ETFs
Buffer ETFs have not yet recreated American success in Europe
Buffer ETFs may have taken retirement accounts in the United States by storm, but these products have yet to generate much interest among European investors looking to manage downside risk.
Buffer – or defined outcome – strategies were first incorporated into US-listed ETFs in 2018, offer to investors cost-effective access to the structured product model of capping upward returns and hedging against losses over a predetermined period.
After modest inflows of just over $500 million in their first year, the COVID-19 pandemic and central bank-led 2022 correction have highlighted the use case for buffer ETFs, inspiring the asset collection of over $20 billion in the last two calendar years. according to Morningstar data.
However, while investors have invested more than $37 billion in more than 200 buffer and back-hedge ETFs available in the United States, the products have yet to generate the same enthusiasm since. enter Europe in 2020.
Gregg Guerin, senior product specialist at First Trust – whose buffer ETFs have raised $20 billion in the US and $24 million in Europe – said at a recent conference ETF Feed roundtable: “What resonates in the United States, but not yet in Europe, where we have just introduced these products, are these target buffer strategies. »
Three startup problems
A first natural explanation for the modest initial asset collection is the lack of familiarity with the new ETFs available in Europe.
Antoine Ternon, multi-asset portfolio manager at APICIL Asset Management, said he was “positively surprised” by the evolution of buffer ETFs and added that he was aware of the existence of these strategies but “at a lower cost”. high or a significant ticket amount”.
“I would like to see innovation in ETFs around structured products,” he said. “There would be a very good place for this in Europe.”
A second challenge is how these ETFs will compete with long-standing, actively managed outcome vehicles, such as the $2.7 billion Atlantic House Defined Returns Fund.
Despite this, Adrien Samuel-Lajeunesse, investment funds and ETFs specialist at BNP Paribas Wealth Management, believes there is a use case for options strategies wrapped in ETFs.
“One area we’ve looked at recently is options strategies embedded in ETFs, such as covered call and buffer strategies,” he said.
“It’s a good way to democratize sophisticated strategies reserved for the largest clients.”
Wayne Nutland, multi-asset investment manager at Skerritts, added: “The wider European market has used structured products often distributed through private banks to provide similar defined outcome products. This market could be an opportunity for buffered ETFs given their more transparent pricing and trading. nature exchanged.
A third sticking point has been the recent macroeconomic backdrop, with the first half of 2024 consisting of a rare combination of downward revisions to central bank rate cut expectations, accompanied by a stubborn upward march in stock indices.
Although a rise in stocks reduces the appeal of a strategy with capped upside, fears of a larger re-rating or correction could prompt investors to seek hedging opportunities.
Perhaps a more significant barrier to the adoption of buffer ETFs has been the “higher values for longer” mantra maintained by agencies like the Federal Reserve.
As rate hikes or inflationary surprises generate negative returns for most bond maturities, fixed-income ETFs offering guaranteed income, little or no duration, and no equity risk have gained popularity, such as the ETF Xtrackers EUR Overnight Rate Swap UCITS (XEON) of $8.3 billion. ), who appreciated 6.4 billion dollars in revenue in 16 months and currently pays investors the European interbank rate of 3.9%.
Although lack of familiarity, existing competition and the current macroeconomic environment all pose potentially solvable conundrums, proponents of buffer ETFs may find it more difficult to convince unconvinced fund selectors.
Risk-adjusted no man’s land
While buffer, tail hedge and covered call ETFs have struck a chord with investors in the United States, the ETF market dominated by professional investors is more hesitant about an ETF offering a risk/return profile intermediate between equities and fixed income securities.
“Institutional investors [prefer] purer asset exposures using asset allocation decisions as the primary means of adjusting portfolio risk-return profiles,” Nutland said.
“Typically, buffered ETFs do not fit easily into asset allocation-driven investment processes, particularly where a range of risk-profiled asset allocations are being implemented. construction. »
Allan Lane, CEO of Algo-Chain, agreed and said it was “less obvious” that buffer ETFs should be included in a model portfolio offering built on a target risk foundation.
“It is possible to figure out how to add an allocation, but many discretionary fund managers will instead use their own mix of stocks, bonds, commodities and alternatives to deal with the possibility of a sell-off of actions,” he concluded.
Overall, buffer ETFs may have to wait for the widely touted “rise of retail” in ETF usage to recreate the asset-gathering boom seen in the United States.