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Rising counterparty risk sees Architas shun synthetic ETFs

Architas chief investment officer Caspar Rock says the firm’s multi-manager team is avoiding synthetic ETFs as counterparty risk has increased due to bank downgrades.

Synthetic ETFs get access to assets by using derivatives such as swaps, as opposed to physically-backed ETFs which hold the underlying assets the ETF tracks.

Rock says the multi-manager range has had exposure to synthetic ETFs in the past where he has not been able to find a tracker fund that accesses the same asset but he is avoiding them now as there is too much counterparty risk.

He says: “We prefer to use passive funds over synthetic ETFs because they are cheaper. The really low-cost ETFs are synthetic and we do not want to use them. There is no such thing as a free lunch and you are taking on counterparty risk in swap-based ETFs. It has become such a high-profile concern in the last few months because of the European bank downgrades.”

The European Commission, the FSA and the Serious Fraud Office have all sounded warnings over synthetic ETFs in the last year. The FSA and European Commission said they are concerned at ETFs’ use of derivatives while the SFO voiced concerns about the way they are marketed.

Last month, Morningstar released a report on synthetic ETFs in Europe, Asia, Australia and Canada. It concluded there needs to be common industry standards on labelling synthetic ETFs and disclosing information about the funds’ asset or collateral baskets, counterparties and embedded costs.

Values to Vision Financial Planning director Nick Lincoln says: “I only use ETFs that use physical replication. You have counterparty risk with synthetic ETFs, so I avoid them. Also, synthetic ETFs tend to track esoteric areas of the markets, which clients do not really need access to.”

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