Structured Protection ETFs vs. Traditional Investments

Structured protection ETFs offer a unique combination of protection and potential returns, setting them apart from traditional investments.

In contrast to traditional investments, structured protection ETFs can provide a guaranteed return of principal, such as $100, at maturity.

These ETFs often have a fixed term, such as 5 years, and can be designed to track a specific market index, like the S&P 500.

Structured protection ETFs can also offer a potential upside, such as 10% returns, if the underlying index performs well.

Investors who want to preserve their capital while still earning a return may find structured protection ETFs appealing.

For example, a structured protection ETF might offer a 5% return, while guaranteeing the return of principal.

Structured Protection ETFs are a type of investment that combines the benefits of a traditional ETF with the added protection of a buffer. They seek to track the share price return of an underlying ETF, such as the iShares Core S&P 500 ETF (IVV), up to an approximate upside cap, while providing downside protection up to an approximate buffer against losses.

iShares offers three types of Buffer ETFs on IVV that seek the following: Max Buffer, offering up to 100% downside protection over a one-year period; Moderate Buffer, providing first 5% downside protection every quarter; and Deep Buffer, offering next 5-20% downside protection every quarter.

Structured Notes work similarly to Buffered ETFs, but without the ETF wrapper. They have the same four components as Buffered ETFs, but offer additional benefits, such as the potential for a higher yield and the ability to hold them to maturity without seeing constant NAV and ETF share-price changes.

Buffered ETFs and Structured Notes can fit in an investor's diversified portfolio, potentially dampening overall portfolio volatility. Investors must weigh their unique risk tolerance and return objectives before buying either vehicle, as Buffered ETFs are generally more standardized while Structured Notes offer a higher level of customization.

The most common type of buffered ETF has a 12-month outcome period, with the range of returns possible over the period defined by the options contracts the fund holds. The downside protection is typically fixed, depending on the strategy, and usually ranges between 10% and 20%.

Structured protection ETFs offer a unique benefit: protection from capital losses. If you hold the ETF for exactly twelve months, you're guaranteed to break even, and any gains are capped at 9.8%.

One thing to note is that these ETFs match the S&P 500's price return, not its total return. This means you won't benefit from dividends or other income the S&P 500 generates.

The protection promise is only applicable if you hold the ETF for the full year, and during that time, it can fluctuate. If you need to withdraw your money before the year is up, you might face losses.

In 2022, many investors learned the hard way that diversifying across stocks and bonds may not be enough to mitigate risk against changing market conditions.

Financial advisors are now exploring alternative options for downside protection.

There are three main reasons investors are seeking more ways to protect their investments:

Some investors are considering Structured Alternative Protection ETFs. These ETFs offer a way to match the S&P 500's return over one year, with gains capped at 9.8%.

However, it's essential to understand the terms and conditions of these ETFs. For example:

Keep in mind that during the 12-month period, the ETF may fluctuate, and if you need to withdraw your funds before the year is up, you might still experience a loss.

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Structured protection ETFs can be a great addition to a diversified portfolio, potentially dampening overall volatility and limiting portfolio drawdowns during bear markets.

Investors must weigh their unique risk tolerance and return objectives before buying these hybrid securities.

Buffered ETFs are generally more standardized, while Structured Notes offer a higher level of customization, but with added complexity.

Structured Notes are a type of protective investment that work similarly to Buffered ETFs, but without the ETF wrapper. They're popular with risk-conscious investors seeking a higher yield from their portfolios.

Structured Notes have the same four components as Buffered ETFs, but they offer additional benefits. Holding them to maturity doesn't involve seeing constant NAV and ETF share-price changes, which can be a relief for investors who want to avoid market fluctuations.

These investments are typically provided by large financial institutions, often major Wall Street banks. This is a key difference from Buffered ETFs, which are products of ETF issuers.

The Structured Notes market has a long-standing history, spanning decades and accumulating to over $3 trillion globally. This level of market presence can provide a sense of stability and security for investors.

Here are the key characteristics of Structured Notes:

Overall, Structured Notes offer a unique combination of customization and market presence that can appeal to investors seeking a higher yield and more control over their investments.

ETFs, or exchange-traded funds, are a type of investment that allows you to buy a small piece of a larger portfolio of stocks, bonds, or other assets.

They're not typical stock or bond funds, but rather something in between, more like alternative investments.

ETFs can be used as a complement to a stock portfolio, or as a bond alternative, or even as an alternative-investment sleeve that zigs when other parts of your portfolio zag.

A super-wide array of ways to use these products is available, making them a versatile option for investors.

They're often purchased by financial advisers on behalf of their clients, rather than individual investors, which might be a good thing.

The stock-bond correlation is a measure of how two securities move in relation to each other. It ranges from +1 to -1, where +1 indicates returns move in tandem, -1 indicates returns move in opposite directions, and 0 indicates no correlation.

Past correlations are not indicative of future correlations, so advisors and investors should be cautious when making decisions based on historical data. This is especially true when considering the stock-bond correlation.

The stock-bond correlation can be calculated over a specific period, such as 12 months, as seen in Chart 1: Stock-Bond Correlation. This chart shows the rolling 12-month correlation of the S&P 500 and Bloomberg US Aggregate Bond indices from 12/31/2013 to 12/31/2023.

Understanding the stock-bond correlation is essential for advisors seeking targeted downside protection for their clients.

Structured protection ETFs are an attractive option for investors seeking customized protection in their portfolios. They offer a wide range of risk and return profiles, making them suitable for both speculative and conservative strategies.

One key difference between structured protection ETFs and their counterparts is customization. While structured notes are highly customizable, tailored to investor preferences, buffered ETFs are standardized and considered "off-the-shelf".

Structured protection ETFs are typically provided by large financial institutions, whereas buffered ETFs are issued by ETF issuers and listed on financial TV. This difference in issuers can impact the market presence of each product, with structured notes having a long-standing history and a market presence of over $3 trillion globally.

The liquidity of structured protection ETFs can be a concern, especially before maturity, whereas buffered ETFs generally have more liquidity during market hours. This difference in liquidity can impact the ease of buying and selling the products.

Here's a comparison of the two products:

Structured protection ETFs can be a valuable addition to a portfolio, especially during volatile markets. Their customizable nature and wide range of risk and return profiles make them an attractive option for investors seeking tailored protection.

Cost is a significant pitfall of buffered ETFs, with an average expense ratio of 0.77%, higher than the typical 0.59% fee for actively managed diversified U.S. stock ETFs.

You need to time your purchase carefully, as it's best to buy these funds within a week of the start of its 12-month stretch, just when the fund rebalances. This is because the buffer and cap will shift depending on the broad market's moves and the fund's net asset value each day.

You should plan to hold the ETF for at least the full year, as the buffer and the cap on any given ETF apply to its full outcome period. If you don't buy at the start of the outcome period, the buffer and cap will shift, making it harder to predict the outcome.

The outcome period of a buffered ETF is fixed, such as April 1, 2024, to March 31, 2025, for the April series of Innovator S&P 500 Buffer ETF. What happens in the interim is immaterial, as all that matters is where the market stands at the end of the outcome period.

At the end of the 12-month period, you may want to consider what to do next with the money in the fund, as you can always do nothing and have your assets automatically roll over to the next year-long period.

Structured protection ETFs can be a game-changer for investors looking to balance risk and reward.

These funds can help mitigate risk by targeting a level of downside protection, in exchange for capping upside potential. This is especially useful for investors who are risk-averse or want to protect their portfolios during market downturns.

Advisors can choose a level of downside protection on the iShares Core S&P 500 ETF suitable for their clients – ranging from 3-15% of potential losses. This flexibility allows advisors to tailor the protection to their clients' specific needs.

Structured protection ETFs can be used strategically in portfolios to gain exposure to equities, and as a complement to fixed income or alternatives. They can also be used as a tactical trade allowing advisors to pursue higher returns.

Here are some key benefits of structured protection ETFs: