Synthetic replication is another type of approach that can be adopted by ETFs, referring to the way the selected benchmark is tracked. In this case the underlying securities are not physically purchased but instead different methodologies are adopted.
Main Features of Synthetic ETFs
A synthetic ETF tracks the chosen index by utilizing derivative contracts instead of physically buying the securities. Usually a swap agreement is entered between the fund manager and a counterparty. This contract offers a pay-off structure that is identical to the one of the index tracked by the ETF. In this way investors should receive the same returns as if they were actually owning the basket of underlying securities.
Cons of Synthetic ETFs
Synthetic ETFs are subject to a counterparty risk. Swap contracts are usually defined between the fund manager and another financial institution like a bank. Were this party not able to meet its obligations, there might be the possibility of investors not receiving their money back or experiencing losses. These contracts could be collateralized as to minimize risks.
Another negative aspect of synthetic ETFs concerns an ESG-related controversy. The current ESG disclosure requirements are in fact fulfilled at an index level and not with reference to the basket of securities used as collateral in the swap agreement. Accordingly, an always larger number of market participants is calling for more transparency around the ESG characteristics of the collateral used.
Our Offer
At VanEck Europe we do not offer our clients synthetic ETFs. On the contrary, we proceed to physically buy the securities included by the indices tracked by our products. Emphasis is put on transparency and risk minimization.