Investing with Guardrails: First Trust Cboe Vest Fund of Buffer ETFs (BUFR) Webinar Key Takeaways
Here are some of the key points investors interested in BUFR need to know.
Earlier in September, Cboe Canada hosted a webinar in tandem with First Trust Portfolio Canada to talk about the First Trust Cboe Vest Fund of Buffer ETFs (BUFR), which I covered before in a previous article. As one of Canada's first "defined outcome" ETFs, BUFR employs an elaborate options strategy to cap its downside risk, also known as a buffer.
For those of you interested in the full webinar, a link can be found here. For the more visual-oriented readers out there, I've also distilled the main takeaways from the webinar for you in today's article. Here's all you need to know before investing in BUFR:
Key Takeaway 1: A History of Buffer ETFs in Canada
Buffer ETFs, introduced in 2019, have experienced significant growth in popularity, with First Trust being a leading provider and having a notable partnership with Cboe Vest.
Buffer ETFs are a relatively new financial instrument, first introduced to the market in 2019. By August of that year, Canada saw the launch of its first Buffer ETF.
Since then, this category of ETFs has seen considerable growth across the industry, with various providers jumping on board. First Trust has emerged as one of the primary players in this space.
They have a significant partnership with Cboe Vest, which is the asset management arm of CBOE. For those familiar with the industry's history, Cboe Vest pioneered this concept as early as 2012, and subsequently, they launched the first mutual fund utilizing the target outcome concept.
Key Takeaway 2: How Buffer ETFs Work
Buffered ETFs or Target Outcome Funds offer investors predefined return outcomes, which differ from traditional ETFs, by combining the structured returns commonly seen in other financial instruments with the benefits of an ETF wrapper.
Detailed Explanation: Buffered ETFs or Target Outcome Funds are not about introducing a new type of return outcome but rather about packaging existing structured returns into a more investor-friendly format.
While structured returns have existed for decades, primarily in Structured Products or annuities, incorporating them into an ETF wrapper brings several advantages:
- Transparency: The ETF format provides clear visibility into the holdings and workings of the fund.
- Liquidity: ETFs can be easily traded, offering investors better liquidity compared to some structured products where exiting might entail hefty penalties or, in certain cases, might not be feasible at all.
- Favorable Taxation for Canadians: By moving these returns to an ETF, the taxation changes for Canadian investors. Instead of being taxed as interest income, these products now offer capital gains taxation, which is roughly half the tax.
Fundamentally, the mechanism works by taking a well-known index, such as the S&P 500, and then creating a package that offers a predefined buffer. This buffer could be, for example, a 10% downside protection, with a capped upside return limit.
If the market falls by 8% during the holding period, an investor would get their initial investment back (minus fees), as long as they invested at the start of the period. In essence, this provides investors with a known outcome, contrasting the unpredictable nature of traditional investments where the value might increase or decrease based on market dynamics.
Key Takeaway 3: What Makes BUFR So Special?
BUFR mitigates timing risk with its quarterly rollover system, allowing for consistent downside protection and adaptable upside caps, serving as a scalable, low volatility hedged equity solution.
The ETF comprises of point-to-point offerings. These give investors exposure to the S&P 500, providing protection on the first 10% of the downside but capping the upside potential. The cap is decided by the call option that's sold to finance the downside shield.
Each of these point-to-point offerings is designed for different months. For instance, the one that starts in August would trade on the third Friday of that month and mature on the third Friday of August the next year, having a lifespan of one year. There are four such offerings, each with different starting months.
Instead of investors needing to pick one of these four offerings and worrying about timing it right, BUFR incorporates all four into a single fund. This diversifies the timing risk, ensuring that investors don't have to be overly concerned about entering or exiting the market at the perfect time. In essence, it's a tool that simplifies diversification and implementation for portfolios or models.
BUFR's design means that every quarter, as one of its point-to-point components matures, a new one is added, ensuring that there's always a rolling 10% downside protection. Furthermore, the upside caps adapt based on prevailing market conditions, offering potential for better gains during favorable conditions.
BUFR's design simplifies decision-making, making it particularly suitable for growing portfolios or advisors with varying client entry times. Its ease of use and broad appeal is evident by its success in the U.S., where it became the first buffer ETF to cross a billion in assets.
With a beta of 0.6 to the S&P 500, BUFR acts as a hedged equity solution, offering reduced volatility. This makes it an attractive option for investors and advisors aiming for stability and a measure of protection in uncertain markets.
In essence, BUFR is designed for those who want exposure to equity markets but with predefined risk and reward parameters, making it suitable as a core allocation in diversified portfolios.
Key Takeaway #4: Why Consider Using BUFR?
Amidst the unpredictable nature of markets and the recent realization of bond risks, the buffer ETFs offer a predictable, forward-focused investment that provides known outcomes, making them an attractive long-term hold for advisors and investors.
Historically, bonds have been viewed as a stable ballast in portfolios, offering protection and offsetting equity market declines. However, in 2022, bonds experienced surprising losses, moving in tandem with equities and eroding the trust many investors had in their defensive qualities.
In light of this, advisors began exploring other risk management tools. Among the popular alternatives are low-volatility strategies, equity-to-cash switching, and investments in private debt and real estate.
However, these solutions aren't infallible. For instance, private debt can become illiquid, and low-volatility strategies might outweigh the wrong market sectors, leading to unexpected losses.
Buffer ETFs, on the other hand, come with a predefined outcome from inception. It's not dependent on historical correlations between assets, but rather, it operates like a forward contract. Investors agree to terms upfront, such as a 10% buffer against downside risks, and can have a predictable outcome.
Despite many being bearish at the outset of the year and expecting negative market movements, the actual market performance defied these expectations. This unpredictability reinforces the challenge of forecasting market directions.
Buffer ETFs, in this context, have provided solid returns without investors needing to guess market directions. For instance, while cash might yield5%, and the 10-year Canadian government bond yield sits at around 4%[1], these buffer ETFs have been providing double-digit returns.
In an uncertain and ever-evolving marketplace, the ability to rely on a product with known outcomes is invaluable. The dream, as alluded to, is predicting markets accurately, but since that remains elusive, buffer ETFs present a pragmatic, grounded solution for long-term investors.
Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.
