10 April 2024
The Exchange Traded Fund (ETF) sector has grown significantly in recent years, allowing investors to trade a vast range of different assets. Those who follow the investment markets will know that ETFs are tradable during regular market hours, which gives them a considerable advantage over collective investments. However, why are they even being talked about in the same breath as annuities?
An ETF is an investment fund that is tradable in a fashion similar to company shares. A buffered ETF offers additional benefits by providing a structure that limits the downside and caps the upside. This is done by using derivatives, which effectively reduce the impact of both bear and bull market extremes. Since they first emerged in 2018, they have become very popular, especially among investors concerned about market volatility.
Considering their liquidity, defensive nature and the choice of different buffered ETFs, it is no surprise they are very popular amongst those looking towards retirement. This is a period of life where many people are more focused on defending and maintaining the value of their investments rather than taking an aggressive approach to growth.
Consequently, with ETF net assets rising from around $500 million just five years ago to a staggering $37 billion today, they are taking market share from the massive $3.3 trillion US annuities market. There is also evidence to suggest buffered ETFs are taking market share from the often pricey structured notes offering to protect principal or guaranteed minimum returns. Initially, there were just a handful of buffered ETFs, but over the years, this has grown to more than 200.
Financial advisers across the US are certainly taking advantage of the acceptance of buffered ETFs amongst investors, but there is a degree of controversy. The added elements of downside protection and the capping of the upside come with higher than average management charges (up to 0.7% against just 0.1% for traditional passive ETFs). Some experts believe that financial advisers do not take into account this above-average cost, while others are more focused on the limited downside, even if there is a cap on the upside.
Considering that buffered ETFs have attracted $10 billion in net inflows in 2022 and 2023, this perfectly illustrates their growing popularity. However, an analysis of one buffered ETF fund in isolation found that for the 9% downside protection, investors gave away 6% in annualised total returns since April 2020. Is this an expensive trade-off for peace of mind or a sensible move for those concerned about market volatility?
There is no doubt that periods of market volatility since the 2008 financial crisis have shaken the confidence of many investors. The traditional approach to diversity has changed, with many investors now looking for a solid backbone on which to add a degree of investment for long-term growth. In the eyes of many investors and advisers, buffered ETFs offer this degree of solidity and a strong backbone.
A typical buffered ETF might offer protection of 10% against losses, meaning if the markets fell by 15%, investors would only lose 5%. Conversely, the annual upside might be limited to 15%, which would be challenging to experience if markets were on a bull run. However, in the investment world, you rarely “have your cake and eat it” when it comes to stability and exposure to growth stocks/sectors.
It is really down to a case of suitability for investors and investment in line with their risk profile. Those of a more cautious nature may benefit from a degree of buffered ETF exposure while they might not be suitable for those more focused on significant (often high risk) growth. The key is to find a balance between protecting your funds 10, 20 or 30 years before your death and maintaining a degree of long-term growth.
While buffered ETF investments are relatively unknown in the UK, investment trends which start in the US tend to export to other major markets in due course.
Back to News
+44 (0)20 7048 9400
Email Us
Client login
