Last Updated: 31 January 2023
iShares announced this morning that it is launching a new range of swap-backed ETFs. The firm has up to now been renowned primarily for using physical replication for its exchange-traded fund range (although it has for several years managed a series of swap-based ETFs in Germany, based on the Stoxx 600 Europe sector indices). In a press release to accompany the issue of the new funds, iShares reiterated that physical replication would remain its tracking technique of choice.
Physically replicated ETFs hold all, or a sample, of the stocks in the index being tracked (although some may be lent out to enhance returns). Swap-based funds, by contrast, hold a basket of collateral, typically equities or bonds, that is likely to be unrelated to the index being tracked, but which exists primarily as backing for a derivatives transaction with a swap counterparty. The swap contract guarantees the fund its index return (net of fees and any other swap-related charges).
The two initial funds in iShares’ new swap-backed range track emerging market equity indices, the MSCI Russia Capped Index and the S&P CNX Nifty India Index. Emerging markets have presented the greatest tracking error problems for fund managers that use the traditional physical replication technique, with iShares’ flagship MSCI Emerging Markets fund in the US (NYSE Arca: EEM) trailing its benchmark by over 7% last year.
iShares’ new ETFs have several distinctive features: the funds will use multiple swap counterparties and multi-dealer primary and secondary market models, which should ensure best execution for clients, the firm says; iShares will overcollateralise its ETFs by up to 20%, limiting risk exposure to market counterparties; and the firm will disclose daily collateral and index holdings, swap spreads and aggregate swap exposure on the iShares website.
Up to now disclosure of the collateral composition for most swap-based ETF providers has been limited to mandatory half-yearly reporting in the semi-annual and annual fund accounts, although Credit Suisse recently launched a new swap-based fund range with daily disclosure of fund collateral.
According to Axel Lomholt, head of product management for iShares in Europe, the Middle East and Africa, “This initiative is an important expansion of the iShares product set and reinforces our position as the market leader in one of the fastest growing areas of fund management. iShares remains committed to its physically backed ETF structure offering, which we believe continues to be the most effective and efficient way for investors to access mainstream asset classes, and will always be our first option when launching products.
“Counterparty risk and transparency have been the driving concerns for investors using swap-based ETF structures. Considering this, iShares has engineered an enhanced platform following a unique model which, coupled with an overcollateralised and highly transparent fund structure, helps to significantly minimise counterparty risk for investors.
“We are delighted to have RBS, UBS and Credit Suisse act as swap counterparties to the new funds and plan to add further counterparties over time.”
The iShares MSCI Russia Capped Swap ETF carries an annual total expense ratio of 0.74%, while the iShares S&P CNX Nifty India Swap ETF charges 0.85%.