Glossary · Fund structure
Physical and synthetic replication
The two ways an index fund can track its index: by holding the securities in it (physical) or through a swap contract with a bank (synthetic).
A physically replicating fund holds the index’s constituents — all of them (full replication) or a representative sample when the index is very large. Its holdings are published and can be seen directly.
A synthetic fund holds a basket of other securities and agrees a swap with one or more banks, which pay it the index’s return. This can track some markets more closely or cheaply, but adds counterparty risk: the fund depends on the bank meeting its side of the swap. UCITS rules limit that exposure and require collateral.
Some physical funds lend part of their holdings to other institutions for a fee, which carries a smaller risk of the same kind. Providers publish which method each fund uses.
Related terms
- Index fundA fund that aims to match the return of a market index, such as the FTSE 100 or the S&P 500, by holding the shares or bonds in it.
- ETFA fund whose units trade on an exchange throughout the day like a share.
- UCITSA European regulatory framework for retail funds, setting rules on diversification, liquidity and disclosure.
More terms on fund structure
Definitions describe how a term is used on Fundology. This is information, not advice.