First Trust launches two ‘buffered allocation’ ETFs

Nov 1st, 2021 | By | Category: Alternatives / Multi-Asset

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First Trust has extended its suite of defined outcome strategies with the launch of two so-called ‘Buffered Allocation’ ETFs, funds-of-funds that invest across the firm’s S&P 500 Target Outcome ETFs.

First Trust launches two Buffered Allocation ETFs

Defined outcome ETFs provide exposure to an index up to a pre-determined cap while protecting invested capital against a pre-determined amount of potential losses over a specific outcome period.

The FT Cboe Vest Buffered Allocation Defensive ETF (BUFT US) and FT Cboe Vest Buffered Allocation Growth ETF (BUFG US) have been listed on Cboe BZX Exchange.

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 offers two different approaches within its S&P 500 Target Outcome ETF suite. Its ‘Buffer’ ETFs shield investors from the first 10% of losses in the S&P 500 over a one-year outcome period, while its ‘Deep Buffer’ ETFs cater to investors seeking stronger risk management by protecting against 25% of losses between -5% and -30% over a one-year outcome period.

To achieve their target outcome profiles, these ETFs invest in FLexible EXchange (FLEX) Options on the SPDR S&P 500 ETF (SPY 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 new upside caps dependent on market conditions at that time.

As Target Outcome ETFs have been tailored for their specific outcome period, an investor may encounter a different risk profile if they invest in the ETF 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. The newly launched Buffered Allocation ETFs aim 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.

Each Buffered Allocation ETF is actively managed by Cboe Vest which allocates the ETFs’ assets to a mix of underlying Target Outcome ETFs based on various factors including remaining upside cap/buffer levels, the number of days left in the outcome period, the NAV of each ETF, implied market volatility, the current price of SPY, and the price sensitivity of the underlying FLEX Options to price movements of SPY.

Each Buffered Allocation ETF will typically hold between five and seven underlying funds including both Buffer and Deep Buffer ETFs. The portfolios will be evaluated on a monthly basis.

The FT Cboe Vest Buffered Allocation Defensive ETF is designed for investors seeking a greater degree of downside risk management, with reduced potential for upside participation, while the FT Cboe Vest Buffered Allocation Growth ETF offers less of a downside buffer with greater potential for growth.

Each ETF comes with an expense ratio of 1.05% which consists of a 0.20% management fee as well as 0.85% in acquired fund fees for investing in the underlying ETFs.

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