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ETF Strategy: synthetics firmly back on buy lists

by Emma Dunkley on Feb 29, 2012 at 00:01

ETF Strategy: synthetics firmly back on buy lists

Synthetic exchange traded products (ETP) have won back favour among investors, posting positive inflows in January and bucking a six-month trend of outflows amid concerns over counterparty risk.

The latest BlackRock industry report reveals synthetic ETPs attracted inflows of $1.8 billion (£1.13 billion) in January this year, contrasting the last six months of last year where swap-based products experienced combined outflows of $11.7 billion. Physically backed ETPs saw inflows of $9.7 billion over the same period.

Interest in swap-based ETPs even surpassed that of physically backed products, which only gathered $1.5 billion through January.

Broader trend towards passives

The uptake of synthetic ETFs may partially reflect a broader trend towards passives, as January flows surged to a new record. BlackRock’s report said concerns about the European economy, coupled with the US outlook for an extended period of low interest rates helped drive the global ETP industry to its best January ever, with $34.1 billion of net inflows.

January usually sees low or negative flows due to the cyclically high flows in the previous month. Although inflows of $15.8 billion in December 2011 were strong, January still exceeded this figure.

But the wall of cash flowing into swap-based ETPs also suggests investors are becoming more comfortable with the use of derivatives.

Some wealth managers have the ability to trade over-the-counter derivatives, such as swaps and futures, and so are less concerned about the swap component within the ETF.

While investment banks tend to issue swap-based ETFs, as it is a natural extension of their business model, this structure is beneficial for tapping certain markets or regions that may be harder to access or less liquid, without incurring too much tracking error.

Providers typically use swaps, for example, to access the emerging markets. iShares, renowned for its physically backed model as opposed to derivative-based, launched its inaugural synthetic ETF range, using the multi-counterparty structure, in 2010. These funds were created in order to efficiently access Russia and India.

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