Hedged ETFs vs Buffer ETFs

Exchange-traded funds have grown immensely popular among investors due to their versatility, transparency, and cost-efficiency. Two specialized types of ETFs, hedged ETFs and buffer ETFs stand out for their distinct approaches to risk management and potential returns enhancement. Understanding their differences, similarities, and implications are essential for investors looking to align their strategies with specific market conditions and financial goals.

The Stratified LargeCap Hedged ETF (SHUS), for example, utilizes a hedged strategy rather than a buffer strategy because we believe it offers a higher upside market participation level. Let’s dive into these two strategies to determine if hedged or buffer ETFs may align best with your portfolio goals.

 

Hedged ETFs: Balancing Risk and Upside

A hedged ETF is an exchange-traded fund that uses strategies that seek to reduce or eliminate specific risks, (typically currency risks, interest rate risks or market fluctuations) associated with its underlying investments. The goal of a hedged ETF is to provide investors with returns similar to the performance of the underlying assets or indices while minimizing the impact of certain external factors.

Key Features of Hedged ETFs

1. Risk Mitigation
   The primary purpose of a hedged ETF is to reduce exposure to specific risks like currency fluctuations, market downturns, or interest rate changes.
2. Cost of Hedging
   Hedging strategies often involve derivatives [1], SHUS utilizes a put-call spread [2] to generate income to offset the cost of the puts.
3. Targeted Exposure
   Hedged ETFs allow investors to maintain exposure to the desired asset class or region while mitigating unwanted risks.

► Pros of Hedged ETFs

• Potential Reduced Risk: Designed to manage downside risks during adverse movements in currency, interest rates, or markets.
• Alternative Low-Volatility Investments: With increased volatility in duration assets, investors are searching for alternatives for their lower-volatility investments. The reduction in volatility offered by hedged equity creates this alternative for investors. 
• Accessibility: Simplifies complex hedging strategies for individual investors. Allows investors to participate in hedging without having to manage it themselves.

► Cons of Hedged ETFs

• Cost: Hedging expenses can eat into returns, particularly during bullish markets.
• Complexity: Hedged ETFs may involve strategies that may be less intuitive for some investors.
• Strategy Type: Depending on the type of hedging strategy used, a fund’s total return may be limited.

How SHUS Takes Hedging to the Next Level

The Stratified LargeCap Hedged ETF (SHUS) may be ideal for investors seeking exposure to large cap stocks with volatility hedging to manage against market declines. By combining a proprietary equal-sector-weight methodology with a tactical hedging strategy, SHUS aims for growth while minimizing the impact of market downturns.

 

Buffer ETFs: Playing Defense with Caps

A traditional buffer ETF is a type of investment product designed to seek potential protection against market losses within a certain range but at the cost of limiting the potential for gains. These ETFs are structured to appeal to investors who want some participation in the stock market but are cautious about downside risks.

In contrast, uncapped buffer ETFs take a different approach—seeking a predefined level of downside protection while allowing for unlimited upside beyond a certain threshold. This structure may appeal to investors looking to participate more fully in strong bull markets while still maintaining some risk mitigation.

Key Features of Buffer ETFs

1. Potential Downside Protection (Buffer)
   These ETFs seek to protect against a predefined percentage of losses, usually in the range of 5% to 30%. For example, if a buffer ETF has a 10% buffer, it absorbs the first 10% of market losses. If the market declines by more than 10%, the investor will experience losses beyond that buffer.
2. Limited Upside
   To fund the downside protection potential, buffer ETFs cap the potential gains an investor can achieve. This cap varies depending on market conditions and the terms of the ETF. For instance, an ETF with a 10% buffer might have a maximum gain cap of 8%-12%.
3. Defined Outcome Period
   Buffer ETFs typically operate within a defined time frame (e.g., one year). The potential protection and cap apply only within this period. At the end of the period, the terms reset.
4. Options-Based Strategy
   These ETFs use options strategies (such as buying and selling call and put options) to create the buffer and cap structure. The returns are based on the underlying index or asset, adjusted for the option strategy.[1]
5. Underlying Index or Asset
   Buffer ETFs are often tied to broad market indices like the S&P 500, Nasdaq-100, or other asset classes, seeking to provide market exposure with potential protection.

► Pros of Buffer ETFs

• Risk Mitigation: Offers a potential cushion against market downturns.
• Market Exposure: Allows some participation in the market with reduced volatility.
• Transparent Terms: Clearly defined buffers and caps.

► Cons of Buffer ETFs

• Limited Upside: Gains are capped, which could underperform in a strong bull market.
• No Unlimited Protection Potential: Losses beyond the buffer are subject to market risk.
• Complexity: May not be straightforward for all investors to understand.

 

Hedged ETFs vs. Buffer ETFs: Which to Consider?

Both types of ETFs can play critical roles in diversified portfolios by offering sophisticated strategies for managing risk exposure to specific market conditions and personal investment objectives.

When to Consider Hedged ETFs

• You seek higher upside participation while still managing downside risk.
• You’re comfortable with derivatives-based strategies.[1]
• You prioritize managing specific risks like market volatility or currency fluctuations.

When to Consider Buffer ETFs

• You seek a predictable level of potential downside protection for a defined time period.
• You’re nearing retirement and prefer less volatility.
• You’re willing to trade some upside potential for peace of mind.

 

Why These ETFs Matter

Many investors struggle to stay the course with equity investments due to the volatility. Whether you prioritize higher upside potential (hedged ETFs like SHUS) or a predefined level of potential protection (buffer ETFs), understanding their mechanisms, costs, and suitability can empower investors who seek to enhance their risk-adjusted returns. By integrating these strategies thoughtfully, investors can navigate complex market landscapes with greater confidence and precision.

 

To learn more about Stratified’s hedged strategy. View SHUS >>

 

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[1] The use of derivatives or options in the investment strategies may not work as intended and are subject to unique risks that may hinder the achievement of the objectives of these Funds.
[2] A put-call spread is an options trading strategy that involves simultaneously buying and selling put or call options with the same expiration date but different strike prices, aiming to profit from a specific market movement with limited risk and reward.