Markets have been in turmoil this year due to uncertainty related to tariffs and trade wars. Defined outcome or “buffer” ETFs, which use derivatives to provide market upside participation up to a cap while limiting downside risk, have become increasingly popular with investors.
This is one of the fastest-growing ETF categories, especially since 2022, when both stocks and bonds delivered dismal returns. Interest in these strategies has surged this year, with investors pouring in about $7 billion.
Buffer ETFs invest in a basket of FLEX options with varying strike prices. The strategy typically involves buying call options to gain index exposure and put options for downside protection, then offsetting the costs by selling call options—thereby capping the upside.
Investors should remember that stocks tend to rise over the long term and that short-term noise is best ignored. Since its inception in January 1993, the SPDR S&P 500 ETF SPY has delivered a little over a 10% annualized return. The Nasdaq 100 ETF QQQ has produced an average annual return of nearly 17% over the past 10 years. By seeking downside protection, investors forgo any potential upside beyond the cap.
At the same time, many risk-averse investors—particularly those in or nearing retirement—have been reluctant to buy stocks. A significant amount of cash remains parked in money market funds and other cash-like instruments.
Some cautious investors turn to products like fixed indexed annuities and market-linked CDs, which protect against downside risk but come with higher fees, steep investment minimums, long lockup periods, and unfavorable tax treatment. Protection ETFs present a more attractive option for such investors.
These funds also made headlines recently due to research released by some high-profile asset managers. AQR Capital labeled these strategies a “failure,” suggesting that better options exist for investors.
Vest countered, arguing that these funds are not designed to outperform equities during bull markets. Instead, they aim to deliver predefined outcomes and greater certainty during volatile periods.
Meanwhile, BlackRock has forecasted that U.S. outcome ETF assets under management will more than triple to $650 billion by 2030.
To learn more, please watch the short video above.
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Invesco QQQ (QQQ): ETF Research Reports SPDR S&P 500 ETF (SPY): ETF Research Reports iShares Core S&P 500 ETF (IVV): ETF Research ReportsThis article originally published on Zacks Investment Research (zacks.com).
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