Buffer ETFs the Real Winners in Active Management, Goldman Says

Fixed income not doing much for you? You can buff that out.

Active ETFs are often marketed as vehicles to beat the market and generate outsized gains. Historically, though, most active strategies have struggled to outperform passive investing over long periods. Goldman Sachs argues advisors may be thinking about the category the wrong way. Instead of replacing core equity exposure, some active ETFs, particularly buffer funds, may work better as substitutes for part of a portfolio’s fixed-income allocation.

Clients generally hold bonds and cash not because they maximize returns, but for ballast. Recessions, layoffs, medical bills, college tuition and home purchases all create a need for stability and liquidity. Proponents say buffer ETFs offer some of that protection, while still keeping investors tied to equity-market upside.

“Defined outcome strategies are a tool for advisors to take clients’ low-risk assets, and instead of tying them to fixed income, where returns are going to be more limited, they can tie them back to the upside in the equity market,” Tim Urbanowitz, chief investment strategist at Innovator ETFs, said at a Goldman event last week.

Young and Old

Rather than a traditional 60/40 portfolio, allocations could evolve toward something closer to 60/20/20, with part of the bond sleeve replaced by defined-outcome strategies. Urbanowitz pointed to expectations that funds tracking the Bloomberg US Aggregate Bond Index could return roughly 4.5% annually over the next decade. Buffer ETFs, by contrast, could provide better returns while still offering some downside protection.

The products are popular among investors nearing or in retirement who want to preserve assets while still participating in market growth. But advisors are also increasingly using them with first-time investors wary of market volatility and ultra-high-net-worth clients sitting heavily in cash, Urbanowitz said. “So many clients out there have a mental hurdle of, ‘I can’t get into the equity market because I have the potential to lose money,’” Urbanowitz said. “The reality is, since COVID, if you didn’t have your money invested, you just lost 25% of the value.”

Issuers First Trust and Innovator, which Goldman finished acquiring this year, have essentially cornered the market:

• At the end of last year, defined-outcome funds from First Trust and Innovator held roughly $40 billion and $28 billion in assets, respectively, according to Morningstar.
• There is the issue of fees, though. A passive bond strategy could have an expense ratio as low as three basis points. Meanwhile, the average fee across Innovator’s buffer ETF is 80.

Breaking Bonds. Morningstar Analyst Zach Evans stressed replacing fixed-income with buffer strategies doesn’t eliminate equity risk. “They could be used as a ballast in a portfolio, however, you’re still highly correlated to the equity market,” he told Advisor Upside. He added that while buffer ETFs are technically active, they tend to act more like passive funds, often following a rules-based strategy instead of on-going securities selections. “From a business perspective, that might mean lower overhead than discretionary management,” he said.