Synthetic ETFs

RoadToRiches

Deleted_User said:

The Big Short?  Kinda like that but they used a different type of derivatives 

Yes something called a collateral debt obligation, mortgage backed securities. CDO's of CDO's :-)

[Deleted User]

jamesd said:

Deleted_User said:

jamesd said:

Synthetic ETFs normally require the counterparty to deliver them security. If they go bankrupt you keep the security. That could be say Japanese government bonds for a US equity tracker.

I think we are talking about swap ETFs. One institution sets up a contract with another institution (counter-party). Its never the government.  The second institution provides the equivalent value of total index return, including dividends. Investor invests in a product held by the first institution.  If the second institution goes bankrupt then the investor will experience a loss; as a minimum he will lose his dividends.  

Depends on whether the value of the security has been updated to reflect the current value of the investment and I expect that it will need to be regularly  updated to do that. Government bonds are a likely choice for security, but as you wrote, governments themselves don't get involved in this.

I am very familiar with several of such ETFs and not one of them involves the use of government bonds as security. The party you buy ETFs from typically uses your cash as collateral so you are unlikely to lose everything.  However, if the counterparty fails to pay up then you will lose something and that portion is not guaranteed. Typically counterparties are large financial institutions so this risk is very small but its non zero. 

Alexland

I'd agree with dunstonh that filtering out synthetic ETFs would be one of the first things to do when cutting down a list of potential investment options. There's plenty of physical ETFs and there are no incentives big enough to be worth compromising on the fundamental position of owning the assets. Barge pole stuff.

jamesd

Deleted_User said:

jamesd said:

Deleted_User said:

jamesd said:

Synthetic ETFs normally require the counterparty to deliver them security. If they go bankrupt you keep the security. That could be say Japanese government bonds for a US equity tracker.

I think we are talking about swap ETFs. One institution sets up a contract with another institution (counter-party). Its never the government.  The second institution provides the equivalent value of total index return, including dividends. Investor invests in a product held by the first institution.  If the second institution goes bankrupt then the investor will experience a loss; as a minimum he will lose his dividends.  

Depends on whether the value of the security has been updated to reflect the current value of the investment and I expect that it will need to be regularly  updated to do that. Government bonds are a likely choice for security, but as you wrote, governments themselves don't get involved in this.

I am very familiar with several of such ETFs and not one of them involves the use of government bonds as security. The party you buy ETFs from typically uses your cash as collateral so you are unlikely to lose everything.  However, if the counterparty fails to pay up then you will lose something and that portion is not guaranteed. Typically counterparties are large financial institutions so this risk is very small but its non zero. 

Yes, that's another way to do it. Either way there is protection for at least the bulk of your capital from whatever happens to the counterparty.