Before the financial crisis occurred in 2008, the market share of the main replication methods used by ETF promoters in Europe was nearly evenly split between physical (full/optimized) and synthetic replication. That said, one needs to bear in mind that the vast majority of assets in the European ETF industry was invested in equity ETFs at this point in time. This changed in the aftermath of the financial crisis as European investors realized that a swap or other derivatives used for synthetic replication have a counterparty risk and, therefore, avoided ETFs which were using synthetic replication where possible.
As a result, physical replication has become the replication method of choice for European investors. Therefore, it is no surprise that ETFs using physical replication held the vast majority (87.24%) of the assets under management in the European ETF industry at the end of December 2024.
In more detail, ETFs using full replication as replication methodology had the largest market share of AUM (€1,021.7 bn, or 49.07%), followed by ETFs using optimization strategies to replicate the risk/return profile of their underlying index (€794.7 bn, or 38.17%), ETFs using a synthetic (swap-based) approach (€251.1 bn, or 12.06%), and ETFs using other replication methods (€14.7 bn, or 0.71%).
Graph 1: Market Share of Replication Methodologies by Assets Under Management (December 31, 2023 vs. December 31, 2024)
Source: LSEG Lipper
Graph 1 shows that the market share of ETFs using optimized replication has decreased (-1.86%) over the course of 2024. In contrast, the market share for ETFs using full replication (+0.70%) and ETFs using a synthetic approach (+1.17%) increased over the same time period. This movement in market shares is generally caused by the higher overall growth (estimated net flows + market performance) of equity ETFs over the course of the year 2024 since optimized replication is the preferred replication methodology for bond ETFs. Additionally, it is noteworthy that swap-based ETFs which invest in U.S. stocks do have a withholding tax advantage compared to ETFs which are using physical replication methods—this might have caused the above average increase of the market share of swap-based ETFs.
More generally speaking, I would expect that the overall trend regarding the preference of physical (full/optimized) replication will continue even as structure terms of the swaps and other derivatives used for synthetic replication have been changed to minimize the counterparty risk within the respective products. Nevertheless, one needs to bear in mind that some asset classes (such as blended commodities indices, etc.) or market segments can’t be replicated with physical replication since the respective assets are not eligible for UCITS products. In addition, the mentioned tax advantage for U.S. equity ETFs might also become a growth driver for synthetic replication.
This article is for information purposes only and does not constitute any investment advice.
The views expressed are the views of the author, not necessarily those of Lipper or LSEG.
