LESSON 5.6 · ADVANCED

Physical vs synthetic replication

Owning the shares, versus a contract that promises the return.

FUNDS, ETFS AND TRACKERS4 MIN READ

Physical replication means the fund buys the shares in its index — all of them, or a representative sample when there are thousands. Synthetic replication means the fund holds a basket of other assets and signs a swap with a bank, the swap counterparty, which promises to pay it the index's return.

Each carries a different risk. A physical fund's main risk is the shares themselves, though many also lend their shares out for a fee, which adds a smaller borrower risk. A synthetic fund adds the bank: if the counterparty fails, the fund is left with its collateral basket instead of the promised return. UCITS rules cap how much a fund can be owed by any one counterparty, which limits the damage but doesn't remove it. The replication method is on the fund's factsheet; the app doesn't show it.

Physical · the fund owns the sharesSynthetic · a bank promises the return through a swap

One carries the risk of the shares. The other adds the risk of the bank that made the promise.

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Educational content only. It is not personal financial advice.