Buffered ETFs Can Help Investors Stay Invested, Manage Downside Risks

Investors worried about quickly turning markets can consider a buffered outcome strategy that is designed to perform across a wide range of scenarios.

“The U.S. economy will likely remain in recovery mode, but the path of the virus will continue to dictate the trajectory of the economy in the near term. However, should an effective vaccine take hold in 2021, we expect a strong rebound in economic activity across all sectors in 2H of 2021,” Charlie Ripley, VP of Portfolio Management, Allianz Investment Management LLC, said in the recent webcast, Investing Isn’t All or Nothing: The Case for Buffered Outcome ETFs.

Ripley warned that the balance of risks is beginning to shift as uncertainty picks up. On the positive side, the Federal Reserve has focused on lifting inflation and achieving full employment, which means it may remain accommodative for the balance of 2021. A decline in U.S unemployment continues to improve domestic economic growth. Low interest rates further benefit company financial statements and equity prices. Improved U.S.-China relations will ease geopolitical risk, providing a boost to trade and markets.

However, Ripley underscored potential negative factors that could contribute to increased volatility ahead. For example, the positive re-opening narrative has already been priced in to current levels. Inflation risks continue to emerge with difficulty determining what is transitory vs. long-lasting. Economic scaring creates permanent disruption to lower-wage industries. Rising energy prices weigh on the economic recovery. Supply chains are materially disrupted for a prolonged period, preventing GDP from fully recovering. Lastly, the virus continues to mutate and some vaccines are not as effective against new strains.

“In the equity markets, we still believe stronger earnings will drive returns and will be more evident in cyclicals, small caps and recovering sectors. However, the party eventually has to end and investors should be mindful as the Fed moves closer to removing some of the monetary support that has been in place since the start of the pandemic,” Ripley said.

Brendan Cavanaugh, ETF Product Specialist, Allianz Investment Management LLC, pointed out that it is not always smooth sailing for the equity markets. For example, since 1957, the S&P 500 Index return was negative 29% of the time, with negative returns exceeding 10% in 9 years and negative returns exceeding 20% in three years.

“Gone are the days of a simple, safer portfolio mix. To potentially achieve a 7.0% return today, investors may have to maintain a much more complex portfolio than they did 30 years ago to generate the same return,” Cavanaugh said.

Cavanaugh pointed out that back in 1991, an investor’s portfolio could be 98% in cash and 2% in fixed income to generate an expected 7% return with a standard deviation of 1.1%. In comparison, an investor is required to include 97% in growth assets to earn the same return of 7.0% in 2021, but this more complex mix of growth assets could come with a standard deviation of 17.3%.

As an alternative way to maintain market exposure and better-manage downside risks, Cavanaugh highlighted Allianz’s suite of Buffered Outcome ETF strategies, including:

“AllianzIM Buffered Outcome ETFs may reduce the impact of market volatility by helping to mitigate investment performance outliers,” Cavanaugh added.

Cavanaugh explained that the ETFs are designed to bring the in-house hedging capabilities and track record of Allianz Investment Management LLC to the retail investor. The AllianzIM Buffered Outcome ETFs are a series of actively managed and transparent funds that participate in the growth potential of an equity index to a cap and provide a level of risk mitigation with a downside buffer.

“The buffer ETFs launched are primarily for investors that are, simply put, looking to manage risk with the potential for more confidence in a liquid product, and the main investor profile does not surprisingly include individuals that are either nearing or in retirement,” Cavanaugh said.

The Buffered ETFs provides index exposure to match the S&P 500 Index returns for a certain range of returns through a synthetic 1:1 exposure to the S&P 500 Index. The ETFs also create a buffer by buying options through a put spread that provides buffers of 10% or 20%. Lastly, the strategies establish a cap or creates a cap by selling options or an in-the-money call option to finance the downside buffer.

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