A new wave of exchange-traded funds (ETFs) offering bondlike income payouts is gaining traction in the market, but experts warn that these funds carry unique and complex risks that investors should carefully consider. Known as autocallable funds, these ETFs have surged in popularity since last summer, with assets surpassing $1.5 billion and many more slated for launch in the near future.

Autocallable ETFs are built around structured notes, which are debt instruments typically issued by major banks. These notes tie their returns to the performance of individual stocks or market indices. Generally, they promise a stated income as long as the underlying asset does not fall beyond a predetermined threshold by specific dates. If the asset remains above a set level at maturity—usually five years—the investor is also repaid the full principal.

A feature of these structured notes is the option for the issuer to redeem, or “call,” the investment after one year if the underlying asset’s price is at or above its initial value. This design aims to provide steady payouts that can resemble bond coupons, often yielding between 12% and 19% annually. However, these distributions are not guaranteed and can fluctuate over time based on market conditions.

The primary risk emerges if the underlying stock or index declines more than the predetermined amount, often around 40%. Should this occur, investors may miss out on income payments and face significant principal losses. While ETFs that include a diversified mix of autocallable notes and staggered maturity dates can reduce—but not eliminate—these risks, they do not offer full protection against sudden or severe downturns in income or capital.

By investing in autocallable funds, investors effectively assume the role of insurers, accepting the risk of moderate to substantial drops in stock prices in exchange for premium-like income. This trade-off can result in infrequent but potentially steep losses when markets turn sharply lower.

Critics point out that many of the indices underlying these ETFs have limited historical data, often relying on backtested performance. For instance, the index underpinning the Calamos Autocallable Income ETF would have suffered a 63.8% loss during the 2007-2009 financial crisis, exceeding the S&P 500’s 55.3% decline over the same period.

Additionally, these products come with relatively high annual expense ratios, typically 0.6% or more, adding to the cost burden on investors.

Brian Jacobs, a portfolio manager at Aptus Capital Advisors in Fairhope, Alabama, cautions that while the yields offered by autocallable ETFs may be attractive, they entail risks linked to stock market exposure in a complex structure that may be difficult to fully understand. “A lot of investors or financial advisers might not understand that,” he said.

As late-cycle market strategies flourish, investors are advised to weigh the appeal of high income against the potential for steep losses and to consider the value of simplicity over complexity in their portfolios.