By Paul R. La Monica

The drop in semiconductor stocks and the broader tech sector Tuesday should serve as a stark reminder to investors of the need for having some downside protection. Enter buffered funds.

Buffered funds, also known as defined outcome funds, typically buy put options on a particular index to help cap losses. An exchange-traded fund with a 10% buffer on the S&P 500, for example, protects investors from the first 10% drop in the index over a specified time period, often 12 months. If the ETF falls more than the buffer, investors lose money -- but it's a smaller loss. An index fund with a 10% buffer would be down around only 5% if the broader market fell 15%.

Just look at the performance of the largest buffered ETF in the last bear market. First Trust's FT Vest Laddered Buffer ETF, which has nearly $10 billion in assets and is designed to protect investors from a 10% loss in the S&P 500, fell just 7.6% in 2022 while the S&P 500 tumbled 19.4%. The fund owns the 12 FT Vest funds that have a target outcome period which ends in specific months, such as the FT Vest U.S. Equity Buffer ETF -- June and FT Vest U.S. Equity Buffer ETF -- July.

But there's a cost to these funds when stocks are rising. Buffered ETFs also sell call options at a specific strike price to pay for the downside protection. That means that gains are capped at the strike price, which limits upside in bull markets.

To that end, the FT Vest Laddered Buffer ETF is up 16% in the past 12 months and 47% for the past three years, compared with 21% and 70% gains for the S&P 500 over the same period. The FT June ETF has gained 12.5% and 45% during the past 52 weeks and three years.

Two other popular First Trust buffered products have lagged behind their benchmarks too. The FT Vest Laddered Deep Buffer ETF has gained just 13% and 39% over the past year and three years. And the FT Vest Laddered Nasdaq Buffer ETF is up 19.5% and 57.5% over the past 12 months and three years, while the Nasdaq 100 is up 35.7% and 101% during the same time periods. First Trust wasn't immediately available for comment about the performance of these funds.

Still, buffered ETFs are growing in popularity. With broader market volatility increasing and valuations for leading stocks becoming more steep, some investors are seeking out safety -- even though they understand that buying these funds may limit their gains.

Other fund companies said investors are looking to buffer funds as a way to spread their bets.

"A lot of institutional investors and advisors are focused on diversifying more than anything. Buffered ETFs can be an alternative to bonds," said Charles Champagne, head of ETF strategy at AllianzIM, which offers a suite of buffered funds.

Champagne added that some investors are looking to replace traditional 60% stocks and 40% fixed income portfolios with ones that have 60% equities, 20% bonds and 20% in buffered ETFs.

And Goldman Sachs recently acquired Innovator Capital Management, the provider of the Innovator ETFs family of defined outcome funds, such as the Innovator Defined Wealth Shield ETF.

Innovator ETF President Graham Day said at a Goldman Sachs Asset Management event in late May that "ultra-high-net-worth clients want more risk management and are willing to give up some upside for more certainty."

Other asset managers say clients want the ability to cap losses too, even if it means missing out when the market is rallying hard.

John Davi, founder and CEO of Astoria Portfolio Advisors, said in a report in May that clients are "increasingly seeking portfolios with more clearly defined outcomes, particularly in an environment where market volatility, elevated valuations, and macro uncertainty remain top of mind."

Davi added that "this trend has fueled significant interest in buffered ETFs" over the past few years. Astoria launched a hedged growth fund for separately managed accounts in late 2020 that offers strategies similar to buffered ETFs. The fund fell 12% in 2022 -- less than the broader market. It has been up between 5% and 11% in the other years since its inception. So this fund, like buffered and other defined outcome funds, has lagged behind the S&P 500 for the most part.

The takeaway? If you're really worried that the AI-fueled rally is a bubble that is about to pop and bring down the entire market with it, then buffered ETFs will help you sleep at night. You'll still participate if the market keeps climbing too, but the gains won't be as big. It's a trade-off that some risk averse investors who don't suffer from FOMO are clearly willing to take.

Write to Paul R. La Monica at paul.lamonica@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

June 23, 2026 13:34 ET (17:34 GMT)

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