The largest synthetic ETF providers in Europe, Lyxor and db X-trackers, have announced they are venturing into the physical ETF market. This comes as the two companies face increasing competitive pressures and net outflows over the past year.
Historically, Lyxor and db X-trackers offered synthetic ETF products, which tracked market indices using swaps. This method of ETF construction opens investors up to counterparty default risk. Meanwhile, physical ETFs buy the actual constituents of their underlying index in order to track the index, instead of using swaps and derivatives.
While Lyxor and db X-trackers' existing ETF line-ups consist primarily of synthetic ETFs, their rival and market leader, iShares, provides an ETF line-up of predominantly physical ETFs.
Synthetic ETF providers have been increasingly under fire as investors have continued to exhibit a preference for physical replication ETFs. According to data from Deutsche Bank, as of November 16, Lyxor and db X-trackers have seen respective year-to-date net outflows of €168 million and €397 million. Meanwhile, Deutsche Bank data show that iShares has experienced net inflows of €10.8 billion for the year-to-date period—accounting for some 68% of net new cash flows into European-domiciled ETFs this year.
In response to this increasing customer preference for physical ETFs, db X-trackers announced on Monday that it is launching six physical replication ETFs tracking the FTSE 100, EURO STOXX 50, EURO STOXX 50 Ex-Financials, DAX, Nikkei 225, and the S&P 500 indices. These new ETFs will be listed on three exchanges in London, Frankfurt, and Milan. This move gives investors the option to track these indices using either physical or synthetic ETFs.
While the official announcement from db X-trackers came only recently, Morningstar originally reported on this eventuality back in October.
In a press release, Thorsten Michalik, global head of db X-trackers stated, "This is a significant step. For the first time investors will be able to go to a single provider and choose not only the type of market exposure they want, but also the type of tracking method they feel most comfortable with. Some client segments have shown a preference for direct replication, and as a provider we aim to meet that demand.”
Meanwhile, Lyxor had previously announced its planned foray into physically replicated ETFs back in September. Lyxor plans to convert four fixed income ETFs tracking EuroMTS indices from synthetic to physical replication in December.
Synthetic ETF providers had previously attempted to assuage investors' concerns regarding counterparty risk by arguing that synthetic products are less costly and track their benchmarks more accurately. This trade-off between increased risk and reduced cost has been at the heart of the heated ETF debate between physical and synthetic ETFs.
For more information on the evolving ETF landscape, read "ETF Wars (and Rumours of Wars)".
