What is a synthetic ETF?

These are financial investment products that are linked to financial indices, such as the FTSE 100 or the S&P 500. These transactions mimic the characteristics of a physical exchange traded fund (ETF).

Where have you heard about synthetic ETFs?

Synthetic ETFs are common in Europe and on the Hong Kong Stock Exchange. You may have heard of the UltraShort Gold ETF or the VelocityShares 3x Inverse Gold ETF which are linked to gold indices.

What you need to know about synthetic ETFs.

Rather than physically holding the securities it is tracking, like a physical ETF, synthetic ETFs rely on derivatives such as swaps to execute their investment strategy. The swaps are between the ETF and a counter party – usually an investment bank.

Because they don't hold the securities in question, synthetic ETFs can offer access to illiquid markets or hard-to-access markets that would be costly and difficult for a physical ETF to track.

The chief risk of a synthetic ETF, apart from a fall in asset prices, is that the counter party may not fulfil its obligation to pay the agreed return, and critics believe that investors can be mislead by them as they may not be as transparent and physical ETFs.