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What are you views on Synthetic ETFs?

edited 30 November -1 at 1:00AM in Savings & Investments
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  • tg99tg99 Forumite
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    Like others have commented above I would opt for physical ETFs though I’m not averse to using synthetics depending on factors such as how the swap is structured, how counterparty risk is managed, how often the collateral is replenished if there is a shortfall, the quality of the collateral etc. That does though require a fair bit of in depth research, going through the prospectus and so on. For example, a synthetic etf that holds collateral of approximately the same quality and liquidity as that of the index and over-collateralises on a daily basis (e.g. holds collateral worth 102% of NAV) might be worth considering in those scenarios where suitable physical ETFs are not available.
  • bowlhead99bowlhead99 Forumite
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    Have there ever been cases of investors suffering serious losses as a result of counter-party risk?
    Yes
    Are there any strategies for managing this risk (other than simply avoiding synthetic ETFs)?

    How do you manage the risk? Seems like a very open ended question.

    For simplicity- take fewer risks.

    If you are ,going to add in some open ended parameters like, "I don't want to avoid risk, I just want to manage the risk", then you would expect open ended answers like, "monitor your risk, and perhaps take less of it if you have more than you want".
  • cogitocogito Forumite
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    How many people actually understand synthetic ETFs? I don’t and with investments, my view is that if I can’t explain it to an 8 year old, it’s something I should leave well alone.
  • SystemSystem
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    Synthetic ETF are mainly used to short the market, for example:
    https://www.lyxoretf.co.uk/en/instit/products/equity-etf/lyxor-sp-500-daily-2x-inverse-ucits-etf-acc/lu1327051279/eur
    When shorting the market, physical replication is not possible so there is not really a choice between physical and synthetic (indirect) replication
  • masonicmasonic Forumite
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    economic wrote: »
    Synthetic ETF are mainly used to short the market, for example:
    https://www.lyxoretf.co.uk/en/instit/products/equity-etf/lyxor-sp-500-daily-2x-inverse-ucits-etf-acc/lu1327051279/eur
    When shorting the market, physical replication is not possible so there is not really a choice between physical and synthetic (indirect) replication
    Lyxor is a provider of a range of long and short ETFs, though I agree the short ETFs have a better use case.
  • dividendherodividendhero Forumite
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    Think I might put my life savings into a synthetic ETF run by Neil Woodford - what could possibly go wrong? :money:
  • masonic wrote: »
    That sounds like the ETF you are looking at may use derivatives.


    I checked two ETFs at random from major providers and both may use derivatives (iShares and Vanguard):

    https://www.ishares.com/uk/individual/en/literature/kiid/kiid-ishares-core-ftse-100-ucits-etf-gbp-dist-gb-ie0005042456-en.pdf
    "The investment manager may use financial derivative instruments (FDIs) (i.e. investments the prices of which are based on one or more underlying assets) to help achieve the Fund’s investment objective. FDIs may be used for direct investment purposes. The use of FDIs is expected to be limited for this Share Class."

    https://www.vanguardinvestor.co.uk/rs/gre/gls/1.3.0/documents/6021/gb
    "The Fund may invest in financial derivative instruments that could increaseor reduce exposure to underlying assets and result in greater fluctuationsof the Fund's net asset value. Some derivatives give rise to increasedpotential for loss where the Fund's counterparty defaults in meeting itspayment obligations."

    I also looked at big OEIC funds similar to above and they said the same regarding derivatives.

    I feel a bit uneasy about it, you?
  • SystemSystem
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    I also looked at big OEIC funds similar to above and they said the same regarding derivatives.

    I feel a bit uneasy about it, you?
    No, not at all. These statements are about what the funds/ETF/IT may do. You can check the portfolio to see what they are actually doing. For example, RIT Capital Partners uses derivatives (0.1% of the portfolio) as can be seen from its portfolio on page 12: https://www.ritcap.com/sites/default/files/Annual%20Report%20December%202018.pdf
    The objective of the fund is 'To deliver long-term capital growth, while preserving
    shareholders’ capital', and it is doing a good job, see page 1 of the report.
  • masonicmasonic Forumite
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    I also looked at big OEIC funds similar to above and they said the same regarding derivatives.

    I feel a bit uneasy about it, you?
    Not really, derivative positions are used to keep the fund fully invested when they are holding cash pending investing it. These positions won't generally be more than a few of percent of the fund, and will typically be sub-1%. As I said in a previous post "I don't take issue with a small amount of derivative on the side" and "this is still likely to result in a better outcome than if derivatives were never used, even if one day a counterparty should go bust and fail to meet their side of the bargain".
  • londoninvestorlondoninvestor Forumite
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    masonic wrote: »
    Not really, derivative positions are used to keep the fund fully invested when they are holding cash pending investing it. These positions won't generally be more than a few of percent of the fund, and will typically be sub-1%. As I said in a previous post "I don't take issue with a small amount of derivative on the side" and "this is still likely to result in a better outcome than if derivatives were never used, even if one day a counterparty should go bust and fail to meet their side of the bargain".

    And typically these will be positions on major stock indexes: either futures on an exchange, or swaps with large counterparties that are required to have daily variation margin posted (under the rules that have been in place since 2016ish).

    Not something I lose sleep over as a small part of a fund.
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