BlackRock's venture into synthetic ETFs 'surprising' but 'not hypocritical'

BlackRock CEO Larry Fink once quipped that an investor who buys a Lyxor product is just "an unsecured creditor of SocGen"

BlackRock CEO Larry Fink once quipped that an investor who buys a Lyxor product is just “an unsecured creditor of SocGen”

BlackRock’s venture into the synthetic exchange traded fund (ETF) market has surprised many who remember the criticism of the structure from the US giant’s CEO Larry Fink.

BlackRock’s ETF business iShares launched the iShares S&P 500 Swap UCITS ETF in September, a synthetic product designed to track the index of the S&P 500 using a swap-backed replication rather than a physical one.

The launch caught some, who still recall Fink’s 2011 claim that an investor who buys a Lyxor product is just “an unsecured creditor of SocGen”, off-guard.

Gary Buxton, head of EMEA ETFs at Invesco, recalled that the synthetic ETF market was “hugely popular” between 2004 and 2006, but began to receive criticism, “heavily led” by BlackRock, in the wake of the 2008 Global Financial Crisis.

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The criticism centred around the notion that “you do not know what you are buying, you do not know what assets the vehicle owns and so it is a riskier instrument to buy than the physical format”, Buxton explained.

However, following meetings with regulators in 2012 to explain the structure, “the negativity really ended” and clients became “much more comfortable with the format”.

BlackRock acknowledged it had been critical of the synthetic ETF model in the past. A spokesperson told Investment Week the firm had “consistently argued for clear labelling on swap-based ETFs to help investors make informed decisions, greater transparency on constituents, and the use of multiple swap counterparties unaffiliated with the ETF provider to ensure robustness”.

Kenneth Lamont, senior analyst, manager research, passive strategies at Morningstar, described the news as “surprising given iShares’ public stance on the topic” but was keen to add it was “not necessarily hypocritical”.

“You can argue the group is no more hypocritical than the first advocates of synthetic replication, like Xtrackers and Lyxor, who ultimately bent to whims of the market and built out sizeable physical ranges. In both cases I would say the provider is being pragmatic rather than hypocritical,” Lamont said.

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To offer the physical solution and not the synthetic one poses “business risk”, according to Francis Chua, fund manager at Legal & General Investment Management (LGIM), who added that “synthetic has outperformed physical in US equities for quite a while” and “flows tend to follow performance”, which could explain BlackRock’s change in stance.

Ben Seager-Scott, head of multi-asset funds at Tilney Group, believes BlackRock has not “done [itself] any favours by being especially critical about swap-based structures in the past”. But, he reasoned, the firm “sets the tone” for the retail space, so the launch “remains a positive development”.

Buxton agreed, noting increased flows represents “client acceptance” of the model and he is “pleased” to see BlackRock enter the space because it “further reinforces just how good a tool this is for investors”.

But Seager-Scott said investors should be “aware of the different risks and characteristics of the various approaches before investing”.


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