Buffer ETFs may have taken retirement accounts in the US by storm, however, these products are yet to fork much lightning with European investors seeking to manage downside risk.
Buffer – or defined outcome – strategies were first wrapped within US-listed ETFs in 2018, offering investors cost-effective access to the structured product model of capping upside returns and hedging against losses over a predetermined period.
After modest inflows of just over $500m in their first year, the COVID-19 pandemic and central bank-led 2022 correction brought the use case for buffer ETFs into sharp focus, inspiring more than $20bn asset gathering over the last two calendar years, according to data from Morningstar.
However, as investors have poured over $37bn into the more than 200 buffer and tail hedge ETFs available in the US, the products have yet to inspire similar enthusiasm since entering Europe in 2020.
Gregg Guerin, senior product specialist at First Trust – whose buffer ETFs have raised $20bn in the US and $24m in Europe – said at a recent ETF Stream roundtable: “What is resonating in the US and not yet in Europe where we have just brought these products over, are these target buffer strategies.”
Three teething issues
A natural first explanation for modest early-days asset gathering is a lack of familiarity with the new ETFs available in Europe.
Antoine Ternon, multi-asset portfolio manager at APICIL Asset Management, said he was “positively surprised” by developments in buffer ETFs and added he had been aware of these strategies existing but “at higher cost or significant ticket size”.
"I would like to see innovation in ETFs around structured products,” he said. “There would be a very good place for that in Europe.”
A second challenge is how these ETFs will compete with long-standing, actively managed defined outcome vehicles such as the $2.7bn Atlantic House Defined Returns Fund.
Despite this, Adrien Samuel-Lajeunesse, investment fund and ETF specialist at BNP Paribas Wealth Management, believes there is a use case for options strategies wrapped in ETFs.
“One area we have been looking at recently is options strategies that are wrapped into ETFs, things like covered call and buffer strategies,” he said.
“It is a good way to democratise sophisticated strategies that are only available for the biggest clients.”
Wayne Nutland, multi-asset investment manager at Skerritts, added: “The wider European market has used structured products often distributed via private banks to provide similar defined outcome products, this market could be an opportunity for buffered ETFs given their more transparent pricing and exchange traded nature.”
A third sticking point has been the recent macro backdrop, with the first half of 2024 being comprised of a rare combination of central bank rate cut expectations being revised downward, accompanied by the stubborn upward march of equity indices.
While an equity rally reduces the attractiveness of a strategy with capped upside baked in, fears of a rerating or more substantial correction might give investors cause to look for hedging opportunities.
An arguably greater headwind for buffer ETF uptake has been the ‘higher-for-longer’ mantra maintained by the likes of the Federal Reserve.
While rate hikes or inflation surprises spell negative returns for most bond maturities, fixed income ETFs offering guaranteed income, low-to-no duration and no equity risk have boomed in popularity, such as the $8.3bn Xtrackers EUR Overnight Rate Swap UCITS ETF (XEON), which enjoyed $6.4bn inflows in 16 months and currently pays out the EU interbank rate of 3.9% to investors.
Although a lack of familiarity, existing competition and the current macro backdrop are all potentially solvable riddles, buffer ETF promoters may have a more difficult time swaying unconvinced fund selectors.
Risk-adjusted no-man’s land
Whereas buffer, tail hedge and covered call ETFs have struck a chord with investors in the US, the ETF market dominated by professional investors are more reticent about an ETF offering a risk-return profile in the middle ground between equity and fixed income.
“Institutional investors typically [prefer] purer play asset exposures using asset allocation decisions as the primary way to adjust portfolio risk-return profiles,” Nutland said.
“Typically, buffered ETFs do not fit easily within asset allocation driven investment processes, especially where a range of risk-profiled asset allocations is being constructed.”
Agreeing, Allan Lane, CEO of Algo-Chain, said it is “less obvious” that buffer ETFs should be included within a model portfolio offering constructed on a target risk basis.
“It is possible to figure out how to add an allocation, but many discretionary fund managers will instead use their own combination of equities, bonds, commodities and alternatives to deal with the possibility of an equity sell-off,” he concluded.
Overall, buffer ETFs may have to wait for the widely touted ‘rise of retail’ in ETF usage to recreate the surge in asset gathering witnessed in the US.
