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An index fund replicates an existing index, such as the DAX. A DAX ETF thus reflects the 30 securities it contains one-to-one. ETFs are used as investment vehicles by robo-advisors or ETF savings plans, for example.
The money in the ETF is then used to collectively buy those securities and, depending on the amount paid in by the investor, the shares are distributed. This makes it possible to diversify broadly even with a small investment volume.
These types of ETFs are called real or physical ETFs because the purchase actually takes place.
Synthetic ETFs as a second type of exchange traded fund
A second type of ETF, on the other hand, are synthetic ETFs. Although these also reflect performance and thus enable the same return, synthetic ETFs often do not contain the products to be tracked. How can this be?
A synthetic ETF agrees a swap transaction (total return swap) with a financial institution (swap counterparty). For this purpose, a contract is concluded which agrees to pay the ETF the index return including all dividend payments in return for a fee.
The fee comes from the investors, who also pay an annual fee for asset management when using a robo-advisor. The big banks have better and more efficient access to the respective markets. Thus, they are more cost-effective and can process the trades cheaply for a fee or enable the synthetic ETF.
Such ETFs are also called swap ETFs. For the investor, the return in the end is the same as if the index were actually tracked. For the provider of a synthetic ETF, too, the handling can bring tax advantages as well as cost savings, since there is less effort to actually buy in all securities.
Synthetic ETF - But only a contract and not a fund?
Now one could assume that the synthetic ETF is correctly not a fund at all, but merely a contract? No, because the synthetic ETF still receives money from the investors. This money is then invested in a collateral portfolio and pays the fee in return for receiving the return from a third party.
In addition to the fee paid to the swap counterparty (the financial institution that pays the return and dividend), the swap counterparty also receives the returns from the collateral portfolio. The portfolio is used to hedge the swap transaction.
The securities in the collateral portfolio do not have to correspond to the securities of the index to be tracked. Thus it can happen that a synthetic ETF that tracks the DAX contains securities from Japan or other countries. The investor in mt4 Exness nevertheless receives the return, as this is realised via the swap transaction with a financial institution.
If the ETF holds the collateral portfolio itself, the ETF is also called an unfunded swap. If the collateral portfolio is held in trust with a third party, the ETF is called a funded swap.
In any case, the collateral portfolio should be looked at. Good ETF providers are transparent so that investors can see the collateral portfolio with all its securities. Unfortunately, investors usually only find out this information upon request.
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