Expert explains the upsides and downsides of buffer fund ETFs

Innovator ETFs Co-Founder and CEO Bruce Bond joins Yahoo Finance Live to explain how investors are turning to buffer fund ETFs in order to mitigate their losses and what to know about these types of ETFs.

Video transcript

- All right. Well, investors looking for a safe haven during a difficult year for the markets have turned to so-called buffer funds. Now, these funds have attracted around $6 billion in inflows this year. Innovator ETFs co-founder and CEO Bruce Bond joins us now for this week's ETF report brought to you by Invesco QQQ. Good to have you on the show. So first off, give us an idea of, in terms of these buffer funds, what are the pros and cons? And who is really pouring into this right now?

BRUCE BOND: OK. Yeah. I'd be happy to do that. Thanks for having me, Rochelle. The idea between the buffer funds, just in case you haven't heard about them, is that there's a 9% buffer, a 15% buffer, and a 30% buffer. And what that means-- these are based on the S&P 500. We have others. But just consider the S&P 500. And then over the next year, if the market's down 9%, you don't lose. If you would be down 10%, you would lose 1%. So same thing for the 15. You're buffered for the first 15% of losses and so on. The 30%, you're buffered for 30% of the losses.

And so the people that are using these are people that typically have owned a 60/40, and they're just very concerned about-- I mean, bonds and stocks have been correlated here over, really, since January. Both are down significantly and have lost money in people's portfolios. And they're trying to figure out what to do.

Whereas if you look PSEP, which would be our power buffer from last September, the market's down. The S&P 500 is down about 12%. Well, that 15% buffer isn't down at all. Only the amount of the management view, which is about 79 basis points. So people are like, well, instead of being down 12%, or even in the AG, the AG is down 13%, they're saying, hey, I'd much rather own something linked to the equity market that has a buffer built in to give me some protection on the downside.

- But what is the downside, Bruce, of these funds?

BRUCE BOND: Well, I think that the downside would be if the market is up substantially. So you have a downside buffer. But you have to give up some of your upside performance. Now, to give you an idea, in the buffer, which has the 9% downside buffer, you get 22.5 about percent of the upside for the September issue, which will be resetting tomorrow morning. And so you can buy that. You're going to get 22 and 1/2% of the upside. But you're going to have a 9% buffer. On the 15% buffer, you get 16.81% of the upside with a 15% buffer. And then for the 30%, buffer you get 13 and 1/2% of the upside with a 30% buffer on the downside.

So the downside is that the market may go up more than the buffer. And that is really the only downside for you. But the huge benefits of the upside for you is the known outcome. Now you know if you buy and you get a 9% buffer on the downside, you think to yourself, OK, do I think the market's going to go down another 9%? Yeah. It could. It could down 10%. But it could go up too. Who knows right now, right? You can get 22 and 1/2% or 22.51% of the upside with a 9% buffer on the downside.

So that is really, if you think about it, you're going to match the market one for one on the upside up to the cap. And then you don't go above the cap. That's your risk. So you're going to meet the market on the upside to the cap. But then on the downside, you have a buffer built in. And you're going to tend to outperform on the downside and equal on the upside to the cap.

- Bruce, have you noticed any trends just in terms of who is buying these buffer ETFs? Is it people that are maybe closer to retirement? They want to limit some of the risk that's in their portfolio. Or have you maybe not seen any trend just in terms of who is buying these ETFs?

BRUCE BOND: No, that's a great question. We have seen some trends. And, initially, it was people close to retirement if you think about it, if you own a 60/40 portfolio like VBIX and it has a 60/40 allocation, you're down 15% this year. Most people in retirement-- or since last September, most people in retirement, they don't want to take that kind of hit in their portfolio. And they would rather have a downside buffer against losses against the market and get some of the upside.

What we're finding is that many investors are willing to give up some upside-- they may not give up any upside-- just above the cap. They're willing to give up [INAUDIBLE] performance in order to have a known buffer on the downside. And we're seeing that, really, across the board now. It might have started with people that were close to retirement.

But now people are thinking, OK, I'm going to use this kind of as a third asset. Maybe you have equities and bonds. But then you also have buffers in there. They give you equity exposure but with a downside level of protection against losses. And most people don't know this type of thing is available to them. Innovator was the first ones to bring this out. And I think the market has kind of spoken with the amount of flows we've seen, especially over the last year or so.

- Yeah, Bruce. About $6 billion of inflows so far this year. So certainly a sector here of ETFs that is gaining in popularity. Bruce Bond, thanks so much for joining us today.