“Structured products” are proliferating in exchange-traded funds, and defined-outcome ETFs, or “buffer ETFs,” are among the most popular. These ETFs use options to provide an explicit amount of loss protection over a given period but limit potential gains. And with their relatively high price tag, investors should make sure they get what they pay for.
Morningstar’s new Guide to Defined Outcome ETFs unpacks the rapidly evolving landscape, outlines potential use cases, and provides an overview of the largest eight defined-outcome ETF providers. Interested readers can download a copy of the full report here.
In this article, we take a look at the rise of buffer ETFs, outline how they work, and explain how investors can get the most out of them.
Buffer ETF Investors Pay for Peace of Mind
The defined-outcome Morningstar Category had the most ETFs of any fund category, with 420 available at the end of 2025. It was also among the fastest growing, with an average annualized organic growth rate of 39% over the past three years, amassing USD 78 billion by year-end.
Defined-outcome ETFs have grown in popularity over the past several years for their ability to shield a portfolio from losses. The stock and bond market decline of 2022 was the perfect opportunity for these ETFs to take hold. That year, bonds failed to provide much ballast, so investors were left scratching their heads for ways to control downside risk if bonds don’t always hedge stock losses.
Enter buffer ETFs, which explicitly defend against stock market declines. They aren’t without some risk, however, and many can lose money under the right circumstances. Standard buffer ETFs expose an investor to any and all losses after the buffer level is breached. Only max buffer ETFs should avoid losses altogether, before fees. No matter what percentage of losses an ETF purports to protect, all limit gains to some degree.
The peace of mind provided by buffers may be worth the foregone gains for some, but defined-outcome ETFs’ total returns are likely to fall well short of uncapped stock or allocation portfolios over extended time horizons. This makes defined-outcome ETFs suboptimal holdings for long-term investors. They’re a better fit for risk-averse investors with shorter time horizons that don’t mind some additional complexity.
Understanding the Buffer Structure
Defined-outcome ETFs are complex and must be bought and sold in accordance with their stated outcome period, usually one year, to achieve an advertised outcome. These ETFs use options to deliver their results. Several option structures exist within the defined-outcome category, and investors should expect different results from each structure.
A standard buffer, like those that protect against the first 10% of losses, is by far the most common. In the standard buffer structure, a defined-outcome ETF follows the performance of a reference asset, like the S&P 500 index or Nasdaq 100 index, up to a cap while avoiding a certain percentage of the asset’s losses should it decline. Defined-outcome ETFs also forego dividend payments.
The chart below shows a hypothetical example of a defined-outcome ETF using a standard buffer structure. Investors can gain no more than 20% over the defined year but are shielded from the index’s first 10% of losses, before fees. Performance will mimic the reference asset if it returns between 0% and 20% in this example.
Other structures have started to appear. Max buffer ETFs offer the most protection but come with little upside. Laddered and dynamic option strategies spread performance out over multiple outcome periods. Enhanced or accelerated structures leverage returns up to a cap while usually maintaining some downside buffer. Each promises a distinct outcome from the standard buffer structure.
Significant opportunity cost is potentially embedded in each outcome structure. The vast majority of defined-outcome ETFs are pegged to the performance of the S&P 500 index, aiming to capture some of that index’s upside while mitigating downside risk to varying degrees.
Comparing Buffer Levels
A defined-outcome ETF’s buffer level indicates its risk level. Larger buffers make for shallower drawdowns than smaller buffers, but they also make for lower returns in positive markets.
Historical performance illustrates these potential trade-offs. The S&P 500 lost more than 20.0% in just 3.9% of 12-month periods going back to 1970, but it gained more than 20.0% in nearly a third of those periods. So, the downside protection on a 20% buffer may not get fully utilized very often.
An ETF’s buffer level determines an investor’s return over an outcome period relative to its reference asset. Shown below, AllianzIM US Large Cap Buffer20 Jan ETF JANW was the only ETF tested that shielded against all of the S&P 500’s 18% loss in 2022, but only because it protects against the first 20% of the index’s loss. Meanwhile, 15% and 9% buffers declined for the year because the market’s losses exceeded the buffer’s protection level.
Investors should not expect defined-outcome ETFs to diversify stock market losses. They will not rise when markets fall. Instead, standard buffer ETFs are positively correlated to the stock market and will fall with the market until their options structure intervenes. Protection can be valuable, but investors should know what they’re in for.
Buffer ETFs Can Help Diversify Conservative Portfolios
Buffer ETFs have positive correlations with stocks, which means that a standard buffer ETF can enhance the upside potential of bond-heavy portfolios without sacrificing downside protection. The chart below demonstrates just this, with Innovator US Equity Power Buffer ETF PJAN, a 20% annual buffer product, inserted into several portfolios of varying risk levels, from 2020 through 2025. The conservative portfolio (20% stock, 80% bond) benefited the most from a 20% allocation to Innovator US Equity Power Buffer ETF. Stock-heavy portfolios were largely hampered by its addition.
Merit and Use Cases of Buffer ETFs
Defined-outcome ETFs are not for everyone. For the right investor in the right circumstance, they can be an effective tool to control risk. Other investors may want to stay away. The following summarizes the trade-offs to consider:
Pros:
- Explicit and reliable risk control if the outcome period is followed.
- Known outcomes help risk-averse investors stick to their investment plan.
- Investors with short time horizons may benefit from stock exposure with guardrails.
- A variety of defined-outcome types allows advisors to tailor an investment to an investor’s specific risk tolerance.
Cons:
- Potentially high opportunity cost, especially in the long run.
- Expensive. Defined-outcome ETFs charge 0.75% annually, on average.
- Large swings in market volatility and interest rates can impact cap levels.
- The defined-outcome mechanism is restrictive for most ETFs. An outcome is only assured if the ETF is purchased at the beginning of the period and held to the end.