For years, advisors could count on one basic portfolio relationship: When equities sold off, high-quality bonds helped cushion the decline. That relationship has grown less reliable. According to Dow Jones Market Data, the 40-day rolling correlation between the S&P 500 and the Bloomberg U.S. Aggregate Bond Index has climbed to its most positive level since 1999.

For investors looking for a return to normality, the Federal Reserve's 25-basis-point interest-rate hike wasn't especially encouraging. Both asset classes initially weakened after Fed chair Kevin Warsh reinforced a hawkish outlook during his press conference and markets began pricing in the possibility of additional rate hikes before year-end.

Fixed income remains an essential portfolio building block, but if bonds aren't offering the downside protection they used to, where should investors look instead?

A complement, not a replacement. Buffered ETFs use options to help cushion downside while keeping investors invested in equities, adding a line of defense alongside fixed income. Also known as defined outcome ETFs, they complement traditional fixed income by adding defined downside protection from the equity side of the portfolio instead of depending on bonds alone to offset market declines.

That's an attractive pitch in today's uncertain markets. The challenge is implementation because for many advisors, whether they work independently or within firm-approved model portfolios, investment policy guidelines often prescribe how much of a client's portfolio must remain in fixed income.

Those guidelines may, for example, require a 30% allocation to high-quality bonds, cap allocations to alternatives, or establish minimum bond exposures by client risk profile. Because these parameters are typically set by an investment committee or home office rather than the individual advisor, advisors can have limited flexibility to adjust fixed-income exposure.

The more workable path is to leave the bond sleeve untouched and swap a portion of core equity into a buffered ETF instead. The buffer supplies its own hedge to provide downside protection, freeing up room to take on modest credit risk in the bond sleeve for extra yield. If equities and bonds fall together again, that buffered position in the equity sleeve can still dampen the drawdown, even though the bond mandate never moved.

Calming investor jitters. Defined outcome strategies have several uses beyond replacing fixed income. Some advisors use them to keep clients invested during volatile stretches instead of moving to cash after a selloff. A defined outcome position won't quiet the day-to-day price swings and headlines that rattle a client's confidence, but it can take enough edge off the ride that clients are less likely to sell into a drawdown they could have ridden out.

Amid the tariff-driven market volatility in the first six months of 2025, for example, advisors reluctant to move clients to cash used buffered ETFs to keep equity exposure intact while adding guardrails to help mitigate the drawdowns.

Other advisors use them with clients waiting on the sidelines for a more comfortable entry point. Money-market fund assets hit a record $8.28 trillion in late May, and remained near that record at $7.89 trillion by mid-July, per Investment Company Institute data. For clients holding some of that cash, a buffered ETF seeks offers a defined level of downside protection already in place, rather than waiting indefinitely for the market to feel safe again.

Where the trade-offs come in. Buffered ETFs help provide real protection on difficult market days, protection that comes at a modest cost on the upside. Morningstar's analysis of buffer ETFs tracking the S&P 500 found that every fund in that group outperformed the index's 18% drop in 2022.

The trade-off is intentional. Defined outcome strategies aren't designed to outperform their reference asset in strong bull markets. Instead, they seek to exchange some upside participation for a more defined risk profile. Outcomes can also vary depending on when investors enter and exit the strategy relative to the outcome period, meaning realized results may differ from the stated buffer or cap.

For advisors, the trade-off between downside protection and upside participation should align with a client's objectives and support long-term investment discipline. A defined outcome strategy that performs as designed will typically lag a strong bull market, since the same structure that limits losses also limits gains. That's the nature of the trade, not a flaw, and advisors who understand the ceiling going in can size the allocation appropriately and set expectations from the start.

Charles Champagne is the VP, head of ETFs and CEO at Allianz Investment Management LLC. Prior to joining Allianz, he was the head of portfolio insights and ETF Analytics at SPDR ETFs.

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