An exchange-traded fund (ETF)- specifically, a type of synthetic ETF, that replicates its index with a swap transaction (e.g., a total return swap). The synthetic or indirect replication of the index involves a swap transaction along with a collateral. The ETF enters into a contract with a financial institution, whereby the latter delivers the index return in exchange for a fee. Given the use of swap contracts in the ETF construction, the fund is exposed to the counterparty risk involved in the swap.
These ETFs are a cost-effective alternative allowing ordinary investors to have exposure to niche markets or asset classes such as commodities and money market. In addition to that, swap-based ETFs can track certain markets in a more efficient and accurate way compared to physical ETFs.
A swap-based ETF can take different forms depending on the type of the swap (funded swap vs. unfunded swap) [for more, see: funded swap ETF and unfunded swap ETF].
