'Buffer' Funds Protect Investors in Volatile Markets
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What is the main topic discussed in this episode?
Here's your money briefing for Wednesday, May 6th. I'm J.R. Whelan for The Wall Street Journal. The wild market swings we've seen during the pandemic are enough to make any investor, large or small, a bit queasy. Enter buffer funds.
What are buffer funds and why are investors choosing them now?
This kind of investment fund has surged in popularity in part because they protect investors against potential losses.
What can happen if over the set period, the market drops below the level of buffer? Investors can be exposed to losses, but they should still be buffered against the first set proportion as advertised.
That's Wall Street Journal reporter Misha Frankel-Deval. Coming up, he'll explain how buffer funds work and the trade-offs that come with investing in them.
During the pandemic, the S&P 500 has been down as much as 30%. In a volatile market like that, more investors are turning to a relatively new kind of fund, one that promises to ease their potential losses. It's called a buffer fund, and Wall Street Journal reporter Misha Frankel Duvall is here to tell us all about them. So, Misha, how do these buffer funds protect investors against losses?
So effectively, these buffer funds use a suite of options to track an underlying index or ETF. And they ensure that if they are held to maturity, investors are protected against a certain amount of downside.
So to what degree are they protected?
How do buffer funds use options to provide downside protection?
So there are a range of products and they offer different levels of downside protection. Some offer 9, 10 or 15% against initial losses and some offer a greater degree.
But what happens if the market suffers a drop beyond, let's say, the 10 or 15 percent?
The buffer products don't actually track directly on top of the underlying. But what can happen if over the set period the market drops below the level of buffer? Investors can be exposed to losses, but they should still be buffered against the first set proportion as advertised.
What levels of downside protection do buffer funds typically offer?
Okay, so in this case, investors are protected against the first 10 or 15% in losses. But if the market keeps dropping, they could lose substantially more than just the loss limits?
It's possible, yes.
Are there also caps on gains?
Absolutely. So the trade-off is that in exchange for this sort of defined outcome, in exchange for this downside buffer, you also cap your gains at a certain level. And typically, the higher, the more extreme the level of buffer, the lower the cap as well.
What other tradeoffs are there?
So in exchange for the protection you get, you do give up some other benefits. And most notable is probably the lack of dividends, because in the case of some of these ETFs, they follow the S&P 500 price index. So that's not the total return index. And the dividends that you would receive if you held other types of tracker funds don't apply to you.
What do these funds typically invest in?
So these funds typically invest in the majority or all of their assets in options that track a liquid underlying. Normally, it can be the S&P 500, it can be an S&P 500 ETF, or it can be the Russell 2000, the NASDAQ, that kind of thing.
Which of these funds has seen the most investment this year?
So the ETF that's pulled in the most this year is one issued by First Trust and managed by SIBO Vest, which has pulled in about $425 million so far this year.
What happens if the market drops beyond a buffer’s protected range?
Since it launched, which was in mid to late February, it's down about 5%. And since then, the S&P is down about 10%. But the time to really judge will be at the end of the outcome period. That's when the buffers that attach to the fund will be fully effective. Another popular buffer fund is one offered by Innovator that tracks the S&P 500 while offering a buffer against 9% of losses. The version of that that was launched last April completed its outcome period in the April just gone, and it performed as its issuers would have expected. Less fees, it was at zero after the outcome period, and during that time the S&P 500 fell about 8.8%, so within the buffer.
Now, these funds can offer safety and some stability in a volatile market. Have they been around since before the pandemic?
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Chapters
5 chapters
1
What is the main topic discussed in this episode?
0:05–0:19
2
What are buffer funds and why are investors choosing them now?
0:19–1:34
3
How do buffer funds use options to provide downside protection?
1:34–2:08
4
What levels of downside protection do buffer funds typically offer?
2:08–3:28
5
What happens if the market drops beyond a buffer’s protected range?
3:28–5:05
Speakers
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