Guide to the
Target Buffer Strategy

We buy protection on our homes, on our cars and even on our lives. However, in any given year with a 20% chance of market loss, why don’t more investors protect their investments?

When will the next pullback occur, or when will interest rates or inflation rise? While it’s not possible to predict the future, there are ways to prepare for it.

The Target Buffer Strategy seeks to protect equity investors from losses with a contractual level of certainty (“contractual certainty”) that is simply not possible with a 60/40 allocation or market timing. The contractual certainty comes from options, which we will explore further. To understand the contractual nature of options and why it matters, click here.

The Target Buffer Strategy aims to protect an investment through the use of options, which have contractual features that provide a formulaic payment based on the performance of a reference asset. The payment for options is dependent on the performance of the reference index being above (in case of a call option) or below (in case of a put option) a predetermined price (strike price) on a specific date in the future (exercise date). The contractual nature of options makes them similar to personal property insurance contracts, as they make a payment on a future date that is contingent on an event taking place.

The Target Buffer Strategy is constructed from a combination of call and put options with an expiry corresponding to the outcome period, overlaid on an exposure to the reference asset. The overlay strategy has two components, as illustrated in the following example where the reference asset is the S&P 500 and the downside buffer is 0 to -10%.

The Target Buffer Strategy can fit in two places in an investor’s portfolio:

• Low Risk/Hedged Equity

  A common way to reduce downside risk is to lower the allocation to equities. However, this creates the risk of missing out on potential upside. The Buffer Strategy, in contrast, seeks to deliver some potential upside from equities with reduced downside risk, allowing investors to stay persistently invested.

• Alternatives

  The Buffer Strategy’s risk/return characteristics provide lower downside risks through capping some upside, similar to alternative investments such as hedged funds. As a result, the Buffer Strategy may be used as a potentially cost-competitive replacement to hedge funds.

Fixed-term Target Buffer Strategies with varying levels of protection can be “blended” or combined to achieve specific risk objectives and/or potentially improve the risk/return of multi-asset portfolios.

For example, an investor may invest in an 80%/20% blend of “Buffer” (0 to -10% protection) and “Deep Buffer” ( -5% to -30% protection) Strategies, respectively, beginning in a specific month, in pursuit of a specific risk objective.

The Target Buffer Strategy is designed to protect an investment over a specific outcome period, and its value is determined by the price of the reference asset at the end of the period. Because Target Buffer ETFs and mutual funds offer liquidity and price transparency, investors have the flexibility to purchase or sell them during the outcome period.

These “intraperiod investors”—who invest in the strategy after it starts, or sell before it ends—will, however, have different outcomes than individuals who invested at the inception and held the Target Buffer ETFs or mutual fund until the end of the outcome period.