Lyxor Announces Details Of Physical ETF Switch

Last Updated: 3 June 2023

European exchange-traded fund provider Lyxor will switch four of its swap-based ETFs to physical replication in December, has learned. The move confirms an announcement by the firm in September that it would change the tracking methodology for some of its funds.

Physically replicated ETFs have gained heavily in Europe at the expense of derivatives-based (also called swap-based or synthetic) ETFs over the last two years, with Lyxor’s competitor iShares the main beneficiary of this trend.

Four of Lyxor’s government bond trackers will move to physical replication in the first two weeks of December.

The Lyxor ETF EuroMTS AAA macro-weighted government 3-5 year will change its replication methodology on December 6, says the issuer. The ETF, which is based on the EuroMTS macro weighted AAA government 3-5 year index, currently has €22 million in assets under management, according to Lyxor’s website.

The remaining three ETFs undergoing the switch, the Lyxor ETF EuroMTS AAA macro-weighted government 5-7 year, the Lyxor ETF EuroMTS AAA macro-weighted government 1-3 year and the Lyxor ETF EuroMTS AAA macro-weighted government bonds, will convert on December 11. These funds currently have €402 million, €332 million and €370 million, respectively, in assets under management.

The EuroMTS macro-weighted AAA government bond index series includes eurozone sovereign issuers with the highest credit rating (AAA) from two out of the three main ratings agencies. Of the major eurozone government issuers, currently only Germany, France, Netherlands, Austrian and Finland fall into this ratings category.

The indices’ country weightings are primarily based on issuers’ gross domestic product, adjusted by four additional indicators: debt to GDP ratio, current account (as a percentage of GDP), quarter-on-quarter GDP growth and long-term interest rates.

Under the existing, so-called “unfunded swap” replication model used by Lyxor, its ETFs own a so-called “substitute” basket of securities that may be unrelated to the index being tracked, together with a swap contract via which a derivatives counterparty guarantees the index return. Shifting to a physical replication model will therefore mean bringing the composition of the securities basket into line with that of the the index, and terminating the swap.

However, according to Lyxor’s website, which discloses holdings for its ETFs’ substitute baskets, the four funds being converted already own bonds that are substantially similar to the index holdings. In other words, only a little further rebalancing is needed to move to full physical replication. Swap contracts in Lyxor’s ETFs are currently contracted with the firm’s parent bank, Société Générale.

Under their new structure, the ETFs will not engage in securities lending, says Lyxor. Using securities lending would generate negligible performance benefits for investors and would not justify the addition of counterparty risk to the fund, the firm said in a prepared statement.

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