European exchange traded fund investors were selling “synthetic” products that trade derivatives last month, shifting more assets into ETFs that track equities, bonds and commodities.
According to a BlackRock research note, derivative-based synthetic ETFs experienced net redemptions of $1.86 billion in October, whereas physically-backed passive index funds garnered $3.11 billion, reports Christopher Condon for Bloomberg. [European Investors Drain Cash from Synthetic ETFs]
European investors took $608 million from synthetic ETFs that track broad European equities in October while investing $779 million into passive European stock index-based ETFs. Additionally, synthetic gold ETFs leaked $2.2 million, whereas physically-backed gold ETFs added $1.2 billion.
Synthetic funds are under greater scrutiny due to greater concerns that investors may not fully understand the risks and how the complex financial instruments work. [Complex European ETFs Face Scrutiny from Regulators]
The Financial Times recently reported investment banks can save on funding costs by running synthetic ETFs that use derivatives to follow benchmarks. “The savings come through using cash from ETF investors to fund illiquid assets banks have to hold as part of their market-making functions,” FT reported.
In Europe, synthetic products make up 40% of total ETF assets, whereas in the U.S., synthetic products cover leveraged and inverse products, along with some commodity-based ETFs. The Securities and Exchange Commission already suspended approvals for new derivative-based products in March 2010. [European ETF Transparency Push Raises Questions]
BlackRock recently proposed changing the way synthetic products are labeled to exchange traded instruments, or ETIs. Competing fund companies that offer synthetic ETFs say the proposal only serves to promote “its own agenda” since BlackRock mainly offers physically-based ETFs. [What’s in an ETF Name?]
Earlier this year, Morningstar argued that outflows from synthetic ETFs in Europe are not being driven solely by fears over synthetic products.
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.