Deutsche Bank’s ETF business, db x-trackers, says it will soon offer a choice of replication method to investors in some of its European equity funds.
In addition to its current range of ETFs, all of which track their benchmarks using derivatives (swap) contracts, db x-trackers says it will soon offer what it calls “direct replication” products on certain German, US, Japanese, British and eurozone share indices.
European providers offering so-called synthetic (derivatives-based) ETFs have lost a great deal of market share over the last two years to issuers of physical (directly replicated) funds. This year, according to research firm ETFGI, physical ETFs have had net inflows of US$17.7 billion, compared with only US$1.7 billion received by synthetic ETFs.
“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,” said Thorsten Michalik, global head of db x-trackers, in a prepared statement. “Some client segments have shown a preference for direct replication, and as a provider we aim to meet that demand.”
Deutsche Bank says its direct replication ETFs will invest directly in all or a subset of the index securities, by contrast with its existing range of indirect replication ETFs, which use derivatives.
The new direct replication ETFs from db x-trackers will carry the identifier “DR” in their fund names and will hit the market in December, with further fund launches planned for next year.
It’s unclear whether the firm also plans to offer directly replicated ETFs in other asset classes, such as bonds. On Friday Lyxor, Europe’s third-largest ETF issuer, said it was switching some of its fixed income funds from derivatives-based to physical replication.
Currently db x-trackers uses two different types of synthetic ETF replication methods: unfunded swaps for its fixed income ETFs, Euro STOXX 50, DAX, CAC 40, MSCI World and Shariah-compliant ETFs; and funded swaps for its ETFs on other equity indices and alternative asset classes.
In the unfunded swap model, an ETF buys and holds a basket of securities that may be unrelated to the index being tracked. The ETF then signs a swap agreement with a market counterparty, under which the return of the basket is swapped for the return of the index.
In the funded swap model the ETF investors’ cash is paid over to the counterparty, in exchange for a promise by the counterparty to pay the index performance and to return the capital at a future date. This promise is backed by collateral posted by the counterparty to the ETF’s account at a third-party custodian, either in the form of a pledge or a transfer of title.
Deutsche Bank hasn’t disclosed whether there will be any difference in headline fees between its new direct replication ETFs and its existing derivatives-based ones.