Buffered ETF - the product of 2026?

 

For better or worse, the top ETF product for 2026 may be the buffered ETF. At a very general level, a buffered ETF, is one that provides downside protection versus some referenced index. That is, there is a buffer on the losses associated with the ETF. However, in exchange for this protection, the investor wil give-up some of the upside. The market has grown from approximately $5 billion in 2020 to a $90 billion AUM as of the end of 2025.

This type of protection can be achieved by managing the portfolio. There is a cost with having the ETF provide you protection, yet there always seems to be a need for these products. First, the mechanism for offering this protection is systematic and removes emotion from any allocation decision. Second, the timing of the protection is well-defined. Yet the payoff structure is complex and comprises multiple option positions. There are parts of the distribution that are protected or buffered, parts that are exposed to risk, and an upside portion that is capped. The folks at Alpha Architect provide a good overview of the problem. 

Realize that if you want protection from downside risk, there is no free lunch. If you move to cash, you lose the upside. If you buy derivatives, there is a cost. If you allocate to alternatives, you are at the mercy of their return profile. Choose your protection wisely.

What are the big risks of 2026?

Each year, the World Economic Forum provides a global risk perception survey. This is one of the most comprehensive risk surveys, and it provides useful context on what business leaders are thinking about potential disruptions to the global economy. The benefit of this survey is that it provides overall rankings for each year and measures change from the prior year.

By far, the current global risk landscape identifies geoeconomic confrontation as the top risk, followed by state-based conflict. Now, for anyone reading the news, this seems very logical, but it is sobering to see it in print. It has moved up from the eighth spot last year to number one. Along with confrontation, economic downturns, inflation, and bubbles pose key risks. These risks are important in both the short and long term, although climate change is still considered a long-term risk.

What does this mean? First, it is hard to believe that risky assets will continue on the current path with these views. Second, as noted in a recent post, Bonds are not always a safe asset; holding bonds may not provide the desired safety during an armed conflict or war.

 

Credit spreads tells about financial risk

 

The paper, “Credit Spread News and Financial Market Risk,” examines a simple issue. Do the changes in bond spreads tell us something about financial risk that we do not already know? The answer after significant analysis clearly indicates that there is something in credit market pricing that provides insight into the behavior of volatility, as measured by the VIX, realized volatility, and GARCH modeling. If there is a shock to credit spreads, there will be a spillover to higher volatility. Now, this shock effect is centered on recessions, but the evidence is clear. Follow debt markets as another tool to tell you something about financial risk. 

Bonds are not always a safe asset.

The new paper "Are Government Bonds Safe in time of war and Pandemic?" examines the behavior of bonds during periods of war and other non-financialcrises. Not surprisingly, there is a difference. Wars are associated with sharp declines in real returns and with returns that lag growth. The reasons are clear. There is elevated surprise inflation during a war, and governments impose financial repression, which creates a wedge between real returns and grwoth/. The bondholders bear the cost of war, even relative to risky assets. That is not the case during a financial crisis or a pandemic. Pandemics are similar to war in that they entail labor supply constraints, trade restrictions, a surge in spending, and significant increases in central bank balance sheets. 

All risks are not equal. Bonds are not always safe. The assumption that government bodies are always safe will be costly. Now, the war scenario may be easy to adapt to, but the real question is whether there are other government or geopolitical-induced events that are adverse for bonds. That is the real current question. When is the environment not safe for bonds?