Quora Answer: Do ETFs Always Own the Underlying Assets They Represent?

The following is my answer to a Quora question: “Do ETFs always own the underlying assets they represent?”

Generally, an ETF, as the name does suggest, is a type of fund, which takes a stake, or owns several classes of assets, and securities, and then divides itself into shares, owned by shareholders, the people who bought the ETF.  For the most part, ETFs are straightforward, although the products are evolving, and gaining complexity.

The exception to the rule are synthetic ETFs, which do not directly own the assets tracked.  Rather, they use derivative products to replicate the chosen tracked index, which are complex mechanisms.  Because they are contractually obligated to match the return of this index, it is subject to significant counterparty risk.  Due to the complexity of the product, and the lack of transparency, it is almost impossible to enforce compliance, and it is starting to attract regulatory attention all over the world.  In essence, they are ETF in name, but should be classed as a distinct product.