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Synthetic ETF

A synthetic exchange-traded fund (ETF) is an ETF that achieves its investment objectives using derivatives, such as swaps, rather than holding the physical assets in its portfolio. Instead of directly owning the underlying securities, the ETF enters into swap agreements with a counterparty to replicate the performance of an index or asset. Synthetic ETFs offer exposure to hard-to-access markets or assets but carry counterparty risk due to the reliance on derivatives.

Example

A synthetic ETF tracking the performance of a foreign stock market uses swap agreements with financial institutions to replicate the returns of the index without owning the actual stocks.

Key points

• An ETF that uses derivatives, such as swaps, to replicate asset or index performance.

• Does not directly hold the underlying securities.

• Exposes investors to counterparty risk from the derivative contracts.

Quick Answers to Curious Questions

Synthetic ETFs replicate the performance of an index using derivatives, while physical ETFs directly own the underlying securities.

Synthetic ETFs carry counterparty risk, meaning that if the institution providing the swap defaults, the ETF’s performance may be impacted.

Investors may choose synthetic ETFs for exposure to hard-to-access markets, assets, or indices that may be difficult to replicate with direct ownership.