Description
Explain That Fund: Does your ETF actually own the index?
When investors buy an ETF tracking an index, they may assume the fund simply owns every company or bond in that benchmark. In practice, that is not always the case.
This week, David looks at the different methods ETFs use to deliver index returns. A fully replicating ETF holds every constituent, while an optimised ETF may own only a representative sample. Synthetic ETFs take a different approach again, using a swap to receive the performance of the index.
The discussion follows BlackRock’s decision to move around €13bn of ETFs from optimised sampling to full replication, after rising weights in technology and semiconductor companies pushed some holdings towards UCITS concentration limits.
The section will examine why ETF providers use sampling, where synthetic replication can be useful and why full replication is not automatically the best approach in every market. It will also explain the difference between tracking difference and tracking error – and why the ETF with the lowest fee may not always deliver the closest return to its benchmark.
What will be covered:
- Full replication, optimised sampling and synthetic replication
- Why an ETF may not own every index constituent
- How replication methods affect cost, tracking and risk
- Why BlackRock has changed the structure of several ETFs
- What investors should check before choosing a fund
The index determines the return an ETF is targeting – but the replication method determines how it tries to achieve it.
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