30% to their respective targets. Lastly, the upside is capped by selling an upside call to finance downside buffers.

While the quarterly Defined Outcome ETF series are set up with an annual target, investors can still dive into a series intra-period. For example, Day explained that an investor can still achieve a defined outcome buying the April Series. The outcome period is now 307 days and the ETF and S&P 500 have moved slightly from the beginning of outcome periods. PAPR offers investors an opportunity to capture upside, up to a cap, while providing a buffer if the market corrects further through the end of the outcome period.

The Defined Outcome ETFs can be used in an investment portfolio to better diversify risk, help investors lock in the rally and remain invested while incorporating a buffer to manage downside risks ahead.

Financial advisors who are interested in learning more about alternative investment strategies can watch the webcast here on demand.