ETFs With Downside Protection

After initially launching a few years ago, there are now approximately 80 ETFs that provide a defined outcome with downside protection and capped upside found in structured products, but with the tax and liquidity benefits of an ETF.

Innovator S&P 500 Buffer ETF – January (BJAN) and Innovator NASDAQ-100 Power Buffer ETF –  October (NOCT) provide a lower-risk approach to gaining exposure to the indexes behind SPDR S&P 500 ETF (SPY) and Invesco QQQ Trust (QQQ) by curtailing potential losses during market volatility.

AllianzIM, First Trust, and TrueShares have also expanded their lineups of defined outcome offerings in 2020, giving investors with different risk profiles a variety of ETFs to consider. ETFs that cap the upside and limit the downside to prominent equity indices have swelled in size during 2020.

An array of products known as defined outcome or buffer ETFs are offered by four asset managers. The two largest providers, Innovator and First Trust, combined have approximately $5 billion in assets spread across nearly 70 ETFs, while new entrants TrueShares and Allianz launched a combined 10 ETFs this year.

While there are differences in the upside potential and downside protection of the products, as well as their expense ratios, these ETFs all have a similar goal: to provide risk-controlled exposure to an investment style with limits to how much can be gained or lost within a period no longer than 12 months using options within the ETF.

The defined outcome periods also allow investors to stay invested without having to time the market. After the stated period is up, investors do not need to sell the ETF, but rather can avoid capital gains by sticking with the fund for another year with updated upside and downside levels.

Investors typically buy these ETFs close to the start date, but there is liquidity to buy or sell intra-period. According to Graham Day, Vice President of Product and Research at Innovator ETFs, most of the ETF inflows occur at the beginning of the outcome period when investors have the highest upsell potential and the full buffer. The further away from the start date, the range of outcome possibilities expands.

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