Not sure if I’m missing something, but when you use a broker like IB and buy a US based ETF, you only have 15% withheld tax. You can claim back those 15% through DA-1, so in the end you have no withheld taxes. Of course based on the ETF there might be some minor unrecoverable dividens.
I personally would never use a syntetic ETF, as you have the additional risk to lose (part of) your assets, when the provider of the synthetic products goes bankrupt.
The difference is that with a US domiciled ETF:
- YOU need to Reclaim
- US Inheritance Tax
- Disclosure rights of US Authorities (Fatca)
With the UCITS synthetic ETF that follows the Hire Act 871m rule where futures and synthetic ETFs on S&P 500, MSCI USA and MSCI World are equally treated in Witholding Tax
- NO reclaim needed
- NO US Inheritance Tax & Fatca disclosures
For the counterparty risk there was 1st NEVER a default of an asset manager (ETF Provider); the SWAPs used in the ETF are backed by equity Investments and reset on a Daily basis. The synthetic ETF is everything but a black box because you know the performance and Dividend yield exactly + you have not a cash drag as the case with Vanguard and Ishares.
With a physical ETF that does security lending you have more counterparty risks btw…This is the reason why we see over the last 2years in Europe massive investments to switch from physical to synthetic. Many articles on that everywhere…
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Thanks for listing up pros and cons. Let me add some comments:
The difference is that with a US domiciled ETF (for Swiss investors):
ETF with physical replication
- YOU need to Reclaim -> Only the 15% and its 1 form
- US Inheritance Tax -> I guess thats an important point to consider, especially when you get older
- Disclosure rights of US Authorities (Fatca) -> What do you mean by that?
- Considered to have a smaller 3rd party risk, as ETF actually holds shares and the 3rd party risk comes from security lending
Synthetic ETF
- NO reclaim needed
- NO US Inheritance Tax & Fatca disclosures
- Considered to have a higher risk, as the ETF does not own any shares. The etf only owns the swap and the collateral. In case of a default of the swap provider. For EU ETS (didnt see it for US ones) the collateral should cover 90% of the ETFS NAV. But the collateral is usually also invested. So in a hard market drop, in which the swap provider goes bankrupt, you could loose more than 10%.
I dont think the swaps are backup by something esle, then the collateral (correct me if I’m wrong here).
I found this post of the ECB from 2018 regarding ETFs counterparty risks:
It looks like in 2018 the majority of the (EU) etfs were relying on physical replication.
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Btw I just found this one:
It quotes the us-ch tax tready and comes to the conclustion that Swiss investors have the same inheritance tax exemption like US citizens, which would mean 11 mio. That would be quite new for me. I will try to verify that.
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This is true. It was half the amount 2 years ago, Trump increased it to 11 million.
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Thanks for confirming that. I wrote EDA a mail, but not sure if they will reply:)
…in shares.
So they might hold European shares such as Airbus (instead of Boeing).
Unfortunately, it could be lowered in the future if the new President of US (aka Biden) want it 
But you still seem to lose ~15% of dividend amount, so what would be the benefits compared to a physical UCITS (irish) ETF? (Esp. if the swiss taxes are higher as it seems to be here).
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I just took that point from Matchpoint. Not sure I get your point. In my understanding synthetic ETFs usually to not pay out dividents. If thats the case, it would mean you would be only taxed on the capital gain.
Thanks! Is there a site where I can track this amount?
True, thats why a huge market drop could also minimize the collateral.
Neither do accumulating funds pay out dividends. Many synthetic funds happen to be accumulating.
Investors will still be taxed as if a (fictitious) dividend had been paid it (at least as long as the fund is reporting figures):
“Massgebend für die Ermittlung des steuerbaren Ertrages von Swap-based ETFs, welchen Aktien- indizes zugrunde liegen, ist die Nettodividenden-Rendite (net yield dividend). Darunter ist die Bruttodividenden-Rendite der entsprechenden Indizes, abzüglich der anwendbaren Quellensteuern zu verstehen”
Eidgenössische Steuerverwaltung, 1-024-VS-2017-d
…just as it would (correlatedly) minimise the values of holdings in a physically replicating fund.
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Ah interessting, so the Swiss tax authorities will anyway calculate theoretical “dividents”.
The correlation depends on the asset types and assets that the collaterial is invested in. I’m unaware of the regulations on this. But I doubt that they try to replicate the index with the collateral or buy an index ETF with it, otherwhise it would be a physical ETF in a synthetic ETF.
But I see your point, that based on the correlation of the collateral assets and the index, the loss is smaller or bigger, if the 3rd party, who offers the spaws, goes bankrupt.
Europe has pretty strict regulations on this…:
Sure it does!
The biggest part will be just (other) listed securities.
Taking a practical example, such as AMUNDI S&P 500 UCITS ETF - EUR, you can export the (sub-) fund’s holdings as an Excel sheet. The top 15 are as follows:
| ISIN | Name | Share of holdings |
|---|---|---|
| ES0113900J37 | BANCO SANTANDER SA REG SHS | 4.72% |
| DK0060534915 | NOVO NORDISK | 4.02% |
| ES0144580Y14 | IBERDROLA SA | 2.90% |
| NL0011585146 | FERRARI NV | 2.61% |
| JP3351100007 | SYSMEX | 2.41% |
| PTEDP0AM0009 | EDP-ENERGIAS DE PORTUGAL SA - REG.SHS | 2.34% |
| DE0008430026 | MUENCHENER RUECKVERSICHERUNGS AG REG SHS | 2.18% |
| JP3890350006 | SUMITOMO MITSUI FINANCIAL GROUP INC | 2.16% |
| JP3783600004 | EAST JAPAN RAILWAY CO | 2.15% |
| FR0000121014 | LVMH MOET HENNESSY LOUIS VUITTON SE | 2.12% |
| DE0005810055 | DEUTSCHE BOERSE AG REG SHS | 2.10% |
| ES0178430E18 | TELEFONICA SA | 2.06% |
| DE000BAY0017 | BAYER AG REG SHS | 2.03% |
| FR0000120271 | TOTAL SE | 1.99% |
| US0846707026 | BERKSHIRE HATHAWAY -B- | 1.96% |
Also published is “Swap counterparty and market value of the swap contract as a percentage of the Net Asset Value, as at 15/12/2020” as being 0.20% of Net Asset Value.
If I’m not mistaken, the value of securities held actually exceeded the fund’s NAV by 1.5% at the end march 2020 (last available semi-annual report). In other words, the synthetic ETF owned more collateral stocks than it was actually worth! Which wouldn’t be that surprising giving the timing and rather “boring” (probably lower-than-average volatility) nature of many stocks included.
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Thanks for your detailled feedback!
Can we conclude therefore, that there is a higher risk for synthetic ETFs in the event of a bankrupt of the swap provider. You could loose the returns of the current and year and you might have an additional loss, if the current NAV of the collateral is less than 100%?
That’s what they’ll warn you of themselves in their prospectuses.
If I’m understanding correctly though, Amundi in the example above does seem not to exhaust the leeway allowed by regulations. I any case, I’m not concerned much about synthetic replication method - however, I don’t believe that that alone magically makes them “better” or more efficient.
Well few points to the above:
Synthetic ETFs are better than physical for the following underliyings:
S&P500, MSCI USA, MSCI World
Because there was the hire act 871m in the US where ETF providers can in a synthetic manner replicate the Gross Index.
For Invesco if you compare their S&P 500 collateral basket it is almost only S&P 500 stocks.
If you compare a synthetic ETF to a physical ETF that does security lending a synthetic ETF is safer. Almost every physical ETF does Security lending…
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While they can offer the gross return, could you point to which S&P500 ETF that does? Those I’ve checked matched the Irish ETFs (so 15% withholding).
E.g. lyxor acc, vs. ishares acc, vs. invesco acc: TradingView Chart — TradingView (ishares is physical, the others are synthetic)
The first ETF Provider replicating the Gross Index is Invesco since January 2019. so if you look at the performance and compare it to Ishares they outperform Ishares by 30bps (2% div yield x 15% US Witholding Tax because Ishares is Irish domiciled)