The View from the Hill - Perspectives on Markets and Strategies

Large-Cap Growth and Downside Buffer Strategies: Happy Partners in U.S. Equity Allocations
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2020 is stacking up to be another year in which active strategies are struggling to beat cap-weighted indexes, this time with a bundle of volatility along the way. A tilt toward growth stocks was the ticket this year to outperformance. In fact, over the last three years, the answer to how to beat the S&P 500 has been relatively simple—overweight growth stocks and underweight value. Between December 2017 and November 2020, the S&P 500 Growth index delivered annualized returns of 18.9% compared to 5.5% for the S&P 500 Value index and 12.7% for the S&P 500. The Russell 1000 Growth index results were even more favorable at 21.2% vs. 4.7% for Russell 1000 Value and 13.2% for the broader Russell 1000 index. That said, the large-cap growth indexes have a slightly higher risk than the broader cap-weighted benchmarks. And with their recent strong performance, some investors are looking to reduce their growth holdings in favor of more cyclical stocks.

One approach to reaping the benefits of a growth tilt in U.S. large-cap with less downside risk is to partner strategies that emphasize growth stocks with buffer protection strategies, now available through ETFs. To look at the benefits of this approach, we compared the performance and risk of allocating 20%, 30% and 40% weights to a 10% downside S&P 500 buffer protection index and the remainder to S&P 500 or Russell 1000 Growth index exposure. The historical results of this strategy show that this risk-controlled approach allowed investors to capture the outperformance of growth equities while taking risk down to levels below that of the S&P 500 or Russell 1000 index.


Examples and Analysis of Growth + Buffer Indexes

For the analysis here, the Cboe S&P 500 Buffer Protect Index Balanced Series (Ticker: SPRO) represents the buffer protection strategy. The indices have a return history available back through April 2016 (4.7 years). SPRO tracks the returns of a composite, laddered portfolio of S&P 500 10% downside buffer index strategies, holding positions that roll their downside protection range and upside cap every 12 months. These 12 indexes each roll in a different calendar month and have returns capped to pay for the cost of the downside protection. The holdings of SPRO are very similar to the buffer Target/Defined Outcome ETFs available from select sponsors.

To look at the benefits of combining growth and buffer strategies, we evaluate monthly returns for the S&P 500 compared to the S&P 500 Growth Index with a 20%, 30% and 40% weight of SPRO, rebalanced at the end of each month. We do the same thing comparing the Russell 1000 index to the Russell 1000 Growth index combined with 20%, 30%, and 40% weights in SPRO. The historical performance of the S&P 500 balanced index strategies (without commissions or management fees) is shown in Table 1 and Figure 1 below.

Table 1: S&P 500 vs. S&P 500 Growth Plus 10% Downside Buffer Strategy

S&P 500 Growth
80% Growth + 20% Buffer
70% Growth + 30% Buffer
60% Growth + 40% Buffer
S&P 500
Annual Return
Std Deviation

Source: Cboe and Bloomberg

Figure 1: S&P 500 vs. S&P 500 Growth Plus 10% Downside Buffer Strategy

(April 2016 - November 2020)

Source: Cboe and Bloomberg.

It is clear from the exhibit that the strategies partnering U.S. large-cap growth with downside protection have offered diversification benefits that reduce risk, while still allowing investors to capture outperformance to the S&P 500. For example, combining 70% S&P 500 Growth with a 30% position in SPRO, rebalanced monthly, resulted in the outperformance of the S&P 500 by 1.34% while taking risk down a bit more than 10% (from 15.25% to 13.55%). Since these buffer strategies packaged in ETFs typically come with somewhat higher fees than basic index exposure, there may be some slippage in implementation, but even a small weight in a buffer protection strategy like SPRO brought risk levels below that of the S&P 500 index while keeping returns competitive. 

A historical analysis based on the Russell 1000 index shows the same pattern of performance results (see Table 2 below).  Some of the outperformance of a tilt toward growth was retained, but risk was reduced by adding a 20-40% weight in a downside-risk-control strategy.

Table 2: R1000 vs. R1000 Growth Plus 10% Downside Buffer Strategy

R1000 Growth
80% Growth + 20% Buffer
70% Growth + 30% Buffer
60% Growth + 40% Buffer
Annual Return
Std Deviation 16.29%

Source: Cboe and Bloomberg.

For the Russell 1000, the benefits of this approach were even more pronounced since the annualized return of the R1000 Growth index was 21.3% compared to 15.5% for the broader index—a larger return difference than for the S&P 500. The pattern of lowering the risk profile below that of the broader index is consistent with that of the S&P 500 but offers a performance advantage for this historical period.

Figure 2 below shows the cumulative performance for the various S&P 500-based strategies. The benefits of the combined growth and downside buffer index accrued primarily in the last three years when growth stocks began to shift to a higher return advantage relative to value.

Figure 2: S&P 500 Growth & 10% Downside Buffer Strategy vs. S&P 500 Growth / S&P 500

(Cumulative Performance April 2016 - November 2020)

Source: Cboe and Bloomberg.

Also, the higher volatility of 2020 provided an opportunity for the downside buffer strategy to dampen volatility and leave the combined portfolio in a better position to reap the rewards of the market rebound later in the year.


Incorporating the Growth Plus Buffer Approach in Portfolios

Investors face a dilemma in developing strategies for 2021. Should you stick with what has worked over the last several years and retain an overweight to growth/technology stocks? Or should you begin to add more value-oriented equities to large-cap holdings? Alternatively, by adding an allocation to buffer strategies, you can capture a portion of growth outperformance with less risk than a full commitment to growth. The base portfolio for the buffer strategy is the full S&P 500, so you can bring in value exposure via these indexes, while retaining a measure of risk-control for your broad index holding.

Whether you have an active growth strategy or one that is index-based, such as those used in this analysis, it is worthwhile to take a look at combining a growth tilt with a downside buffer approach. You can use the return history of an index like SPRO or other similar Target Outcome indexes, combined with your portfolio returns over the recent years to assess how the approach outlined here could impact your return and risk profile. Going forward, as we move into economic recovery, introducing a buffer protection strategy allocation to your portfolio can provide another option for risk management while allowing you to maintain a tilt to growth.