While this year’s stock sell-off wiped roughly $1 trillion from the US exchange-traded fund industry, the same turmoil propelled a young breed of funds to their most explosive growth yet.
Assets of so-called buffer ETFs – which cushion losses in exchange for capping gains – have jumped 80% to $16 billion so far in 2022, according to data compiled by Bloomberg. They attracted total net inflows of $8 billion during the period, nearly triple the amount of all of last year.
Buffer funds use options to protect against a number of losses over a period of time, but will also simultaneously limit gains.
For example, the Innovator US Equity Power Buffer ETF – October (ticker POCT) seeks to cushion the first 15% of losses in the SPDR S&P 500 ETF Trust (SPY) in each annual period beginning in October. The earnings cap varies each year, but for the current one that started earlier this month, they will be capped at around 20%.
Stocks were shaken by the rapid pace of rate hikes by the Federal Reserve to curb inflation. Investors’ rush to buffer funds shows a pivot from previous years in which they were less willing to give up potential gains for greater protection.
“Before it was always ‘you know what, I don’t want to miss the upside,’” said Athanasios Psarofagis, ETF analyst at Bloomberg Intelligence. “Now I feel like the sentiment has completely collapsed: ‘I’m willing to give up some of the pros because the cons right now are so much more important to me.'”
Innovator, one of the largest issuers of buffer funds, has seen investment advisers turn to their products because bonds – assets that were typically used for protection – have recently fallen alongside stocks, according to the director. Graham Day Investments.
Its buffer funds have also become more attractive because the issuer can set higher caps on earnings when interest rates are higher and equity volatility is heightened, due to the way Innovator manages funds through of call and put options, Day said.
Other types of ETFs that aim to tame wild swings haven’t seen the meteoric growth of buffer funds. Low-volatility ETFs, which seek to invest in stocks that won’t move too much, have seen their assets rise about 2% this year.
Low-volatility ETFs lack the guarantee that buffer funds offer to protect against a number of losses, Psarofagis said. Holdings of low-volatility ETFs can also vary widely depending on the discretion of the fund’s portfolio manager, while buffer funds all generally follow the same strategy and are “a bit simpler”.