First Trust adds US small-cap ‘Buffer’ ETF-of-ETFs

May 31st, 2024 | By | Category: Equities

First Trust Advisors has expanded its defined outcome investment suite with an ETF-of-ETFs that diversifies across four of the firm’s Russell 2000 ‘Moderate Buffer’ funds.

First Trust adds US small-cap ‘Buffer’ ETF-of-ETFs

Defined outcome ETFs seek to deliver a more controlled investment experience.

The FT Vest Laddered Small Cap Moderate Buffer ETF (BUFS US) has been listed on Cboe BZX Exchange with an expense ratio of 1.10%.

Defined outcome ETFs provide exposure to an index while protecting, or ‘buffering’, invested capital against a pre-determined amount of potential losses over a specific outcome period.

First Trust’s Russell 2000 Moderate Buffer ETFs shield investors from the first 15% of losses in the Russell 2000 over a one-year outcome period.

To achieve their defined outcome profiles, these ETFs invest in FLexible EXchange (FLEX) Options on the iShares Russell 2000 ETF (IWM US). FLEX Options are customizable exchange-traded option contracts guaranteed for settlement by the Options Clearing Corporation.

The downside protection comes at the expense of a cap on the potential upside of each ETF over the outcome period. The cap for each fund is set at the beginning of the outcome period and is dependent upon market conditions (notably implied volatility) at that time.

At the end of each outcome period, the ETFs do not expire but, instead, rebalance and reset, providing investors with fresh buffers and new upside caps dependent on market conditions at that time.

As the Moderate Buffer ETFs have been tailored for their specific outcome period, an investor may encounter a different risk profile if they invest after the outcome period has begun. For example, investors may be exposed to immediate risk on the downside, and have less potential for upside participation, if the ETF has risen between the beginning of its outcome period and when the investor entered the fund.

Similarly, investors could also be exposed to less downside protection, and greater potential for upside participation, if the ETF has fallen between the beginning of its outcome period and when the investor entered the fund.

These dynamics can present a challenge from a portfolio management perspective; however, the newly launched FT Vest Laddered Small Cap Moderate Buffer ETF aims to alleviate much of this complexity by offering a strategy that can be allocated to at any point during the year without regard for the outcome period of the underlying ETFs.

The fund invests equally across four Russell 2000 Moderate Buffer ETFs which have outcome periods with start dates that are staggered throughout the year in February, May, August, and November. The ETF rebalances towards an equal allocation of the four Buffer ETFs each quarter.

By diversifying across the four Buffer ETFs, the FT Vest Laddered Small Cap Moderate Buffer ETF offers a simple means to reduce timing risks over the long term. The rules-based approach does mean, however, that the ETF will always be invested across the four Buffer ETFs even if these funds reach their caps or exhaust their buffers.

Ryan Issakainen, Senior Vice President, ETF Strategist at First Trust, commented: “Risk management remains a top concern for many investors, which helps explain the growing popularity of buffered ETFs. We believe BUFS may be an effective tool for investment professionals seeking exposure to small-cap stocks with lower volatility and some level of downside protection via its underlying ETF holdings.”

Jeff Chang, President of Vest Financial, subadvisor to BUFS, added: “Today’s launch of BUFS may be attractive to investors seeking a risk-diversified way to participate in some of the upside potential of the Russell 2000 Index with a level of protection against losses. BUFS offers a convenient built-in laddered approach that recalibrates a portion of the investment to the prevailing levels of IWM on a rolling basis. There has been a steady increase in demand for risk-diversified buffer investments since 2016 when we introduced the first laddered portfolio of buffer strategies in a registered investment company.”

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