Rising Trend: Buffered ETFs boost retirement portfolios, optimize returns, reduce risk

The investment environment is continuously changing, with a recent development being the increasing popularity of buffered Exchange-Traded Funds (ETFs). These modern financial tools aim to offer investors, especially those concentrating on retirement investments, a degree of safeguarding against market declines while also enabling growth opportunities.

Over the past two years, investors with a focus on retirement portfolios have invested over US$20 billion into US exchange-traded funds that limit gains and losses, posing a competitive threat to traditional offerings from insurance providers. Buffered ETFs, also known as defined outcome ETFs, employ derivatives to moderate the effects of market fluctuations, whether bullish or bearish. Gaining traction since their introduction in 2018, these financial instruments have become particularly attractive to investors who have navigated crypto market volatility caused by the pandemic in 2020 and a challenging year for both stocks and bonds in 2022.

The market turbulence experienced in recent times has heightened crypto investor interest in the downside protection offered by buffered ETFs, leading to a greater willingness to pay a premium for exposure to US equities within a structure that restricts potential losses, thereby safeguarding their retirement savings. As a result, US financial advisers have increasingly incorporated buffered ETFs into client portfolios, attracting US$10 billion in net inflows in both 2022 and 2023. This shift has occurred at the expense of the US$3.3 trillion US annuities market and costly structured notes that promise to safeguard the principal or ensure minimum returns.

Ben Johnson, Morningstar's head of client solutions, noted that these products are capturing market share from other methods of achieving similar results, particularly in the case of structured products and index-linked annuities. Currently, there are over 200 defined outcome ETFs in the US, with approximately US$37 billion in assets, a significant increase from five years ago when only US$500 million was divided among about a dozen products, according to Morningstar Direct data.

"As more investors transition into retirement or navigate this life stage, they are seeking a sense of control or a perception of increased security," Johnson explained. This inclination has led them to gravitate toward financial products that offer protective mechanisms to mitigate significant market downturns. The growing demand from investors for these ETFs has prompted major asset management firms like BlackRock and AllianceBernstein to enter the market and compete with established providers of buffered ETFs such as Innovator Capital Management, First Trust, and Allianz.