BlackRock CEO Larry Fink’s views on synthetic ETFs have been well-documented over the years, as has the asset manager’s u-turn on the structure.
Following BlackRock’s acquisition of iShares from Barclay’s in 2009, Fink called out European rivals Lyxor and SocGen for their use of synthetic ETFs as it looked to build out its market share on the continent.
Chief among its criticisms were swap provider risks, with the providers themselves in the spotlight following the global financial crisis. Additionally, many of the banks providing the swap were also providing the ETF, creating a substantial conflict of interest.
At the time, BlackRock exclusively offered physical ETFs, with cynics questioning the motive behind the asset management giant's warning on the structure.
Fast-forward a decade and BlackRock had completed its u-turn, entering the synthetic ETF market with the iShares S&P 500 Swap UCITS ETF (I500) in September 2020, which has grown to $7.3bn assets under management.
The group’s swap-based range has now extended to five ETFs, following the launch of the iShares Russell 2000 Swap UCITS ETF (RU2K) and the iShares Nasdaq 100 Swap UCITS ETF (N100) earlier this month.
However, there is an argument to say BlackRock’s warning helped improve the overall quality of the synthetic structure.
Over the past decade, European issuers worked to fix many of these problems by bringing in iron-clad collateral arrangements and multiple banks to provide the swaps, meaning there is a back-up if one goes bust.
Brett Pybus, head of iShares EMEA strategy at BlackRock, said: "We have seen increased client demand for swap based ETFs. This has been primarily driven by improvements in the derivatives ecosystem which has changed how we look at physical versus swap based ETFs for US equity exposures.
"This includes the increased adoption of multi-swap counterparty models, which are now common, reducing counterparty risk. Our products use multiple, independent swap counterparties to achieve competitive swap pricing while providing full transparency of collateral baskets.”
Demand has since risen sharply for the structure, particularly for US equities where its tax and cost dodging capabilities have meant synthetic ETFs have outperformed their physical counterparts.
The substitute basket of the ETF is restricted to non-paying dividend-paying stocks, meaning they pay no withholding tax resulting in a substantial tracking difference.
Despite this, investors must still pay attention to the counterparty risks involved with the synthetic structure – as well as keeping an eye on how the swap spreads change throughout time.
Final word
Despite BlackRock gradually building up its synthetic range, signs of its early scepticism could be impacting its current market offering.
The group lags major players such as Invesco, whose $32bn Invesco S&P 500 UCITS ETF (SPXS) is a market leader in the space.
BlackRock’s range is also limited to US equities, with one global equity swap-based ETF, leaving room to expand into other areas such as China and India where the structure offers additional tax benefits.
