Simplicity was a strong selling point of the first exchange traded funds offered in the early 1990s. Issuers bought the shares that made up the underlying index and sold them on to investors in the form of a single easily traded security.

But as the range of assets covered by ETFs has expanded it has become more difficult to assemble the underlying portfolio. Issuers have found a way round this difficulty by means of swaps, exchanging a perhaps less than perfect bunch of assets for a swap that precisely mirrored the relevant index.

Has this damaged the original concept and introduced an unwelcome element of complexity? The recent financial meltdown and subsequent credit crunch have made many investors suspicious of complex financial products. Plain vanilla is back in fashion.

Fully replicated ETFs still account for most of assets under management globally – $607.6bn (£392.2bn, €445.9bn) against just $99.2bn in synthetic ETFs, according to Barclays Global Investors and Bloomberg. But recent investment bank-backed entrants to the ETF market, including Lyxor and db x-trackers, have launched only synthetic ETFs.

“Full replication means you know what you are buying,” says Chris Sutton, senior investment consultant at Watson Wyatt. “The key thing about ETFs is their transparency.” But Mr Sutton acknowledges that full replication may not be possible for some classes of asset.

Full Story: http://www.ft.com/cms/s/0/a6e09c3c-4e08-11de-a0a1-00144feabdc0,dwp_uuid=d8e9ac2a-30dc-11da-ac1b-00000e2511c8.html

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