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Courtesy of Innovator ETFs, the first batch of defined outcome exchange traded funds debuted in 2018. Today, that corner of the ETF market has about $70 billion in assets under management.
That confirms more asset allocators and investors are embracing these funds. One reason for the popularity of these products is that they’re easy to explain to clients. Put simply, defined outcome ETFs provide some upside capture while providing downside protection.
More growth is on the way. In a new white paper published by Cerulli Associates and Innovator, the parties forecast significant growth for defined outcome ETFs over the next several years, confirming advisors are likely to widen their embrace of these products.
“New Cerulli research finds that significant tailwinds such as home-office approvals at large broker/dealers could accelerate asset growth in the Defined Outcome exchange-traded fund (ETF) category to a 29% to 35% five-year compound annual growth rate (CAGR). In the more optimistic scenario, Defined Outcome ETFs™ are projected to more than quadruple over a five-year period, reaching more than $334 billion assets under management by 2030,” according to the research firm.
Clients Like Defined Outcome ETFs
As advisors know, some clients are comfortable with risk, but others are not. That doesn’t mean those in the latter camp don’t want upside exposure. Of course they do. Defined outcome ETFs can bridge the divide between “all in” and zero risk.
Said another way, investors are often more fearful about losing money than they are optimistic about making it. That’s one reason why put options are typically more expensive than calls and that element of behavioral finance speaks to the utility of defined outcome ETFs.
“According to a recent Cerulli survey of individual, affluent investors, almost three-quarters (68%) prefer a portfolio that limits their downside risk, even if it means giving up some upside potential,” adds the research firm.
Another reason why defined outcome ETFs are gaining traction among advisors is that these vehicles may be superior to some of the risk-reducing alternatives long favored by the wealth management community. Assuming that superiority shines through over the long-term, client outcomes will be enhanced and that’s always a good thing.
“Traditional risk mitigation strategies may offer diversification and stability, yet they often fall short on providing the certainty that clients increasingly seek,” observes Cerulli. Some advisors have also adopted risk mitigation products such as structured notes or variable annuities in their client portfolios to build client confidence, but many find these products to be costly and restrictive, due to high minimums and long lock-up periods.”
Defined Outcome ETF Growth Wave Just Starting
As noted above and confirmed below, defined outcome ETFs are in the nascent stages of what’s expected to be a multi-year tidal wave of growth.
(Image Courtesy: Cerulli Associates)
A catalyst for defined outcome ETF would be more advisors and investors turning to these products over fixed income funds for risk mitigation. Cerulli points out that taxable bond funds represented 16% of total ETF assets under management as of the end of the third quarter – enough for buffer ETFs to potentially pilfer some share.
It remains to be seen if defined outcome ETFs wrest assets from fixed income rivals, but the former do provide income and more upside capture while checking the risk reduction box.
“A solution with downside protection and no upside cap, for example, may alleviate an investor’s fears about wealth erosion as it leaves a door open to market participation,” concludes Cerulli. “While difficult to model, should such a swing in advisor and investor preference take shape, it could unlock access to hundreds of billions in additional assets that can shift to Defined Outcome ETFTM solutions.”
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