BlackRock
BlackRock has avoided synthetic equity ETFs for nearly a decade © Bloomberg

A BlackRock fund that physically holds US stocks has seen the largest net outflows of any equity exchange traded fund in Europe in the three months to September, helping explain the group’s decision to make a policy U-turn.

The world’s largest asset manager last week unveiled a “synthetic” US equity ETF that derives its return from a swap contract held with a major bank, rather than by physically holding S&P 500 stocks.

The move was a significant policy reversal, given that BlackRock had avoided synthetic equity ETFs for nearly a decade and several of its most senior figures, including chief executive Larry Fink, had roundly condemned the structure.

BlackRock’s shift accompanies a widening belief that synthetic ETFs are a better structure for US equity ETFs aimed at European investors than “physical” ETFs, which actually hold the underlying shares.

Physical US equity ETFs domiciled in Luxembourg and Ireland, the two main European hubs, face withholding tax of 30 per cent and 15 per cent respectively on the dividend income they receive from their holdings.

Synthetic ETFs can escape this tax, potentially giving them a performance advantage, prompting investors to increasingly switch to the swap-based model.

This trend accelerated in the third quarter, with BlackRock’s $50bn iShares Core S&P 500 ETF — the fund it has launched a synthetic version of — seeing the largest net outflows of any equity ETF in Europe, according to data from Morningstar, leaking €1.1bn.

Vanguard’s S&P 500 ETF, another physical equity ETF, was hit by the same trend, shipping €560m.

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The outflows came despite strong inflows into equity ETFs in general, which raked in €17.1bn in the quarter, up from €4.2bn in the previous three months, and US large-capitalisation funds in particular, which took in €3.4bn.

“We have known for some time that in the case of US equities, the synthetic ETF structure has an edge in performance over physical replication as it avoids the payment of withholding tax on dividends,” said Jose Garcia-Zarate, associate director of ETF strategy at Morningstar.

“iShares Core S&P 500 and Vanguard S&P 500 are both physical ETFs. Some investors in these funds have switched to synthetic competitors.”

Elsewhere, global equity income funds also saw outflows in Q3, something Mr Garcia-Zarate attributed to the number of companies cutting or suspending their dividends this year.

Fixed income flows were dominated by China, with onshore renminbi bond funds attracting a net €2.1bn in the third quarter as Chinese bonds continued to be added to the major global indices.

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