Articles

Synthetic ETFs – understanding the risks

Marco Montanari of Deutsche Bank discusses the emerging issues and concerns in relation to risks with synthetic ETFs, and explains how he thinks the market will develop.

Date: May 2011

Tags: ETFs, Risks, Synthetic, Transparency, Counterparty risk

  • Synthetic ETFs have been obliged to provide more and more transparency in terms of the collateral held against the counterparty risk, to help diversify this risk
  •  Funds which do securities lending – either ETFs which buy physical assets or mutual funds – also incur counterparty risk
  • Investors in synthetic ETFs should ask for the maximum transparency, check who the counterparty is, and look at what collateral is posted
  • Concerns over synthetic ETFs highlight the lack of education in the market

According to Marco Montanari in an interview, synthetic ETFs have been obliged – in the wake of the credit crisis – to provide more and more transparency in terms of the collateral held against the counterparty risk, to help diversify this risk.

At Deutsche Bank, Montanari said the firm publishes the collateral on the internet on a daily basis, which is as transparent as it could be.

This is in response to what clients want to ensure transparency and get sufficient comfort to invest in the product, he explained.

Comparing the situation with securities lending

According to Montanari, funds which do securities lending – either ETFs which buy physical assets or mutual funds – also incur counterparty risk.

Yet all the attention has been on synthetic ETFs to date, he said.

However, a fair representation should consider the entire funds industry given its size, especially compared with ETFs, added Montanari.

What investors should look for in synthetic ETFs

According to Montanari, investors in synthetic ETFs should ask for the maximum transparency, check who the counterparty is, and look at what collateral is posted.

In general, he said he doesn’t see clients steering clear of investing in the bank’s product as a result of the structure.

Instead, they just want to get enough information on which to base their buying decisions.

How the ETF market will involve

Montanari said the concerns over synthetic ETFs highlight the lack of education in the market, which is linked to the fact that this is a young but fast-growing market which is generally under the media spotlight.

With time, investors will grow to understand how the product works, he said.

 
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