By Suzanne McGee
(Reuters) -Investors are increasingly taking refuge from the tumultuous U.S. stock market by pouring into a type of exchange-traded fund that offers a tradeoff, a cap on potential gains in return for a cushion against possible losses.
Over the past month, as the market has pulled back sharply, “buffer” ETFs have seen $2.5 billion of inflows, according to CFRA Research. The category has seen $4.7 billion of inflows so far this year, as the benchmark S&P 500 stock index has declined 6%.
On Monday, the S&P 500’s biggest drop of the year, such buffer ETFs pulled in $140 million in net assets, according to CFRA.
“At some point, the stock market party had to stop,” said Dinon Hughes, a partner at Nvest Financial, a financial planning firm in Portsmouth, New Hampshire. Hughes began redeploying some of his clients’ stock market holdings into buffer ETFs last year as equity valuations rose and his anticipation grew that his clients would confront choppy markets and selloffs.
Buffer ETFs, which are offered by asset managers like Innovator Capital Management, BlackRock and Allianz Investment Management, use options to put limits on how much an investor will lose in a market selloff. The protection is financed by selling other options that remove the potential for unlimited gains if the market roars higher.
The extent of potential gains depends on the market backdrop, with higher volatility environments translating into lower upside potential as investors give up potential profits in exchange for more protection.
Financial advisors like Hughes are increasingly attracted to them as a way to persuade clients not to abandon stocks in a turbulent environment.
“A year ago, we were reaching out to them to tell them and their clients about the concept,” said Graham Day, chief investment officer of Innovator. “Now we’re the ones answering calls from them, as they try to take some chips off the table.”
In a survey of advisors conducted last week, Innovator found that 82% of advisors polled were more worried about stocks than any other asset class.
Stocks have sold off in recent weeks as investor worries about the economic outlook are exacerbated by uncertainty over President Donald Trump’s tariffs.
“When you have these jolts, it creates a new level of both uncertainty and urgency,” said Johan Gran, head ETF market strategist of Allianz. “Volatility spikes have always existed, of course, but now we have one big surge in volatility coming from the new administration.”
Total assets in buffer ETFs stood at $64 billion at the end of February, according to CFRA, up from $38 billion at the end of 2023.
Fuse Research Network, an asset management research and consulting firm, said it expects inflows into buffer ETFs to nearly double this year.
The current volatility “is a reminder to have defensive solutions as part of a portfolio,” said Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors. “No one should be using this one time period to do that. You need to prepare for market moves, not try to predict them.”
That is what California-based financial advisor Stuart Chaussée did in 2022, when he began moving assets of many of his pre-retirement and retired clients into buffer ETFs.
“Until then, I didn’t really want them, but I now believe that as long as the cap on the upside is at least as large as the average market return, I’ll consider it,” he said.
Currently, Chaussée said that about $320 million of the $420 million in assets he manages for clients is invested in buffer ETFs. He acknowledges it is more difficult now to make that allocation decision, since the upside caps — determined by market volatility levels — have shrunk.
“When valuations are high and caps are low — well, you have to make a choice, but I come down on the side of not being greedy,” he said.
Nathan Garrison, Washington, Iowa-based chief investment officer of World Investment Advisors, is wary of the price that investors can end up paying for peace of mind.
“Having someone else cover the first 15% of any selloff sounds great, but in exchange for what?” he said.
Aside from limiting potential gains, buffer ETFs also tend to carry higher fees. The funds can have fees of 0.7% or more, compared to as little as 0.05% for a plain vanilla index ETF or as little as 0.35% for an actively managed ETF.
“You need to be aware of the volatility and risk of the markets these days, but you also want to be careful of what you’re rushing into,” Garrison said.
(Reporting by Suzanne McGee; Editing by Lewis Krauskopf and David Gregorio)
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