Portfolio
The way an ETF tracks its index: full physical replication, physical sampling (a representative subset), or synthetic replication via a swap with a bank. The choice affects tracking accuracy, costs and possible counterparty risk.
An ETF's job is to track the performance of an index as closely as possible. The replication method describes the technical route it takes to do so. In practice, three approaches have become established.
With full physical replication, the fund buys every constituent of the index at its respective weighting. With physical sampling, it holds only a representative subset, which mainly saves costs on very broad indices. With synthetic replication, the fund does not track the index through the securities themselves but through a swap, an exchange agreement with a bank.
The method is not a minor detail: as a rule it affects tracking accuracy, ongoing costs and, in the case of a swap, a possible counterparty risk should the swap partner default. Which variant applies can be found in the fund documentation.
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