Navigating “Too Much of a Good Thing” via Buffered ETF Fund-of-Funds

Guest Author: Marc Odo, Client Portfolio Manager, Swan Global Investments

“Too much of a good thing can be wonderful.”

-Mae West

With apologies to Ms. West, too much of a good thing can also be overwhelming. Since 2018 the market has become saturated with buffered or defined outcome ETFs. In 2023 alone over 40 new buffer funds were made available.

Options-Based ETFs, AUM and Fund Count

^{Source: Morningstar Direct, Swan Global Investments}

Clearly investors have embraced the basic value proposition of a buffered ETF: if the market is up over a one-year period, the ETF should participate in gains up to (but not beyond) a predetermined breakpoint. If the market is down, the ETF’s put options should shelter the ETF from losses, up to a point. If the market is down by a larger amount, the investor willingly accepts that far “left tail” risk. Given the uncertainty surrounding equities, bonds, and the global economy people have been flocking to relative certainty of buffered ETFs.

Payoff Profile

^{Source: Pacer ETFs}

The problem, however, is that investors are overwhelmed by the sheer number of buffered ETFs available. The risk/return profiles range from conservative to aggressive, with many options in-between. Also, many buffered ETFs are now available in monthly series, so even the most basic defined outcome might have 12 different “vintages” to choose from.

Further complicating the investor’s decision is whether the buffered ETF should be considered a “buy-and-hold” investment or if it should be actively traded. The issuers of buffered ETFs always state that the caps and floors of the ETFs assume the investor holds the ETF for the full one-year investment period. 

But should the investor hold the ETF for the full one-year period? What if an investor wants to be more opportunistic? Perhaps in a bull market scenario the market has rocketed up in the first six months of the year, and there is little upside potential remaining due to the ETF hitting its cap? Conversely, what if in a bear market the buffer/put option is exhausted, and the ETF is now exposed to market losses? Does it make sense to hold on to a buffered ETF in these scenarios? Or should the investor opportunistically rotate into a different buffered ETF?

In response to these questions, the next generation of buffered ETFs is a “fund-of-funds” portfolio. This is an “easy button” solution. An investor can purchase a single ETF with one ticker, and gain exposure to a multitude of buffered ETFs. The “fund-of-funds” is professionally managed and the responsibility of choosing between all the various individual buffered ETFs is outsourced.

This type of approach should be quite familiar to investors. For the last decade or two the proliferation of professionally managed model portfolios has helped investors offload their diversification and money manager selection decisions. Investors can “set it and forget it” with a well-designed model portfolio suited to their risk/return needs. This concept has been extended to the world of buffered ETFs.

Of course, even within the fund-of-funds space, an investor has choices. The primary distinction is between passively and actively managed approaches. Passively managed fund-of-funds tend to diversify across vintages of the same risk profile. For example, a moderate risk profile buffered ETF might have a buffer that hedges market losses of 0% to 15%. This moderate buffered ETF might have 12 different vintages: i.e. the first has outcome period that extends from January 1^st to December 31^st, the next vintage has a period of February 1^st to January 31^st, etc. A passively managed fund-of-funds might equally-weigh each of these 12 vintages so that the investor is diversified across the calendar, with 8.33% of the portfolio rolling every month.

Average Managed Fund of Funds Across Vintages

^{Source: Swan Global Investments}

Alternatively, an actively managed fund-of-funds might be diversified across vintages and risk profiles. In this case the portfolio manager has a wider array of risk/return profiles available and can construct a more robust portfolio to exploit changing market conditions. Moreover, the portfolio manager might have the authority to make discretionary allocations, over- or underweighting constituent ETFs based upon the PM’s attempt to maximize the fund’s return-vs-risk potential.

Actively Managed Fund of Funds Across Vintages and Risk Profiles

^{Source: Swan Global Investments}

Swan Global Investments and Pacer ETFs have collaborated to produce an actively managed buffered ETF fund-of-funds. This actively managed buffer ETF provides investors with access to a dozen different ETFs spanning three different risk profiles and quarterly vintage, all within a single ticker. Over the course of two bull market years (2021 and 2023) and one bear market year (2022), An actively managed buffered ETF fund-of-funds has provided investors with respectable capture ratios and reduced volatility relative to the market.

Active vs. Passive Buffered Fund-of-Funds

^{Source: Morningstar Direct, Swan Global Investments}

Of course, buffered fund-of-funds aren’t for everyone. Some investors might prefer making their own decisions when it comes to the buying and selling of individual buffered ETFs. Other investors might believe the additional layer of management fees for the fund-of-funds solution isn’t worth it. Some investors might like the simplicity of knowing what their caps and floors are if they buy-and-hold a single ETF. But for those investors who want exposure to a diversified portfolio of buffered ETFs in a single, “easy button” solution, the fund-of-funds approach offers many advantages.

About the Author

Marc Odo, CFA, FRM, CAIA, CIPM, CFP®, is the liaison between Swan’s portfolio management team and all its various stakeholders. He is responsible for helping clients and prospects gain a detailed understanding of Swan’s Defined Risk Strategy, including how it fits into an overall investment strategy. His responsibilities also include producing most of Swan’s thought leadership content.

Odo is a frequent speaker at industry conferences and was also a regular presenter at the Wharton School of Executive Education from 2006 to 2011. As well as presenting, Odo has written numerous in-depth white papers, short-form pieces, and contributed to many articles in the financial press.

Prior to joining Swan, Odo was Director of Research for 11 years at Zephyr Associates, a leading provider of investment analysis software. 

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