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Stock Rally Is Driving Billions Into Funds That Limit Losses

(Bloomberg) — The darkening economic backdrop to the U.S. equity rally is translating into booming demand for a breed of young funds that promise to both share in gains and cushion losses.

Investors have poured more than $2.2 billion this year into exchange-traded funds known as buffers, which seek to shield them against a certain percentage of declines in return for a cap on their potential upside.

Fear of missing out on the S&P 500’s march back toward a record combined with rising coronavirus cases is boosting the appeal of these defined-outcome products, reckons Bruce Bond at Innovator ETFs. The firm launched buffers in 2018, targeting retail investors and financial advisers looking to manage risk.

“They’re just completely exposed to the tragedy and the upside of the market,” said Bond, Innovator’s chief executive officer. “The more sophisticated investors, they control that exposure.”

The good news for investors piling in is that so far this year, buffer funds have performed as promised.

At the height of March volatility, the $246 million Innovator S&P 500 Power Buffer ETF, ticker POCT, was down 17.5% for the year compared with a 30% slump for the S&P 500. Five months later, the U.S. benchmark is up about 4% and the ETF has gained around 2.8%.

While Innovator currently commands the lion’s share of defined-outcome ETF assets, popularity and performance are breeding competition. Allianz Investment Management launched two buffers in June to complement its similarly structured variable annuity lineup, while New York Life Investments’ IndexIQ unit has also filed plans.

Meanwhile, the largest buffer fund on the market is the FT Cboe Vest U.S. Equity Deep Buffer ETF – February, which has gathered $510 million in assets since launching six months ago. The debut was well-timed, according to Cboe Vest’s Karan Sood — the virus-fueled turmoil in the weeks which followed showed a traditional portfolio mix of 60% equities and 40% fixed-income failed to effectively shield portfolios.

“In March of this year, everything went down together,” said Sood, Cboe Vest CEO and a portfolio manager of the fund. “This style is not dependent on historical relationships holding up in the future, it’s forward-looking.”

Defined-outcome ETFs may soon branch outside of equities. Innovator filed plans with the Securities and Exchange Commission in June for the Innovator 20+ Year Treasury Bond 5% Floor ETF – July, which would track the performance of BlackRock Inc.’s iShares 20+ Year Treasury Bond ETF on a buffered basis.

Such a strategy would protect investors from the growing duration risk — a measure of sensitivity to interest rate changes — as long-dated Treasury yields fall, Bond said.

“If you want to stay invested in fixed-income today you either need to get in a money-market fund or go super short-term,” he said. “This allows you to stay in long Treasuries in a 60-40 type portfolio mix, but cuts off the risk tail.”

(Updates prices in 6th paragraph.)

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