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What Is Synthetic ETF?

Posted by on Jun 15, 2017

A synthetic ETF is a synthetic exchange traded fund. A synthetic ETF is an investment instrument that imitates the characteristics of any exchange traded fund through its derivatives or variables which are also known as swaps.

Like any other investment instrument, the synthetic exchange traded fund(ETF) keeps a tab on the changes in the values of the underlying asset indices using swaps. The one who provides the ETF makes a deal with a counterparty(a bank or any financial institution), where the counterparty makes a promise to return the swap value as per the underlying asset index. Therefore, the returns on the investment are dependent on the ability of the counterparty to fulfill the commitment.

There are 2 types of exchange traded funds:

  • Physical ETFs
  • Synthetic ETFs

While synthetics deal with collaterals and swaps, the physical ETF deals with securities of the index. The physical ETFs are highly transparent, whereas their synthetic counterparts are a little less transparent. Traditionally, the counterparty risk is more in synthetic ETFs than physical ETF and this cannot be ignored in synthetic ETFs. However, the risk of counterparty damage can be mitigated by collaterals.

Synthetic ETFs can be employed in sophisticated financial markets which are more transparent and ready for scrutiny and have the ability to deal with additional regulations imposed on the firms that deal with them.

The main advantage of synthetic ETFs is that they are very useful in tracking the underlying asset indices and setting up an effective benchmark with lesser tracking errors. The synthetic ETFs help in accessing relatively obscure and untouched markets which have lesser liquidity levels.

In the case of automated robot apps like the Millionaire Blueprint, synthetic ETFs may work well because the software may recognize cost-effective and untouched markets which yield lucrative returns.

Millionaire Blueprint and synthetic ETFs may be useful in tapping the obscure binary markets and help the applicants/ users in generating digital incomes. This app is one of the first to deal in binary options.

Synthetic ETFs have slowly gained acceptance as reliable instruments involving lower costs. The counterparty risks can also be mitigated with regulations to limit the damage of any swap on the ETFs net asset value.

The system is complex and difficult to comprehend for any individual or small-time investor. Though synthetically replicated trade funds are becoming more accurate and reliable, it is prudence to assess the quantitative and qualitative effects of these ETFs before investing in them.

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