Types of ETFs
Index tracking ETF (Index-tracker)
8. An Index-tracking (based) ETF typically seeks to replicate the performance of an underlying index or benchmark. It may do so either as a physical
ETF or as a synthetic ETF.
9. The investment strategy of a physical ETF is to hold physical securities and other assets to obtain returns that correspond typically to those of an underlying index or benchmark by replicating (and where appropriate, by sampling) the component securities of the relevant index or benchmark. Replication generally involves investing in the component securities of the underlying index or benchmark in the same approximate proportions as in the underlying index or benchmark.
10. In certain cases, it may not be possible for an ETF to own every stock of an index (for example, due to, transaction costs, the index being too large, its components being illiquid, or because its market capitalisation weighting would result in the ETF violating regulatory requirements for asset diversification). In such instances, a physical ETF may rely on sampling techniques. For example, by acquiring a subset of the component securities of the underlying index, and possibly some securities that are not included in the corresponding index designed to improve the ETF's index-tracking.
11. The investment strategy of a
Synthetic ETF is to meet its investment objective by entering into a derivative contract (typically through a total return swap) with a selected counterparty. The swap contracts can take one of two forms:
a. an unfunded structure; or
b. a funded (or prepaid swap) structure, as described below.
12. In both models, the derivative exposure is collateralised or reduced through the use of collateral or a portfolio management process, that may involve the services of a third party as collateral agent (in the funded model) or is covered by the substitute basket as assets of the
ETF (in the unfunded model).
Synthetic ETF (unfunded)
13. In a synthetic
ETF adopting the unfunded structure, the ETF Fund Manager invests the cash proceeds from investors in a so-called substitute or reference basket of securities (typically bought from a bank). The basket's return is swapped via a derivative contract with an eligible counterparty (frequently, the derivatives desk of the same bank), in exchange for the return of the index referenced in the ETF's investment objective.
Synthetic ETF (funded)
14. In a synthetic ETF adopting the funded structure, the ETFFund Manager enters into a swap in exchange for cash (or for the entire ETF portfolio) without the creation of a substitute basket.
A leveraged ETF
15. A leveraged ETF (which is often an index-tracking ETF) can have leverage exposure to an index, or exposure to a leveraged index.
Actively managed ETF
16. An ETF is actively managed if the
Fund Manager exercises discretion over the composition of the invested portfolio in an attempt to outperform a chosen index or other benchmark. The key difference, compared to an index tracking ETF, is a Fund Manager's ability to adjust the portfolio without being subject to the set rules of the index or other benchmark referenced. An actively managed ETF could be a physical ETF or a synthetic ETF—with a portfolio selected at the discretion of the Fund Manager or derivatives designed at the discretion of the Fund Manager.
DFSA regime does not permit the creation of actively managed ETFs (see CIR Rule 13.9.3) as there is less transparency relating to the underlying portfolio of assets. This gives rise to potential difficulties in clearly identifying risks associated with exposures to counterparties and any collateral used in such ETFs, compared to ETFs that passively track the performance of a specified index or other benchmark.
Derived from DFSA RM218/2018 (Made 22nd February 2018) [VER23/12-18]