MW These ETFs can help investors protect themselves from selloffs like the DeepSeek panic - but here's the catch

By Isabel Wang

Buffer ETFs have outshined the broader market this week. But investors should understand the trade-off before jumping in, say analysts.

Hello! This is MarketWatch reporter Isabel Wang. Today, we look at buffer ETFs, which have outshined the broader market this week as the DeepSeek panic sent technology stocks tumbling across the board. We also explore leveraged ETFs tied to Nvidia, which have lured investors despite Monday's selloff.

Please send tips or feedback to isabel.wang@marketwatch.com or to christine.idzelis@marketwatch.com. You can also follow me on X at @Isabelxwang and find Christine at @CIdzelis.

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The sudden rise of Chinese AI startup DeepSeek spurred a spike in stock-market volatility VIX this week, just as investors were struggling to navigate a bumpy start to the year amid interest-rate uncertainty and the elevated valuation of some U.S. megacap tech behemoths.

Investors seeking refuge from this trifecta of problems may consider so-called buffer exchange-traded funds to swap some stock-market gains for downside protection. But make sure you understand the trade-off before jumping in, said ETF experts.

The Innovator U.S. Equity Power Buffer ETF PJAN has dropped a modest 0.1% so far this week, while the broader S&P 500 index SPX was off 0.5% and the tech-heavy Nasdaq Composite COMP tumbled 1.4% in the same period, according to FactSet data.

With around $1 billion assets under management, PJAN is one of the most popular U.S.-traded buffer funds tracking the large-cap benchmark index. It is designed to offer protection against the first 15% of the S&P 500's decline over a one-year outcome period. But in exchange, it can only make a 12% maximum return in the same time span, according to Innovator's website.

Other buffer ETFs have also outperformed the broader stock market so far this week. BlackRock's iShares Large Cap Max Buffer Jun ETF MAXJ was off 0.2% this week, while the PGIM S&P 500 Max Buffer ETF PMJA remained flat in the same period, according to FactSet data. Both funds seek to offer a 100% downside hedge to risk-averse investors looking to tap the broader market over a one-year period.

Chinese startup DeepSeek's AI advancement "wakes people up to the fact that the markets can move extremely quickly when valuations are so high," said Tim Urbanowicz, chief investment strategist at Innovator Capital Management. "I don't think it's one of those things where you want to be out of the game, but investors have to think about how they are managing downside risk in this environment."

From MarketWatch archive: Tips for investors considering 'buffer' ETFs to protect against stock-market selloffs

Buffer ETFs, also known as defined-outcome ETFs, use options contracts to limit losses while capping upside potential for the indexes they track. This type of fund has become particularly popular since 2022, when the Federal Reserve hiked interest rates to combat inflation, sending the stock market into a tailspin.

By the end of 2024, there were 358 U.S.-listed buffer ETFs representing around $60 billion assets, up from just 170 such funds in 2022. This ETF category also saw surging investor interest last year, with the entire buffer ETF sector bringing in $14.7 billion in 2024, compared with $11.1 billion in 2022, according to data compiled by CFRA Research.

Aniket Ullal, head of ETF research and analytics at CFRA, said that even though buffer ETFs help manage rather than amplify the risk in the stock market, they are "complex since they require investors to understand details of the reset periods and the remaining caps and buffers on each product."

To be sure, most of the buffer ETFs are designed to be held for the entire outcome period - usually a year or two. Then the funds reset and roll into a new set of options contracts with a new upside cap and the same buffer level. Buying intraperiod is possible, but investors may not get full upside exposure when investing midway through the outcome period, Ullal noted.

"It's important that investors not only look at the upside cap and the downside buffer on the funds' description or the prospectus. They also need to look at what the remaining amount is based on current market conditions. If a lot of the cap has already been used, there might not be much upside left," Ullal told MarketWatch in a phone interview on Thursday.

It's worth mentioning that buffer ETFs are designed for conservative investors as a lower-risk, fixed-income alternative in an investing portfolio.

"Investors are using these strategies as a way to tie their lower-risk dollars, which would have traditionally been in investment-grade fixed income or low-volatility stocks, low-beta stocks or in defensive sectors, and they're tying them back to the broad equity market via the buffer ETFs," Urbanowicz told MarketWatch via phone.

He said that some financial advisors also use buffer funds as a tactic to replace their equity exposure for preretirees - people who are approaching retirement age.

"A lot of those individuals don't have the time to stomach a large drawdown in the stock market ... because if the market or the tech stocks were to fall, investors wouldn't be able to hit their retirement goals, whereas the buffer ETFs could offer them a way to get exposure," he noted.

But for investors who still want to "participate in the market upside," buffer funds may not be the best long-term investment vehicle, especially during a bull market, Ullal said.

Another downside is that buffer ETFs generally charge higher fees than traditional passive funds tracking stock indexes. The average expense ratio for U.S.-listed buffer ETFs was 0.8% in 2024, compared with a less than 0.1% expense ratio for the SPDR S&P 500 ETF Trust SPY and 0.2% for the Invesco QQQ Trust Series I QQQ, according to FactSet data.

Investors piled into leveraged ETFs tied to Nvidia amid DeepSeek selloff

On the flip side of playing it safe, some thrill-seeking investors piled into leveraged exchange-traded funds linked to Nvidia Corp.'s stock $(NVDA)$ amid the DeepSeek rout.

Investors plowed $1.53 billion into the GraniteShares 2x Long Nvidia Daily ETF NVDL on Monday - its largest one-day net inflow on record, according to Dow Jones Market Data.

See: Does DeepSeek spell doomsday for Nvidia and other AI stocks? Here's what to know.

That came despite shares of Nvidia slumping nearly 17% on Monday, after DeepSeek's AI progress raised concerns that its potentially cheaper model could challenge American companies' dominance in the AI sector - and their lofty valuations that have powered the bull market for the last two years. Nvidia saw over $590 billion in market capitalization wiped out on Monday, making it the largest one-day market-cap decline for any publicly listed company on record, according to Dow Jones Market Data.

As a result, NVDL fell over 33% on Monday, while the Direxion Daily NVDA Bull 2X Shares ETF NVDU fell nearly 34% and the T-Rex 2X Long Nvidia Daily Target ETF NVDX was off 33.8%, according to FactSet data.

As usual, here's your look at the top- and bottom-performing ETFs over the past week through Wednesday, according to FactSet data.

The good...

   Top performers                                                                                                                                                                       %Performance 
   KraneShares CSI China Internet ETF                                                                                                                                                   6.3 
   WisdomTree Cloud Computing Fund                                                                                                                                                      5.2 
   iShares China Large-Cap ETF                                                                                                                                                          4.3 
   iShares MSCI China ETF                                                                                                                                                               4.2 
   iShares U.S. Pharmaceuticals ETF                                                                                                                                                     3.8 
   Source: FactSet data through Wednesday, Jan. 29. Start date Jan. 22. Excludes ETNs and leveraged products. Includes NYSE-, Nasdaq- and Cboe-traded ETFs of $500 million or greater. 

... and the bad

   Bottom performers                          %Performance 
   YieldMax NVDA Option Income Strategy ETF   -15.7 
   Invesco Semiconductors ETF                 -11.4 
   VanEck Semiconductor ETF                   -10.3 
   YieldMax TSLA Option Income Strategy ETF   -10.0 
   United States Natural Gas Fund L.P.        -9.6 
   Source: FactSet data 

New ETFs

-- Grayscale on Thursday announced the launch of Grayscale Bitcoin Miners ETF MNRS, which specifically invests in bitcoin-mining companies that generate the majority of their revenue from bitcoin-mining activities or mining-related hardware, software, services, and/or projects, the firm said in a press release.

-- BlackRock BLK on Thursday launched the iShares BBB-B CLO Active ETF BCLO, which invests primarily in a portfolio composed of CLOs rated from BBB+ to B-, according to a press release.

Weekly ETF Reads

-- Bond ETFs slip as Fed Chair Powell waits on White House policies (MarketWatch)

-- Wall Street's Levered ETF Boom Is Near-$1 Billion Money Spinner (Bloomberg)

-- Vanguard's S&P 500 Fund Is About to Become World's Largest ETF (Bloomberg)

-- Memecoin ETFs and Other Crypto News: What Investors Should Know (MorningStar)

-Isabel Wang

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January 30, 2025 18:47 ET (23:47 GMT)

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