When synthetic benefits become real
The simple objective of a passive Exchange Traded Fund (ETF) is to deliver, on a consistent basis, the performance of an index. Discover the ways in which ETFs can replicate an index and when swap-based ETFs might provide a structural advantage.
Replicating an index
An ETF can replicate an index either one of two ways, through physical or synthetic replication.
Your choice
One method might have advantages over the other when replicating certain indices.
Our offering
For each of our ETFs, we choose whichever method offers the best potential outcome for investors.
How ETFs can replicate an index
Physical replication
The ETF tracks the index by buying and holding a portfolio of securities that closely matches the index’s composition. When the index rebalances, the ETF will need to buy or sell securities so that it continues to resemble it. There are two ways a physical ETF may invest:
- Full replication – The ETF holds all of the securities in the index in the same proportions as they appear in the index.
- Sampling – The ETF holds a sample of securities from the index that are expected to perform similarly to the actual index.
Synthetic replication
The ETF also buys and holds a basket of securities but not necessarily those of the index being tracked. The ETF will aim to deliver the index performance through a financial agreement (swap contract) provided by an investment bank (counterparty).
Why consider swap-based ETFs?
It’s important to understand there is no right or wrong way to replicate an index; one is not always going to be better than the other. The decision on which approach to take often comes down to the index itself. In some instances, however, the most efficient way to access a particular market might be through a swap-based ETF.
If you’re thinking of investing, here’s what you need to know.
Transcript
How does synthetic replication work?
Even though the securities are different from those in the index, they’ll still be expected to generate a return. Of course, on any given day, the return could be more or less than the index return.
Synthetic ETFs contract with one or more banks to exchange the performance of their basket for the performance of the index (plus or minus a fee) using what’s known as a ‘swap contract’. That’s why synthetic ETFs are also known as swap-based ETFs. This contractual agreement means that the synthetic approach is likely to be able to track an index more closely than a physical approach.
Discover more about why structure matters when choosing an ETF.
Transcript
Are there risks?
Every investment comes with risk. The primary risks of an ETF are related to the underlying market being tracked, whether the ETF is replicating the index physically or synthetically. Having a counterparty involved, however, presents an additional risk. Counterparty risk means there is always a chance, however remote, that a counterparty fails. But ETF providers like us have long found ways to mitigate this risk successfully.
We use multiple banks to back up our swap-based ETFs and we ensure they are all in good financial health. And, when you’re talking about banks as big as JP Morgan, that health is very robust indeed.
It’s worth noting that a physically replicating ETF also has this counterparty risk if the ETF engages in securities lending.
Transcript
1 Enhanced returns
Swap-based ETFs receive favourable treatment on withholding tax in the US and stamp duty in the UK, which can lead to a potential performance advantage over physically replicating ETFs.
2 Market targeting
Some investors use swap-based ETFs for precise market targeting. You get the same exposure as you would with a physical ETF but swap-based ETFs are likely to track the performance of some markets more closely.
3 More precise tracking
Swap based ETFs aim to deliver very precise tracking, as the swap counterparty is contractually obliged to deliver precise index performance to the ETF, which can help keep costs low and predictable.
Invesco’s swap-based ETF offering
Our range of swap-based ETFs includes some of the lowest cost exposures to key equity benchmarks.2
Please view the product information below in conjunction with the investment risks.
For ETFs domiciled in Europe, there’s an advantage for using swap-based ETFs to replicate the performance of certain major US equity indices, such as the S&P 500 index.
US tax legislation currently allows European-domiciled ETFs using swap contracts to replicate the return of these indices to avoid paying what’s known as ‘withholding tax’ (WHT) on any dividends they receive from the companies in the index. Physical ETFs are subject to a 15-30% tax rate on dividends paid by companies in the same index. As a result of this differing tax treatment, a swap-based ETF tracking certain key US equity indices have a structural advantage allowing them to outperform a physical ETF tracking the same index.
MSCI USA
MSCI World
S&P 500
S&P 500 ESG
S&P SmallCap 600
Nasdaq-100 Swap
In the case of UK and European equities, physical ETFs are required to pay stamp duty taxes on the purchase of securities from certain countries within the fund. With swap-based ETFs they don’t hold these securities that are subject to stamp duty, and instead get exposure to the index through swap contracts. This structural advantage means swap-based ETFs still aim to deliver the return of the underlying index, with no added stamp duty impact.
FTSE 100
FTSE 250
Euro STOXX 50
MSCI Europe
STOXX Europe 600
MSCI Europe ex-UK
The China A-Shares market is another case where synthetic replication can provide an advantage. Rather than the benefit coming from any tax treatment, it is due to the unusual dynamics of the market itself. Find out more in ‘Why structure matters when choosing an ETF’.
Why Invesco?
Consistent and competitive performance
With over a decade’s expertise in managing swap-based ETFs, offering the world’s largest product in this space, the Invesco S&P 500 UCITS ETF.1
Transparent approach
We provide full transparency around fund holdings, swap counterparties and counterparty risk.
Robust risk management
We have prioritised risk management since we pioneered the first multi-counterparty swap-based ETFs in 2009.
Swap-based ETF FAQs
Invesco’s swap-based ETFs use an agreement/contract where two parties agree to exchange cashflows. Invesco’s synthetic ETFs use total returns swaps, where the ETF exchanges the total return on its portfolio of assets for the total return of the relevant index.
The swap fee is the all-in amount paid by the fund to the counterparty for the service of replicating the index return.
An ETF and its swap counterparty are required to ‘reset’ the swap agreement - and settle the difference – if the value owed to either party exceeds a specified amount.
A bank that enters into a swap contract with the ETF.
The possibility that the bank (swap counterparty) is unable to honour its agreement to pay the index performance to the ETF.
We accept only quality securities in the basket
We choose what securities are accepted into the fund basket and what is deemed unsuitable. You can find the basket of securities for each fund, on the product pages of our website.
We reset the swaps frequently
Our ETF and its swap counterparty are required to ‘reset’ the swap agreement – and settle the difference – if the value owed to either party exceeds a specified amount. We endeavour to reset the swaps within tight trigger values; a policy designed to further limit the amount any swap counterparty can owe the ETF.
We regularly assess and monitor swap counterparties
We apply strict financial assessment criteria when considering any counterparty and continually check each chosen counterparty to ensure it remains in a healthy financial position to meet its obligations.
We use multiple counterparties
An ETF provider can choose only one or a range of counterparties to provide swaps for its ETFs. We use multiple counterparties as it helps diversify the risk of being over-reliant on a single bank and should reduce the financial impact if one on those counterparties is unable to fulfil its obligations.
Most of the fund value is in the fund basket
Our swap-based ETF owns a basket of equities which accounts for the vast majority of the fund value. The only time that the fund has exposure to the swap counterparty is if the index being tracked performs better than the basket held by the fund.
Securities Lending is a well-established practice involving the short-term transfer (loan) of securities, for either a defined or open-ended time period.
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Footnotes
1 Invesco, as at 30 May 2024 – Invesco S&P 500 UCITS ETF
2 Invesco, as at 30 May 2024 – Invesco S&P 500 UCITS ETF
Investment risks
Value fluctuation: The value of investments, and any income from them, will fluctuate. This may partly be the result of changes in exchange rates. Investors may not get back the full amount invested.
Use of derivatives for index tracking: The Fund’s ability to track the benchmark’s performance is reliant on the counterparties to continuously deliver the performance of the benchmark in line with the swap agreements and would also be affected by any spread between the pricing of the swaps and the pricing of the benchmark. The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.
Synthetic risk: The fund might purchase securities that are not contained in the reference index and will enter into swap agreements to exchange the performance of those securities for the performance of the reference index.
Concentration risk: The Fund might be concentrated in a specific region or sector or be exposed to a limited number of positions, which might result in greater fluctuations in the value of the Fund than for a fund that is more diversified.
Equity: The value of equities and equity-related securities can be affected by a number of factors including the activities and results of the issuer and general and regional economic and market conditions. This may result in fluctuations in the value of the Fund.
Invesco EQQQ Nasdaq 100 UCITS ETF only
Securities lending: The Fund may be exposed to the risk of the borrower defaulting on its obligation to return the securities at the end of the loan period and of being unable to sell the collateral provided to it if the borrower defaults.
Invesco MSCI World UCITS ETF, Invesco S&P China A 300 Swap UCITS ETF & Invesco S&P China A MidCap 500 Swap UCITS ETF only
Currency: The Fund’s performance may be adversely affected by variations in the exchange rates between the base currency of the Fund and the currencies to which the Fund is exposed.
Invesco S&P 500 UCITS ETF only
Currency hedging: Currency hedging between the base currency of the Fund and the currency of the share class may not completely eliminate the currency risk between those two currencies and may affect the performance of the share class
Invesco S&P 500 ESG UCITS ETF only
Environmental, social and governance: The Fund intends to invest in securities of issuers that manage their ESG exposures better relative to their peers. This may affect the Fund’s exposure to certain issuers and cause the Fund to forego certain investment opportunities. The Fund may perform differently to other funds, including underperforming other funds that do not seek to invest in securities of issuers based on their ESG ratings.
Invesco S&P SmallCap 600 UCITS ETF and Invesco FTSE 250 UCITS ETF only
Small companies: As this fund invests primarily in small-sized companies, investors should be prepared to accept a higher degree of risk than for an ETF with a broader investment mandate.
Invesco EQQQ NASDAQ-100 UCITS ETF, Invesco S&P 500 UCITS ETF , Invesco S&P 500 ESG UCITS ETF only
Currency hedging: Currency hedging between the base currency of the Fund and the currency of the share class may not completely eliminate the currency risk between those two currencies and may affect the performance of the share class
For Invesco S&P China A 300 Swap UCITS ETF & Invesco S&P China A MidCap 500 Swap UCITS ETF only:
Emerging markets: As a large portion of this fund is invested in less developed countries, investors should be prepared to accept a higher degree of risk than for an ETF that invests only in developed markets.
Important information
Data as at 31 Dec 2023, unless otherwise stated. If investors are unsure if these products are suitable for them, they should seek advice from a financial advisor.
Costs may increase or decrease as result of currency and exchange rate fluctuations. Consult the legal documents for further information on costs. An investment in the fund is an acquisition of units in a passively managed, index tracking fund rather than in the underlying assets owned by the fund
For information on our funds and the relevant risks, refer to the Key Information Documents/Key Investor Information Documents (local languages) and Prospectus (English, French, German), and the financial reports, available from www.invesco.eu. A summary of investor rights is available in English from www.invescomanagementcompany.ie. The management company may terminate marketing arrangements.
This is marketing material and not financial advice. It is not intended as a recommendation to buy or sell any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication.
Views and opinions are based on current market conditions and are subject to change.
UCITS ETF’s units / shares purchased on the secondary market cannot usually be sold directly back to UCITS ETF. Investors must buy and sell units / shares on a secondary market with the assistance of an intermediary (e.g. a stockbroker) and may incur fees for doing so. In addition, investors may pay more than the current net asset value when buying units / shares and may receive less than the current net asset value when selling them.
Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”) and have been licensed for use by Invesco. The ETFs are not sponsored, endorsed, sold or promoted by S&P or its affiliates, and S&P and its affiliates make no representation, warranty or condition regarding the advisability of buying, selling or holding units/shares in the ETFs.
The funds or securities referred to herein are not sponsored, endorsed, or promoted by MSCI, and MSCI bears no liability with respect to any such funds or securities or any index on which such funds or securities are based. The prospectus contains a more detailed description of the limited relationship MSCI has with Invesco and any related funds.
NASDAQ® and NASDAQ-100 IndexSM are trade/service marks of The Nasdaq Stock Market, Inc. (which with its affiliates is referred to as the "Corporations") and are licensed for use by Invesco. The Product(s) have not been passed on by the Corporations as to their legality or suitability. The Product(s) are not issued, endorsed, sold, or promoted by the Corporations. THE CORPORATIONS MAKE NO WARRANTIES AND BEAR NO LIABILITY WITH RESPECT TO THE PRODUCT(S).
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The S&P China A 300 Index and S&P China A MidCap 500 Index are products of S&P Dow Jones Indices LLC or its affiliates (“SPDJI”), and has been licensed for use by Invesco. Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”); and these trademarks have been licensed for use by SPDJI and sublicensed for certain purposes by Invesco. The Invesco S&P China A 300 Swap UCITS ETF and Invesco S&P China A MidCap 500 Swap UCITS ETF are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, or their respective affiliates and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the S&P China A 300 Index and the S&P Chia A MidCap 500 Index.
For the full objectives and investment policy please consult the current prospectus.
EMEA3315341/2024
