What are you views on Synthetic ETFs?

That is one investment I wouldn't touch with a bargepole.
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Comments

  • they tend to be vilified, perhaps deservedly so.

    They amount to promises by the ETF issuer (or an appointed agent) that they will pay the returns of the index that is being tracked, backed by a basket of collateral. For example a synthetic ETF that tracks the FTSE100 may actually hold a portfolio of argentinian stocks. If those stocks collapse, the ETF sponsor will have to add more collateral.
  • bowlhead99
    bowlhead99 Posts: 12,295
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    They are investments with greater risk than those that use physical replication of the index components.

    For some indexes they may be the only choice, but most popular (long) indexes have physical replication versions available that are big enough to be cheap to run and have a decent tracking error without having to rely on a lot of synthetic ingredients. This cuts down on counterparty risk versus the synthetic version. Still, ETFs that primarily use physical replication may still use derivatives as part of the model.
  • bowlhead99 wrote: »
    Still, ETFs that primarily use physical replication may still use derivatives as part of the model.

    Are you sure? That seems dodgy
  • DrSyn
    DrSyn Posts: 888
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    I would never buy these, for the reasons stated in post 2 & post 3.
  • bowlhead99
    bowlhead99 Posts: 12,295
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    Are you sure? That seems dodgy

    Don't shoot the messenger. Obviously nobody would buy an ETF without reading the prospectus to check out the risks to which they might be exposed.
  • Are you sure? That seems dodgy


    many phsyical ETFs will use derivatives but wont be a major part of the holdings - it will be cheaper to buy a future, fund or an etf to invest a small amount of cash from dividends etc. Unless its a hedged etf which will use forwards.
  • masonic
    masonic Posts: 23,062
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    It's not just some physical ETFs that use derivatives to keep the fund fully invested. Many open ended index tracker funds do so as well up to a few percent of their underlying assets. The effect in general is to decrease tracking error and overall 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.

    So I don't take issue with a small amount of derivative on the side, but would share your concerns about a substantially or fully synthetic product. If other options exist, then I'd opt for those instead.
  • bowlhead99 wrote: »
    Don't shoot the messenger. Obviously nobody would buy an ETF without reading the prospectus to check out the risks to which they might be exposed.

    I've checked and it only says under Key Risks
    Counterparty Risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to
    derivatives or other instruments, may expose the Fund to financial loss.


    Can you provide an example of a Physical ETF which uses derivatives?
  • masonic
    masonic Posts: 23,062
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    I've checked and it only says under Key Risks
    Counterparty Risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to
    derivatives or other instruments, may expose the Fund to financial loss.
    That sounds like the ETF you are looking at may use derivatives.
    Can you provide an example of a Physical ETF which uses 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."
  • Voyager2002
    Voyager2002 Posts: 15,244
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    Have there ever been cases of investors suffering serious losses as a result of counter-party risk?

    Are there any strategies for managing this risk (other than simply avoiding synthetic ETFs)?
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