First Trust Advisors has begun rolling out a new series of Target Outcome ETFs focused on the US small-cap equity market.

Target Outcome ETFs offer a risk-controlled approach to equities investing.

The FT Cboe Vest US Small Cap Moderate Buffer ETF – May (SMAY US) has been listed on Cboe BZX Exchange with an expense ratio of 0.90%.

Target Outcome investing refers to an investment strategy that shapes the potential outcomes of a reference asset or index to fit specific protection and return levels, allowing for a more controlled investment experience.

The risk-controlled approach has soared in popularity in recent years as investors have sought to navigate increasingly uncertain equity markets – First Trust’s Target Outcome suite housed over $9.5 billion in total assets at the end of April 2023.

Ryan Issakainen, Senior Vice President, ETF Strategist at First Trust, said: “History has shown that remaining disciplined in the face of heightened market volatility has been critical for investors achieving their long-term goals. Target Outcome ETFs have grown increasingly popular among investment professionals because they are an effective tool to help clients gain exposure to stocks, while also mitigating downside risk.”

Investment approach

SMAY is actively managed by Cboe Vest Financial, the fund’s sub-advisor, in line with a systematic rules-based model.

The ETF aims to shield investors from the first 15% of losses on the Russell 2000 Index over a one-year outcome period. The initial outcome period runs until 17 May 2024.

To achieve its target outcome profile, SMAY invests in FLexible EXchange (FLEX) Options – customizable exchange-traded option contracts guaranteed for settlement by the Options Clearing Corporation – on the iShares Russell 2000 ETF.

SMAY’s downside protection comes at the expense of a cap on its potential upside over the outcome period. The cap is set at the beginning of the outcome period and is dependent upon market conditions at that time. According to First Trust, the initial cap for SMAY is 17.76% before fees and expenses.

All of First Trust’s Target Outcome ETFs have a perpetual structure meaning that, once an outcome period ends, a new target outcome period begins with the cap and buffer reset.

Investors should note that, as the target outcome profile has been tailored for the entire outcome period, this may affect the ETF’s interim returns during the outcome period in two ways.

Firstly, due to the time value of the underlying options, the ETF is likely to exhibit a lower beta than traditional index-tracking ETFs. As such, it may lag the performance of its reference ETF when markets are trending upwards.

Secondly, SMAY is designed to avoid the initial 15% of losses of the Russell 2000 Index as referenced from the start of its outcome period. An investor who purchases shares of SMAY after the outcome period has begun may be immediately exposed to downside risk in so far as the Russell 2000 Index has appreciated since the start of the outcome period.

While these dynamics can present a challenge, First Trust provides full daily disclosure for each of its Target Outcome ETFs including remaining cap and buffer levels, remaining downside before buffer, and remaining days in the outcome period.