This article is Part 6 of our definitive guide to Equity Index Investing. Back in 2009, I managed client portfolios of CDO and CDO-Squared – some of the most complex and toxic financial instruments ever assembled by Wall Street Banks. After working out structured finance portfolios, synthetics raised my eyebrows. Not very Golden-retriever friendly, to say the least. Over the past years, though, the products got safer. Why do investors choose them? French Investors get around restrictions to invest in companies outside Europe within the PEA tax wrapper. Other Europeans use them to avoid being taxed on US Dividends. But how competitive are they today compared to the cheapest physical ETFs like the $5.5bn SPDR S&P 500 UCITS ETF that will see its TER cut from 0.09% to 0.03% in November 2023?

KEY TAKEAWAYS

• Not everyone will benefit from savings. If you want a hassle-free, one-ETF portfolio, a synthetic ETF may not be the best choice. Only granular portfolios with dedicated S&P 500 ETFs may benefit.
• Tax savings may boost S&P 500 ETF performance. That’s because U.S. Stocks’ dividends are taxed between 0% and 30%. Physical ETFs domiciled in Luxembourg pay 30%, Irish ETFs have a preferential tax treatment of 15%, but Synthetic ETFs do not pay any tax.
• Synthetic S&P 500 ETFs outperformed 0.07% TER Physical ETFs by 0.2% to 0.3% annually. The fee of the SPDR S&P 500 UCITS ETF that as of Q4’23 is 0.03% is still insufficient to outperform synthetics.
• There could also be savings with MSCI World ETFs. Since we first ran this analysis two years ago, Synthetic MSCI World ETFs also caught up. They are a preferred choice for French Investors in PEA tax wrappers.
• Synthetic ETFs are not without risks. Tax laws may change. But exposure to Banks can be mitigated. Based on my experience, an unfunded swap structure, solid bank counterparties, a liquid basket that resets frequently can mitigate risks.