Buffer ETFs gain steam among rattled advisors and investors

As growing geopolitical and economic uncertainties stir turbulence in the markets, financial advisors and investors are increasingly turning to buffer ETFs.

The funds, which provide downside protection in exchange for capped upside potential, have attracted $2.5 billion in inflows over the past month, according to CFRA Research. Year to date, the category has seen $4.7 billion in inflows as the S&P 500 has declined 6 percent.

Buffer ETFs saw particularly strong demand on Monday, when the S&P 500 posted its largest drop of the year. On that day alone, the funds pulled in $140 million in net assets, CFRA reported.

Expanding options for risk management

Offered by asset managers including Innovator Capital Management, BlackRock, and Allianz Investment Management, buffer ETFs use options strategies to establish a protective floor against market declines. The downside protection is financed by selling options that limit an investor’s potential gains if the market moves higher.

Goldman Sachs Asset Management deepened its presence in the space earlier this month with the launch of the Goldman Sachs US Large Cap Buffer 3 ETF. The fund, which resets quarterly, joins two similar products introduced by the firm in recent months. The Goldman ETFs offer downside protection ranging from 5 percent to 15 percent, while capping upside potential between 5 percent and 7 percent.

"The feedback we were getting from clients was, I’m in the marketplace. I can live with down a few percent. That’s kind of like what I expect. It gets painful when I’m talking down 5 to down 15," Brendan McCarthy, global head of ETF distribution at Goldman Sachs Asset Management, told CNBC.

A January analysis by CFRA found that at the end of 2024, buffer products accounted for 40 percent of listed derivatives-based equity ETFs, giving them largest share of the market by count.

The level of upside participation varies depending on market conditions. In periods of higher volatility, buffer ETF investors tend to receive lower return caps in exchange for greater downside protection.

"A year ago, we were reaching out to [advisors] to tell them and their clients about the concept," said Graham Day, chief investment officer of Innovator, told Reuters. "Now we're the ones answering calls from them, as they try to take some chips off the table."

Growth in assets and cost considerations

Buffer ETFs have grown significantly in recent years, with total AUM in the category reaching $64 billion at the end of February, up from $38 billion at the close of 2023, according to CFRA. Fuse Research Network expects inflows to nearly double this year as investors seek defensive solutions in response to market uncertainty.

"When you have these jolts, it creates a new level of both uncertainty and urgency," said Johan Gran, head ETF market strategist at Allianz. "Volatility spikes have always existed, of course, but now we have one big surge in volatility coming from the new administration."

Despite their popularity, some advisors caution that buffer ETFs come with trade-offs. The funds typically carry higher expense ratios, often around 0.7 percent or more, compared to fees as low as 0.05 percent for traditional index ETFs or 0.35 percent for some actively managed ETFs.

"Having someone else cover the first 15 percent of any selloff sounds great, but in exchange for what?" said Nathan Garrison, chief investment officer of World Investment Advisors, based in Washington, Iowa.

Some analysts have also spoken out against the strategies, including Nicolas Rabener of Finominal, who warned against what he called the "Buffermania" boom.

"Buffer funds are often marketed as low-risk, alternative, or diversifying strategies. However, given their high correlation to equities, this characterization is misleading," he told Bloomberg.

Scott Opsal, director of research & equities at Leuthold, also noted how the Cboe S&P 500 Buffer Protect Index fell less than the broader index during the 2022 bear market, but investors who stuck with the trade missed out on 16 percentage points of profits in the subsequent two-year comeback.

While market volatility is driving demand for structured protection, some industry professionals are urging investors to take a long-term approach in buying insurance for their portfolios.

"No one should be using this one time period to do that," said Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors. "You need to prepare for market moves, not try to predict them."