What Assets does my ETF own?

BY betashares | 26 May 2014
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Investors are rightly interested to know about the underlying assets held inside their investment products. Buying individual stocks gives you potential access to dividends and capital growth the company generates. But what about managed funds and ASX traded Exchange Traded Funds (ETFs) – what do they hold?

We look further into this issue in this week’s BetaShares Academy post.

ETFs are regulated by ASIC  and, in addition, must conform to the ASX’s operating rules for the AQUA market on which they trade.

The current regulatory position is that, to be called an “ETF”, the fund must hold assets which seek to track or follow the performance of a published index (such as the S&P/ASX 200 index) or asset (such as gold bullion).

Apart from these parameters, ETFs can be classified into two broad categories – physical or synthetic.

Physical or synthetic – what’s the difference?

A “physical” ETF holds the underlying securities or asset to replicate the index or asset class. For example, in the case of the BetaShares FTSE RAFI Australia 200 ETF (ASX: QOZ), the fund will actually hold the different shares that make up the index, replicating the index weighting of each individual stock.

Top 10

Top 10 Holdings of BetaShares FTSE RAFI Australia 200 ETF as at 26 May 2014

In comparison, a “synthetic” ETF will not hold the underlying asset or constituents of the index being tracked, and instead will use a derivative (which is traded “over-the-counter” or directly between two parties rather than on an exchange) to obtain synthetic exposure to generate returns for the investor.

In Australia, if an ETF holds such derivatives to a material extent, it is considered a “synthetic” ETF and must include “synthetic” in its name. However, the level of counterparty exposure in an Australian ETF (the amount owed to the ETF by the other party to the derivative) must be limited to no more than 10% of the net asset value of the fund at any time. In practice the counterparty exposure is usually substantially less than that. This maximum level of counterparty exposure marks an important distinction between synthetic ETFs in Australia compared with global markets – the 10% rule does not necessarily apply outside of Australia.

One of the reasons for limiting counterparty exposure is to reduce counterparty risk – the risk that the other party to the derivative defaults on its obligations.

Requiring the use of the “synthetic” label is to ensure investors are made aware the fund is obtaining its investment exposure via derivatives.

Why use synthetic structures?

BetaShares has always sought to adopt the most appropriate structure to deliver investment returns. As a result virtually all of our products use ‘physical’ structures. For example, our gold ETF is backed by physical gold bullion, our equities products hold shares and our Cash product is backed by at-call cash.

However, when it’s hard (or impossible) to hold and store some types of commodities (eg live cattle, grain, oil, etc), in order to create ETF exposure to these assets, the BetaShares commodity ETFs will use derivatives.

Importantly however, the underlying asset backing to these products is cash – so there is still a tangible asset backing the ETF. This type of ETF invests all of its assets into cash and obtains exposure to the commodity price via a swap agreement with a large financial institution.

When purchasing ETFs, investors should consider the structure of the fund and how it is generating returns. If all else fails, don’t hesitate to contact the ETF issuer, who can help you better understand the underlying ETF structure.

2 Comments

  1. In the article dated 26May14 the top 10 holdings of the QOZ portfolio represented 54.3% of the portfolio. I thought that QOZ During the market fall in 2015, the ASX fell 16.38% from 20March to 15Dec. Over the same period QOZ fell 21.78%. What is the explanation for this? The article also states “…in the case of the BetaShares FTSE RAFI Australia 200 ETF (ASX: QOZ), the fund will actually hold the different shares that make up the index, replicating the index weighting of each individual stock.” The website overview for QOZ states “Provides exposure to a diversified portfolio of Australian equities, weighted in a way that is reflective of the economic footprint rather than the market capitalisation of its constituents.” These two statements appear to be in direct conflict, but at the same time may explain the difference between the fall in XAO compared to QOZ. Is there any comment from the Betashares staff?

    1. BetaShares  |  January 27, 2016

      Hi Bob,
      Thanks for your query regarding QOZ. To clarify, the aim of QOZ is to replicate the FTSE RAFI Australia 200 Index, so the objective refers to replicating this index, rather than the S&P/ASX 200. The FTSE RAFI Australia 200 Index is an Index which weights its constituents based on ‘economic footprint’ and using fundamental measures (e.g. cash flow, book value, dividends, sales) rather than price/market cap. As a result of this difference in weighting methodology, the underlying constituents of QOZ will differ from the S&P/ASX 200 which is why there will likely be differences in performance between QOZ and the market cap weighted index. Over the last 12 months these differences have resulted in a small underperformance by QOZ compared to the S&P/ASX 200 index. However, as you will see in the longer term performance figures (see https://www.betashares.com.au/products/name/ftse-rafi-australia-200-etf/#each-performance), the index still maintains outperformance to the S&P/ASX 200 over longer time periods. Hope that helps

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