The ETF labelled 'synthetic' — what is actually different

Physical: it really owns the shares

A conventional ETF buys and holds the index constituents. Track the KOSPI 200 and it owns those 200 names at their index weights.

Open the holdings and you see companies you recognise. What the fund owns is visible.

Synthetic: the return arrives by contract

A synthetic ETF signs a swap with a bank instead: pay us whatever that index returns. The fund posts cash-like assets as collateral and receives the contracted return.

So the holdings show swaps, treasuries and deposits rather than shares. It tracks the index without being a shareholder in anything.

This is common for foreign indices, commodities and hard-to-reach markets, where buying locally is costlier and more complicated.

The added risk: the counterparty

Synthetic replication carries a risk physical does not: what if whoever promised to pay cannot?

In practice this is managed with collateral and by spreading across counterparties, and regulation addresses it. Still, it is managed rather than absent.

It stays invisible in calm markets and surfaces in severe ones. Knowing it is a category of risk physical funds simply do not have is enough.

How to check

Open the holdings. Low equity weight with mostly swaps and cash means synthetic.

Korean funds often say so in the name, sometimes with an H for a currency hedge alongside.

None of this makes synthetic something to avoid — for some indices there is no other route. It is worth knowing what you are buying.

Why synthetic exists at all

Buying the index outright sounds simpler, so why sign a contract? Because some exposures are hard to hold physically.

Markets with foreign ownership limits are the clearest case. If you cannot buy the shares directly, a swap with a local bank that pays the index return is the only route.

Commodities and certain strategy indices are similar. When buying hundreds of names at exact weights costs too much, one contract delivers the same exposure more cheaply — which is why synthetic funds sometimes track better.

What you accept instead

Counterparty risk. If the bank on the other side of the swap cannot pay, you lose that much. Physical funds carry no such exposure.

Regulation requires collateral, so total loss is not the structure. But the collateral may be unrelated to the index, and unwinding it at the moment of trouble can still cost you.

Transparency differs too. Open a physical fund's holdings and you see company names. A synthetic one shows swap contracts and collateral, so what you own is harder to see.

Telling them apart, and choosing

Open the holdings — fastest test. A list of company names means physical. Mostly 'SWAP', deposits and cash-like items means synthetic.

Where both exist for the same index, physical is usually the default choice. Being able to see what you own is worth something by itself.

There are reasons to take the synthetic: markets you cannot reach physically, or a clear tracking advantage. Then the order is to check who the counterparty is and how the collateral is held before deciding.