With every bout of stock-market volatility, nervous investors start snapping up products meant to protect them in a downturn.
This round of swings is no exception: In the first four months of the year, funds that try to mitigate risk raised almost $10 billion, boosting assets to a record $77 billion, according to Morningstar Inc.
There was portfolio insurance before the 1987 Black Monday crash and bets on Wall Street’s fear gauge after the 2008 financial crisis. Now, two increasingly popular strategies are a type of so-called smart exchange-traded funds, which try to pick the least volatile stocks, and buffer funds, which limit losses using options.
Two of the biggest—the Invesco S&P 500 Low Volatility ETF (SPLV) and BlackRock Inc.’s (BLK) iShares Edge MSCI Min Vol USA ETF (USMV) have raised more than $6.4 billion combined so far this year, according to FactSet.
Avoiding ups and downs has paid off in the past year, with the Invesco ETF returning almost 18% and the competing iShares ETF gaining 16%, while the S&P 500 (.SPX) has returned 5.8%.
Still, there are no guarantees with low-vol ETFs. The Invesco fund has about one-quarter of its $11 billion in assets invested in utilities, staid dividend-paying stocks that tend to perform poorly when interest rates rise.
For investors who prefer a little more certainty, other popular choices are the so-called “buffer” funds sold by Innovator ETFs, which is led by the co-founders of PowerShares, now owned by Invesco. The funds use options strategies to limit losses when the S&P 500 falls, but they cap gains when it rises. This can be a worthwhile trade-off for investors concerned about preserving their nest eggs.
Innovator’s dozen buffer ETFs have raised more than $364 million since the beginning of April, according to FactSet—a notable haul for a recent comer pitching a relatively expensive idea. (They cost $79 a year for every $10,000 invested, 26 times more than the cheapest S&P 500 index ETF.)
The buffer strategy isn’t new—insurance firms offer similar structured products—but it is new to ETF investors. The first three launched in August, and Innovator has followed with three more each quarter and plans to debut a monthly version starting in June. Each quarterly suite has three variations with options that provide a cushion against losses of 9%, 15% and 30%.
The financial alchemy may be a bit tough to comprehend for investors used to plain-vanilla index funds. For starters, the buffer isn’t calculated from the day an investor buys their shares but is based on the level of the S&P 500 on the day the funds launched. (The funds will reset their options once a year at the current market levels, though none of the Innovator ETFs have reached their first birthday yet.)
If stocks have dipped below that starting level by the time an investor buys, then some of the downside protection has already been used up. Plus, stocks would have to rebound above the starting threshold before investors would see any gains.
That could also be a good thing, said Scott Kubie, chief investment officer of Carson Wealth Management, one investor in the buffer ETFs. In recent months, the July and October buffer ETFs have become increasingly attractive as the market dips toward the funds’ starting point. Investors get the same protection, but don’t have to wait an entire year to reap the full benefit, he said.
Apart from price, the buffer ETFs have other drawbacks. Investors also forgo dividends, a considerable disadvantage since the S&P 500’s dividend yield is running at about 2% a year.
Still, for investors nearing or in retirement who don’t have years to wait out a prolonged market slump, preserving their savings is worth the cost, Mr. Kubie said.
“Some people have nerves of steel,” Mr. Kubie said. “Other people are more nervous.”
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