Investors in a derivative-linked “synthetic” exchange-traded fund have been left out of pocket after Nigeria was axed from its underlying index, according to a report by the Financial Times.
The losses may expose a hitherto unidentified weakness of the synthetic ETF structure, which relies on having a swap contract in place with a counterparty to replicate the performance of the underlying assets rather than actually owning the assets themselves, as a physically replicated ETF does.
Nigerian stocks accounted for 4.8 per cent of the £68mn Xtrackers S&P Select Frontier Swap Ucits ETF (DX2Z) until October 31.
However, on November 1, S&P Dow Jones Indices stripped Nigeria from the S&P Select Frontier index that the ETF tracks at a “zero price.” As a result, this portion of the fund’s portfolio has been written down to zero.
In contrast, a physical index-tracking ETF or mutual fund would—in theory at least—have been able to sell the Nigerian holdings and plough the proceeds back into the fund.
