First Trust has expanded its defined outcome investment suite with an ETF-of-ETFs that diversifies across four of the firm’s international equity ‘Moderate Buffer’ funds.
The ETF simplifies diversified international equity investing with built-in downside protection.
The FT Vest Laddered International Moderate Buffer ETF (BUFY US) has been listed on Nasdaq with an expense ratio of 1.10%.
Defined outcome ETFs provide exposure to an index while protecting, or ‘buffering’, invested capital against a pre-determined amount of potential losses over a specific outcome period.
First Trust’s international equity Moderate Buffer ETFs shield investors from the first 15% of losses in the underlying MSCI EAFE index over a one-year outcome period.
To achieve their defined outcome profiles, these ETFs invest in FLexible EXchange (FLEX) Options on the iShares MSCI EAFE ETF. FLEX Options are customizable exchange-traded option contracts guaranteed for settlement by the Options Clearing Corporation.
The downside protection comes at the expense of a cap on the potential upside of each ETF over the outcome period. The cap for each fund is set at the beginning of the outcome period and is dependent upon market conditions (notably implied volatility) at that time.
At the end of each outcome period, the ETFs do not expire but, instead, rebalance and reset, providing investors with fresh buffers and new upside caps dependent on market conditions at that time.
As the Moderate Buffer ETFs have been tailored for their specific outcome period, an investor may encounter a different risk profile if they invest after the outcome period has begun. For example, investors may be exposed to immediate risk on the downside, and have less potential for upside participation, if the ETF has risen between the beginning of its outcome period and when the investor entered the fund.
Similarly, investors could also be exposed to less downside protection, and greater potential for upside participation, if the ETF has fallen between the beginning of its outcome period and when the investor entered the fund.
These dynamics can present a challenge from a portfolio management perspective; however, the newly launched FT Vest Laddered International Moderate Buffer ETF aims to alleviate much of this complexity by offering a strategy that can be allocated to at any point during the year without regard for the outcome period of the underlying ETFs.
The fund invests equally across four international equity Moderate Buffer ETFs, which have outcome periods with start dates that are staggered at quarterly intervals throughout the year. The ETF rebalances towards an equal allocation of the four Moderate Buffer ETFs on a quarterly basis.
By diversifying across the four Moderate Buffer ETFs, the FT Vest Laddered International Moderate Buffer ETF offers a simple means to reduce timing risks over the long term. The rules-based approach does mean, however, that the ETF will always be invested across the four Moderate Buffer ETFs even if these funds reach their caps or exhaust their buffers.