The ICI reported $7.77 trillion in money market fund assets at the end of last week. And while that tally was down $22.7 billion from the previous week, it’s still a pretty substantial sum being held on the sidelines by both retail and institutional investors.
So much so that it’s got a lot of wealth managers wondering if they can be using a different vehicle, like defined outcome ETFs, as a structured way to simultaneously obtain yield, downside protection and the liquidity to jump back into stocks if necessary.
Stuart Chaussee, managing director and senior wealth advisor at Lido Advisors, for one, calls defined outcome, or buffer ETFs, a targeted way for conservative or moderate-risk investors to gain exposure to the stock market by typically tracking the return of a reference asset, such as the S&P 500, to a cap, while protecting against initial losses during the outcome period, which is typically 12 months. Most of his clients are either nearing retirement or already retired and would like to have some protection against losses in the stock market. As a result, he implements defined outcome strategies as core holdings for most of his clients.
“Most pre-retirees or retirees that I work with prefer a mix of shallow to moderate buffers. The protection will typically range between 9% to 15% over a 12-month outcome period and the protection will typically refresh in a new outcome period, not a taxable event, so they can be held as long-term investments,” Chaussee said, adding that for more risk averse investors he can purchase buffer ETFs that provide deeper protection of 20% or more.
Mike Bernard, owner of Korhorn Financial, meanwhile, says defined outcome ETFs are an ideal vehicle for clients who have long-term dollars sitting in cash, because they are either nervous about the current levels of the stock market, or are unsure about the potential headwinds in the market.
“Many individuals feel like the market is too high or too risky right now to deploy a lump sum of cash into the markets, while at the same time feel a growing sense of urgency that they need to get these dollars working for them as they watch the interest they are earning on their cash decline. Defined outcome ETFs are a way to get those dollars to work despite those concerns,” Bernard said.
For pre-retirees and retirees who have a defined withdrawal strategy, Bernard says he is using defined outcome ETFs for some of their intermediate-term dollars, in that they provide some market participation on the upside, while having defined downside buffering should the market face volatility in the next 1 to 5 years before the retiree needs to draw that money.
“In this way, you could say these defined outcome ETFs are being used as an alternative to bonds or a complement to bonds,” Bernard said.
Over time, Bernard says he has shifted from a 15% buffer more towards the Ultra buffer, which offers a 30% buffer after a 5% decline. In his view, these have grown more attractive to clients due to the recent surge in the markets, as clients find more comfort in buffering more downside after the sharp rise of the markets.
And to help specifically with idle cash, Bernard says he is seeing an increased number of clients, particularly those in retirement who have excess cash, using the 100% buffer funds.
“Given their ETF structure, these defined outcome ETFs can be a great solution in both non-qualified and qualified accounts. Therefore, the client’s goals, preferences, and financial plan really drive where and how these strategies are used, not the tax treatment,” Bernard said.
FITTING BUFFER ETFS IN A PORTFOLIO
Lido Advisors’ Chaussee believes defined outcome strategies, either via custom option strategies or through buffer ETFs, fit strategically in an overall asset allocation. In his opinion, they can act as a hedge of sorts, for an unhedged equity portfolio, or they can act as a complement, or replacement, to a fixed income portfolio.
“I think replacing a portion of a fixed income portfolio with buffer ETFs is particularly attractive in the current low yielding bond market environment. After inflation, taxes and fees, an investor may be losing money in bonds every year. Buffer ETFs, with moderate protection, give an investor the potential for higher returns than a short-term Treasury bill, while having a defined level of protection in place in case the stock market heads south,” Chaussee said.
Graham Day, chief investment officer at Innovator ETFs agrees, calling the bond comparison a good one.
“Like bonds, Buffer ETFs have a defined tenor, often 3-months or 1-year, but unlike bonds, they don’t mature. Instead, they simply rebalance in a tax efficient manner and start a new outcome period. This allows advisors to communicate clear expectations to clients over a defined time period while incorporating tax efficiency, both invaluable features,” Day said.
And like bonds, defined outcome ETFS can also be laddered to help ease concerns about buyer’s remorse.
“When incorporated effectively, laddering can smooth out the client experience and provide a more evergreen approach to Defined Outcome investing. A popular method is laddering 4 to 6 Innovator Power Buffer ETFs, each offering S&P 500 ETF exposure with a 15% annual buffer. Another method is to use a single actively managed laddered strategy, such as a Managed Buffer or Floor ETF,” Day said.