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The exclusion of Nigeria from the S&P Select Frontier index was due to “significant delays in capital repatriation” for those selling stocks listed in Lagos. This action has brought to light a potential flaw in the synthetic ETF model, which employs a swap contract with a counterparty to mimic the performance of underlying assets. This contrasts with physically replicated ETFs that own these assets.
“In many cases, the outcome for investors would be similar,” said Morningstar. They drew parallels with the removal of Russian stocks from emerging market benchmarks in 2022 following Russia’s invasion of Ukraine. However, he also recognized that this incident highlights a structural disadvantage of swap-based exposures.
Xtracker products countered by arguing that swap-based products can offer advantages, particularly in emerging markets where a fund manager would otherwise need to open securities accounts in each invested country and potentially face foreign ownership restrictions.
Under President Bola Tinubu’s administration since May 2023, Nigeria has addressed its foreign exchange scarcity issue by implementing a “willing-buyer and willing-seller” model. This has allowed for the Nigerian naira to float more freely and the exchange rate to be determined by market forces.
Charlie Robertson, head of macro strategy at FIM Partners, observed that while investors previously faced challenges in repatriating money, the foreign exchange market has now gained liquidity. He noted that some foreign investors are investing in Nigeria as the exchange rate has become more realistic and blockages making it hard to withdraw money are easing. This suggests that investors in a physically replicated ETF wouldn’t have seen their Nigerian holdings devalued to zero, even if there was a delay in receiving the sale proceeds.
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