Managers & Models

First Trust Buffer ETF

Many advisors like the ability to achieve market upside but are looking for ways to protect against a sudden change in markets should we enter a recession, while not necessarily being able to predict it.

The First Trust Buffer ETF model seeks to provide investors with a buffer against downside losses, while still participating in the upside potential of the market up to a limit, or cap. Buffer ETFs do this by using options contracts to create a downside buffer while offsetting that cost by selling against an upside limit. They may also be suitable for investors who are new to investing and are looking for a more conservative investment option.

The First Trust Buffer ETF model is invested with the S&P 500 as the underlying asset, while employing options to create different buffer levels, typically ranging from 10% to 20%. This means that the model is designed to protect investors against the first 10% to 20% of losses in the underlying index. The cap and buff­er are reset at the end of each Target Outcome Period, however, the funds may be held indefinitely, providing investors a buy and hold investment opportunity.

Minimizing Loss with a Downside Buffer

Losses can have a greater impact on investments than gains because the money remaining after the loss must work harder to get back to its original level. The math of percentages shows that as losses get larger, the return necessary to recover to the break-even point increases at a much faster rate. A loss of 10% necessitates an 11% gain to recover. Increase that loss to 25%, and it takes a 33% gain to get back to break-even. A 50% loss requires a 100% gain to get back to where the investment value started.

The First Trust Buffer ETF model may encourage investors to stay invested by providing a defined buffer against potential losses. Traditionally, investment strategies that o­ffer specific payoff­ profiles have been o­ffered through structured products, typically issued by banks or other financial institutions. The Buffer model offers a way to gain access to outcome-based investing — specifically to bu­ffer against a level of downside risk while allowing growth to a maximum cap — eliminating structured product bank credit risk in a convenient, flexible investment vehicle.

Here are some of the potential benefits of investing in the First Trust Buffer ETF model:

• Downside protection: Buffer ETFs provide investors with a buffer against a portion of downside losses. This can be helpful for investors who are concerned about the risk of losing money in the market.
• Upside potential: Buffer ETFs still allow investors to participate in a portion of upside potential of the market. This means that investors can still earn money if the market goes up.
• Diversification: Buffer ETFs can help investors to diversify portfolios. By investing in a buffer ETF, investors can gain exposure to a variety of different stocks and sectors.
• Liquidity: Buffer ETFs are traded on exchanges, so relatively liquid. This means that investors can easily buy and sell this model at any time.