Buffing Out Volatility
Buffer exchange-traded funds may promise protection, but historical data suggests a natural buffer already exists.
You can hardly open your inbox these days without receiving an email about buffer exchange-traded funds. Also known as “defined outcome strategies,” buffer ETFs offer a way to hedge downside equity risk in exchange for lower participation during market upswings. There is typically a downside protection amount (the “buffer”), ranging from 10% to 100%, and a capped potential upside over a set period, typically one year.
Softening the blow during equity market downturns is appealing for most investors. However, we already have a well-established asset category to help achieve this: fixed income. Historically, fixed income investments across a wide range of sectors have had a positive average return when equities have had a negative return. Since 1976, for example, the Bloomberg US Aggregate Bond Index had an average return of 4.53% in years when the S&P 500 Index had a negative return.
Some have questioned the diversifying benefit of fixed income based on recent episodes of rising correlations between stocks and bonds. It’s important to remember that short-term past correlations do not predict future correlations, and historical data shows that the volatility reduction benefit has been insensitive to the correlation between stocks and bonds.
Investors who are worried about equity volatility can benefit from a fixed income allocation—and redirect unwanted buffer ETF emails to the junk mail folder.
EXHIBIT 1
A Natural Buffer: Average Calendar-Year Returns When the S&P 500 Index Return Was Negative
1976–2024
Disclosures
The information in this material is intended for the recipient’s background information and use only. It is provided in good faith and without any warranty or representation as to accuracy or completeness. Information and opinions presented in this material have been obtained or derived from sources believed by Dimensional to be reliable, and Dimensional has reasonable grounds to believe that all factual information herein is true as at the date of this material. It does not constitute investment advice, a recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. Before acting on any information in this document, you should consider whether it is appropriate for your particular circumstances and, if appropriate, seek professional advice. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized reproduction or transmission of this material is strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein.
This material is not directed at any person in any jurisdiction where the availability of this material is prohibited or would subject Dimensional or its products or services to any registration, licensing, or other such legal requirements within the jurisdiction.
“Dimensional” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd., Dimensional Japan Ltd., and Dimensional Hong Kong Limited. Dimensional Hong Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services.
RISKS
Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.
CANADA
These materials have been prepared by Dimensional Fund Advisors Canada ULC. The other Dimensional entities referenced herein are not registered resident investment fund managers or portfolio managers in Canada.
This material is not intended for Quebec residents.
Commissions, trailing commissions, management fees, and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Unless otherwise noted, any indicated total rates of return reflect the historical annual compounded total returns, including changes in share or unit value and reinvestment of all dividends or other distributions, and do not take into account sales, redemption, distribution, or optional charges or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated.
Resources
