Investing in the S&P 500 with no risk of loss is becoming increasingly popular, as more US ETF providers launch so-called ‘buffered’ products that fully hedge downside risk. The costs, however, also eat into the returns.
For investors unable to endure significant market declines but still needing market exposure, solutions are emerging. Chicago-based Calamos Investments and Blackrock have introduced products to address this need. For an annual fee of 50 basis points, Blackrock’s iShares Large Cap Max Buffer Jun ETF aims to track US equity market returns up to 10.6 percent, hedging 100 per cent of downside risk via the options market.
Earlier this year, Calamos Investments, known for its options strategies, filed to launch a buffer ETF each month for a year, beginning with the Calamos S&P 500 Structured Alt Protection ETF May.
These providers target investors wanting to capitalise on the current stock market rally while fearing a prolonged downturn due to a slowing economy and rising interest rates.
One-year holding period
However, to be fully protected against price declines, investors must purchase the ETF at launch and hold it for a year, after which a new coverage period starts. The fine print warns: «An investment in the fund is subject to risk and you may lose money on your investment.»
The strategy, which involves trading call and put options to guard against market volatility, is not without drawbacks. Protection against price declines can significantly reduce returns during market upswings.
This is demonstrated by the Innovator Equity Defined Protection ETF (TJUL), the first buffer ETF offering 100 percent protection. Launched last year, it has gained 1.93 per cent this year, compared to the S&P 500’s 7.8 percent gain.
Similarly, the Global X Annual Buffer Ucits ETF (SPAB), which protects against a 15 percent loss in the S&P 500, was down 7.4 percent year-to-date on 22 January, while the index was up 2.2 percent.
Despite these limitations, demand for these products is strong in the US. Morningstar data shows that assets in such funds have more than tripled over the past two years, as reported by the Financial Times.
Marketing
Roderick van Zuylen, founder of US asset manager Night Watch Investment Management, attributed this interest mainly to effective marketing. Although new to buffer ETFs, van Zuylen recalls a similar experience with a childhood investment product that promised full loss protection but ultimately failed.
«This is a case of ‹Our only mission is commission, and our only vision is commission›,» Van Zuylen told Investment Officer.
Stuart Kirk, FT columnist and former portfolio manager at HSBC, argued that most developed equity markets do not crash frequently enough to justify such protection and rise too often to warrant capping the upside. «Nobody wants to miss out while everyone else is benefiting, but it’s natural to fear losses,» Kirk wrote in a recent column.