SEI’s Owens: Common misconceptions around synthetic ETFs stifling growth

European investors remain sceptical about the benefits of synthetic ETFs

Theo Andrew

Robert Owens SEI

Common misconceptions around synthetic ETFs are stifling their growth in Europe, according to SEI, which delivers technology and investment solutions to the financial services industry.

Speaking to ETF Stream, Rob Owens, managing director and ETF expert at SEI, said the products are often viewed with scepticism by investors and more education was needed around the benefits of using swap-based ETFs.

Signs the tide is turning on synthetic ETFs emerged last November when BlackRock launched its second synthetic ETF, the iShares MSCI USA Swap UCITS ETF (MUSA), in response to investor demand.

It marks a dramatic U-turn by the world’s largest asset manager on synthetic ETFs after it campaigned for three years following the Global Financial Crisis about the dangers of the products, however, Owens believes uncertainty among investors remains.

“The challenge with synthetic products from a distribution standpoint is that they are often greeted with scepticism by investors who are not familiar with the mechanics of the ETF,” he said.

“There is a common misconception that synthetic ETFs are entirely exposed to the swap counterparty but this is generally not the case. In the case of the unfunded swap model, the fund swaps the return on a substitute basket of highly liquid securities for the return on the index being tracked by the fund.”

He added that in certain swap arrangements, there is a reset triggered when counterparty exposure reaches 5% of net asset value (NAV), while the substitute basket remains in the custody of the ETF, protecting investors against large-scale default by any swap counterparty.

Owens said a synthetic approach can often be a good option for US ETF issuers looking to replicate their strategies in Europe, a trend he said was growing as the US ETF market matures and asset managers look to expand globally.

The group, which takes a partnership approach to servicing its ETF clients, provides ongoing advice to its US clients looking to expand into Europe via dedicated technology solutions.

“It can be quite challenging to structure products exactly to their US counterparts given the restrictions imposed in Europe around derivative exposure,” he said.

“Our clients have found that engaging a swap counterparty and adopting a synthetic approach has proven to be the best option for replicating complex index strategies.”

SEI, which manages, advises or administers approximately $1.3trn in assets as of 31 March 2023, has helped facilitate the launch of over 40 UCITS products from new market entrants over the past two years.

“There are numerous benefits for managers from launching synthetic products such as the limited opportunity for tracking error, the ease of setup – once initial counterparty agreements are established – and preferential tax treatment,” he added.

Elsewhere, Owens said there had been a significant increase in demand for thematic products among European investors as well as ETFs hedging against the current market volatility.

“Investors are also becoming more risk adverse with the recent downturn in the global economy and this had contributed to an increased demand for hedging products such as index buffer ETFs and tail hedge ETFs,” he said. “These derivative-based strategies were previously only available to sophisticated institutional investors but they are now freely available to retail investors on the secondary market.”

This article first appeared in ETF Insider, ETF Stream's monthly ETF magazine for professional investors in Europe. To read the full magazine, click here.

About SEI®

SEI (NASDAQ:SEIC) delivers technology and investment solutions that connect the financial services industry. With capabilities across investment processing, operations, and asset management, SEI works with corporations, financial institutions and professionals, and ultra-high-net-worth families to solve problems, manage change and help protect assets—for growth today and in the future. As of March 31, 2023, SEI manages, advises, or administers approximately $1.3trn in assets. For more information, visit seic.com.

Featured in this article


No ETFs to show.