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Manage Downside Risk with a Buffered Outcome ETF Strategy

Max Chen
·5 mins read

This article was originally published on ETFTrends.com.

Investors seeking to diversify their investment portfolios can consider an approach to risk management through exchange traded funds that incorporate a type of buffered strategy to help mitigate risk and reduce volatility.

"In the new decade, investors are facing an unprecedented market dynamic defined by persistent volatility, historically low-interest rates, and a global health crisis," Greg Goin, Risk Management Consultant, Allianz Life Insurance Company of North America, said in the recent webcast, Keep Calm and Buffer On: Seeking Stable Returns in Volatile Markets.

Since 1957, calendar year returns for the S&P 500 have been positive 45 times and negative 18 times. Full year negative returns for the benchmark occurred 29% of the time. Negative returns for the year also exceeded 10% nine times and 20% three times. The number of daily 1% moves up or down in the S&P 500 so far in 2020 was 68 times, compared to the historic average of 62.

"Typically investors do not come into your office and complain about upside volatility, nor do they thank you for providing them with that fantastic return last year, they certainly don’t ask how you did it either. What they do care about is downside volatility and are more concerned with how to navigate that," Goin said.

Looking ahead, Goin warned that the persistently low interest-rate environment presents a challenge to traditional 60/40, equity/fixed-income approaches. The low rates present a challenge to investors whom are starved for yield, and in this environment, traditional bond exposure also did not perform their primary function for being included in a portfolio: that being safety and diversification to equities. According to J.P.Morgan Portfolio Trends Insights, the five most frequently used bond funds among portfolios earlier this year were down 8% on average during the previous 18-months, compared to the Bloomberg Barclays U.S. Aggregate Bond Index’s loss of just 1%.

Meanwhile, investors have exhibited a heightened sense to loss in the current environment. According to the Allianz Q2 2020 Quarterly Market Perceptions Study, seven in 10 participants say the impacts of the COVID-19 pandemic are making them rethink how to protect their retirement savings from volatility, 60% believe they need to accumulate more retirement assets but are too nervous to invest in the market, 66% are keeping money out of the market to protect it from loss, and 55% admit they are keeping too much out of the market.

As a way to help investors better mitigate risk and reduce volatility in a portfolio, Allianz Investment Management LLC (AllianzIM), a wholly-owned subsidiary of Allianz Life Insurance Company of North America (Allianz Life), has come out with a suite of buffered outcome ETFs, including the AllianzIM U.S. Large Cap Buffer10 Apr ETF (NYSE Arca: AZAA), AllianzIM U.S. Large Cap Buffer20 Apr ETF (NYSE Arca: AZBA), AllianzIM U.S. Large Cap Buffer10 Jul ETF (AZAL) and AllianzIM U.S. Large Cap Buffer20 Jul ETF (AZBL).

The new Allianz ETFs suite is "designed to bring the in-house hedging capabilities and track record of Allianz Investment Management LLC to the retail investor," Goin said.

The AllianzIM Buffered Outcome ETFs are a series of active (transparent) funds that seek to generate more consistent and stable returns by participating in growth potential of an equity index to a Cap and providing a level of risk mitigation, with a downside Buffer. Each fund continues indefinitely. When the end of the Outcome Period is reached, the fund automatically begins a new Outcome Period. The new Outcome Period will have a new Cap that is based on current market factors and may be higher or lower than the previous term.

"The buffer ETFs launched are primarily for investors that are, simply put, looking to manage risk with confidence in a liquid product, and the main investor profile does not surprisingly include individuals that are either nearing or in retirement," Goin added.

Joanna Kanakis, Strategic Relationship Manager, Halo Investing, argued that incorporating a buffered strategy into an investment portfolio provides a smarter baseline, smarter decisions and smarter management for investors. The strategy helps provide a rules-based baseline to limit losses or improve downside protection.

Goin explained that when investing in AllianzIM Buffered Outcome ETFs, there are four possible outcome scenarios for the Outcome Period: Index losses exceed buffer. Index losses are within buffer. Index returns are within cap. Index returns exceed cap

Goin also highlighted three cases where investors may utilize the Buffered Outcome ETFs in portfolio construction. Firstly, the investor seeks to reduce their portfolio’s volatility by de-risking their equity position, and they reposition a portion of domestic equity to potentially help reduce downside risk/volatility and maintain a level of equity upside. Secondly, the investor wants to increase their return potential by diversifying a traditional allocation, so repositioning a proportionate share of a balanced portfolio can potentially help increase equity exposure and preserve risk targets. Lastly, a Buffered Outcome ETF can help the investor stay invested if they shift cash off the sidelines, which increases their market exposure up to a cap while maintaining a level of risk mitigation.

Financial advisors who are interested in learning more about ways to mitigate risk and diversify a portfolio can watch the webcast here on demand.

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