Synthetic assets

Definition

Synthetic assets refers to a mix of assets that mimic the return of another asset. In other words, the returns earned by using synthetics are made possible by using a combination of other financial products, such as options, futures or swaps which mimic an underlying an underlying asset. So, instead of getting returns, by directly buying and selling assets such as stocks or bond, synthetic assets derive return from other investment products that are based on the underlying asset.

Usually traders and investors incorporate synthetic asset, to suit their needs and create a strategy with specific cash flow patterns, maturities and risk profiles.

By definition it is impossible to provide an extensive list of all the existing synthetics, however the most common used synthetics present on the market are :

• Options
• Structured products
• Certain type of structured investment in real estate
• Guaranteed investment contrats

Pro and Cons of synthetics

Synthetics can play an important role in large portfolio by enbaling traders to take a position without having to lay out the capital to buy the underlying asset.

Additionally, it allows traders to :

• reduce risk
• diversify their portfolio
• try to obtain stronger return

On the other hand, synthetic investments might cost more in fees and involve more trading prowess due to their complexity and the risk of margin call induce by the high leverage ratio of those products.

Since high amounts of leverage are necessary to attain positions in synthetic asset markets, this type of trading is primarily dominated by investment firms and banks. However, if we look closer at the volume we can notice that these types of trading  dominate our world's financial market today.