Slightly off-topic: a lot of Vanguard's ETFs are synthetic. Is there anyone who can say something about the risk involved in this in contrast to non-synthetic ETFs?
Edit: As it turns out most or all of Vanguard's ETFs are physical.
Edit: As it turns out most or all of Vanguard's ETFs are physical.
From the course, they highlighted synthetic replications risks as consisting of credit risk of the counterparty when swaps are used by the issuer to exchange, performance of the assets held by the ETF for the performance of the underlying index. Blackrocks' IVV [1] has a cost structure of 0.07%, which is pretty good - and does an extremely good job of tracking the S&P500. It uses, "Representative Sampling" - from their prospectus [2] BFA uses a representative sampling indexing strategy to manage the Fund. “Representative sampling” is an indexing strategy that involves investing in a representative sample of securities that collectively has an investment profile similar to that of the Underlying Index. The securities selected are expected to have, in the aggregate, investment characteristics (based on factors such as market capitalization and industry weightings), fundamental characteristics (such as return variability and yield) and liquidity measures similar to those of the Underlying Index. The Fund may or may not hold all of the securities in the Underlying Index.
[1] https://www.ishares.com/us/products/239726/ishares-core-sp-5...
[2] https://www.ishares.com/us/library/stream-document?stream=re...
A potentially major relative risk I can think of for synthetic ETFs vs real ETFs would be that it could diverge due to updates in the composition of the fund - particularly if a stock is removed or added. If the fund previously held a large position in a stock and decided to replace it, then that action will likely have a negative impact on the price of the stock, and you will only get knowledge of the fund adjustment the morning after or possibly later. This means when you readjust your synthetic position, you'll do so at inferior prices, which could hurt returns. Likewise, you'll probably buy new inclusions at a higher price. I saw this happen a couple of times - and usually within particularly volatile sectors with small cap companies where an ETF might come to hold a large chunk of a company.
That being said, I'd wager this effect doesn't outweigh the management fees charged for even the most frugal ETF, so creating it synthetically might be a good deal if you've got the manpower and cost structure to adjust your position regularly - or if you don't mind a bit of divergence. I'd be interested to hear other opinions on this as well.
> Employs a passively managed, full-replication strategy.
[1]: https://advisors.vanguard.com/VGApp/iip/site/advisor/investm...