What is an ETF?
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What is an ETF?
Familiar ground…best of both worlds
Two great investment ideas brought together
Like a stock Trading flexibility intraday on the exchange Long or short Options frequently available
Like a Mutual Fund
Stock
Like an index fund Constructed to track benchmark indexes
Tradable during the day
Low expense ratios Low turnover
Diversified ETFs
What sets ETFs apart? The creation / redemption process enables the unique benefits of ETFs such as liquid access and tax efficiency
Diversified funds that trade like stocks
With short sales, an investor faces the potential for unlimited losses as the security's price rises. There can be no assurance that an active trading market for shares of an ETF will develop or be maintained. Transactions in shares of the iShares Funds will result in brokerage commissions and will generate tax consequences. iShares Funds are obliged to distribute portfolio gains to shareholders. Diversification may not protect against market risk or loss of principal.
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The role of ETFs: uses and advantages
Exchange Traded Funds have become widely accepted investment vehicles and are used by both institutional and retail investors The ETF structure allows for efficient access to low-cost beta and other investment strategies
Typical applications of ETFs: Institutional Investors Cash equitization Low cost hedging tool Expressing macro views
Key advantages of ETFs:
Exposure to markets where investing institutions lack resources
Trade daily on exchange Intraday pricing Transparent
Retail Investors
Easy access
Portfolio completion
Diversified
Asset allocation
Can be more liquid than underlying assets
Tactical investing among sectors
Diversification may not protect against market risk or loss of principal. There can be no assurance that an active trading market for shares of an ETF will develop or be maintained.
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Why do Financial Professionals use ETFs?
Return Return
Risk Risk Total Performance™
Costs (and Costs taxes) (and Taxes)
Seek to outperform other investments
Performance vs. active funds
Manage risk
Diversification Tradability and flexibility
Express a view
Spend less, save more
Cost effectiveness Tax efficiency
Transparency Past performance does not guarantee future results. Diversification may not protect against market risk. Transactions in shares of iShares funds may result in brokerage commissions.
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iShares ETFs and Mutual Funds: Key Differences
Criteria
iShares ETFs
Active Mutual Funds
Performance goal
Track a benchmark
Outperform a benchmark
Management
Passive
Active
Performance risks
Performance may differ from benchmark.
May not meet performance goal.
Holdings not altered during rising / falling markets.
May underperform due to manager’s holdings selection.
Buying / selling shares Intraday on exchanges
Once per day via fund company
Price to buy / sell
Current market price, which may differ from NAV
End-of-day NAV, less fees
Fees
Expense ratio + transaction / brokerage costs
Expense ratio + any sales loads / redemption fees
Tax impact1 of buyers / sellers
Shareholders only impacted by their own action
Shareholders may be impacted by all other shareholders’ actions
Holdings disclosure
Daily
Typically quarterly
* Both vehicles are obliged to distribute capital gains to all shareholders.
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Benefits of iShares ETFs
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Benefits of iShares ETFs
Transparency
Investors can generally see the ETF composition at any given time
Liquidity
ETFs offer two sources of liquidity 1. Traditional liquidity measured by secondary market trading volume 2. The liquidity of the underlying assets via the creation and redemption process
Diversification
ETFs offer immediate exposure to a basket or group of securities for diversification through a single trade Broad range of asset classes, including equities, bonds, commodities, investment themes, etc.
Flexibility
Costeffectiveness
Securities lending
ETFs are listed on exchanges and can be traded at any time the market is open Pricing is continuous throughout the day ETFs offer a cost-effective route to diversified market exposure Ability to estimate in advance the total cost of ownership using ETFs with far higher degree of certainty than with futures ETFs are not subject to additional operational costs when managing risk, settlement and reporting that other derivative products require ETF units and underlying assets can be lent out to potentially offset holding costs
There can be no assurance that an active trading market for shares of an ETF will develop or be maintained. Diversification may not protect against market risk or loss. Buying and selling shares of iShares Funds will result in brokerage commissions. There is no guarantee that there will be borrower demand for shares of the iShares Funds, or that securities lending will generate any level of income. Distributions paid out of the Fund's net investment income, including income from securities lending, if any, are taxable to investors as ordinary income.
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Broker / Dealer primary ETF usage
AP/ETF desk
Sales trading / agency desks
Market making
Principal trading
Structured products
• Facilitate the C/R of ETF units by trading the underlying ETF basket and delivering to the ETF provider
• Recommend ETFs as a trade solution (e.g., other side of pair-trade, for quick tactical calls) and capture ETF trading flow
• Leverage proprietary capital, research and system resources to make profit by buying and selling ETFs intraday
• Take proprietary risk positions utilizing ETFs for specific exposures
• Develop customized and / or enhanced solutions for clients utilizing ETFs to leverage liquidity and enhance structured product flexibility
• Understand ETF trading and flows the consensus views in specific areas of the market
• Used to hedge inventory positions
• May also act on behalf of market makers who are not authorized to transact directly with the ETF provider
• Trade ETFs to take advantage of index arbitrage, volatility arbitrage or global macro events
• Use ETF as hedge for position
There can be no assurance that an active trading market for shares of an ETF will develop or be maintained.
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Familiar ground…best of both worlds Like a stock Trading flexibility intraday on the exchange Long or short Options frequently available Like an index fund Constructed to track benchmark indexes Low expense ratios Low turnover What sets ETFs apart? The creation/redemption process distinguishes ETFs from mutual funds and closed-end funds The creation/redemption process enables the unique benefits of ETFs such as liquid access and tax efficiency
With short sales, an investor faces the potential for unlimited losses as the security's price rises. There can be no assurance that an active trading market for shares of an ETF will develop or be maintained. Transactions in shares of the iShares Funds will result in brokerage commissions and will generate tax consequences. iShares Funds are obliged to distribute portfolio gains to shareholders.
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Different types of ETPs
Legal Structure Comments Open End Fund
Most common structure; may allow dividend re-investment, securities lending and optimization
Grantor Trust
Structure commonly used for concentrated, specialty exposures that don’t meet diversification requirements of open end funds
Unit Investment Trust
Early ETF structure; does not allow for portfolio optimization, securities lending or dividend re-investment
Underlying Assets Comments Index Securities
Securities held either as fully replicating index or optimized proxy
Swaps
Mostly used in levered or inverse funds and exotic exposures; also common in Europe
Futures
Futures contract or a basket of futures contracts held by the fund, most common for broad commodities
Physical Assets
Most common in metals ETPs
Notes
Exchange Traded Notes (ETNs) are debt obligations of the issuer to the holder
"ETP" (or exchange traded product) as referred to above means any portfolio exposure security that trades intraday on an exchange. ETPs include exchange traded funds (ETFs) registered with the SEC under the Investment Company Act of 1940 (open-end funds and unit investment trusts or UITs) and certain trusts, commodity pools and exchange traded notes (ETNs) registered with the SEC under the Securities Act of 1933.
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Mechanics of iShares ETFs
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How traditional mutual funds work
Buyers Mutual Fund
Stock Exchange
Sellers
Investors interact with the fund to buy or sell shares
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ETFs work differently than traditional mutual funds
Buyers Stock Exchange
Authorized participants
iShares
Sellers
Investors buy and sell on an exchange and are insulated from each other’s actions.
Authorized Participants are typically large institutional organizations, such as market makers, who are responsible for sourcing the underlying assets needed when creating units of an ETF/receiving underlying assets when redeeming units of an ETF.
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The innovative mechanism of iShares ETFs Creation and redemption
Cash
On Exchange ETF Liquidity
Two Sources of Liquidity
ETF
Market Maker / Authorized Participant1
Investor / Buyer
Brokerage Account
The creation / redemption process distinguishes ETFs from mutual funds and closed-end funds and enables the unique benefits of ETFs
Underlying Portfolio Liquidity
Deliver ETF Shares
In-kind delivery underlying portfolio basket2
iShares iShares ETFs
The creation / redemption process is the conductor of liquidity between ETFs and their underlying assets 1. Authorized Participants are typically large institutional organizations, such as market makers, who are responsible for sourcing the underlying assets needed when creating units of an ETF/receiving underlying assets when redeeming units of an ETF. There can be no assurance that an active trading market for shares of an ETF will develop or be maintained. 2. Must occur in creation/redemption unit standard sizes, generally in multiples of 50,000 shares.
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Key iShares ETF valuation terms Net Asset Value (NAV): End of day value for the fund Based on previous day closing prices of underlying securities Monitoring value of portfolio, used to assess long-term tracking error Indicative Optimized Portfolio Value (IOPV): Intraday, estimated value of the ETF’s underlying portfolio baskets Based on recent trades and estimated value of securities Does not include impact of transaction costs and risk estimates to acquire underlying securities Bid/Offer Price: Current value of ETF based on all public information Based on best bid/ask spreads Proxy for expected trade value because it includes estimates of transaction costs and risk of acquiring underlying securities
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Growth of Exchange Traded Funds (ETFs)
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Growth of exchange traded funds in the US Increasing adoption of exchange traded products (ETPs)1 2,500.00
10-year CAGR for US ETP assets is 24%2
$2,009 $1,701
2,000.00 $1,350
1,500.00 $1,012
$1,061
$789
1,000.00 $619
$542
$433
500.00 $70
$87
$106
$157
2001
2002
2003
$236
$311
2000
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Source: BlackRock, Bloomberg as of 12/31/14
iShares ETP AUM
Others
Notable statistics3 US ETP AUM has risen from $70.6 billion in 2000 to $2 trillion in 2014. US ETPs had ~$124 billion of inflows in 2014 iShares is the largest ETP provider in the US, with $763 billion of the $2 trillion in 2014, representing a 38% market share ETFs represented ~25% of U.S. daily equity trading volume in 20143 1.
2.
3.
"ETP" (or exchange traded product) as referred to above means any portfolio exposure security that trades intraday on a US exchange. ETPs include exchange traded funds (ETFs) registered with the SEC under the Investment Company Act of 1940 (open-end funds and unit investment trusts or UITs) and certain trusts, commodity pools and exchange traded notes (ETNs) registered with the SEC under the Securities Act of 1933. Statistics as of 12/31/14 unless otherwise noted. 10-year CAGR as of December 31, 2014. ETP flows and assets are sourced using shares outstanding and net asset values from Bloomberg. Inflows for years prior to 2010 are sourced from Strategic Insights Simfund. Asset classifications are assigned by the BlackRock based on product definitions from provider websites and product prospectuses. Other static product information is obtained from provider websites , product prospectuses, provider press. The 10-year CAGR for Equity and Fixed Income ETPs are calculated by BlackRock. Source: NYSE Arcavision.
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Growth of exchange traded funds in the US Increasing adoption of exchange traded products (ETPs)1 $2,009
$2,500
$1,701
10-year CAGR for US ETP assets is 24%2 • 22% for Equity ETPs2
$2,000
AUM ($B)
• 43% for Fixed Income
$1,350
ETPs2 $1,012
$1,500
$1,061
$789
$1,000
$619 $542 $433
$500
$236 $70
$87
$106
2000
2001
2002
$311
$157
$2003
2004
2005 2006 2007 2008 2009 Equity Fixed Income Other
2010
2011
2012
2013
2014
Source: BlackRock, Bloomberg, ICI as of 12/31/14. “Other” category includes alternatives, commodities, currency, target date, asset allocation, and fund of funds.
Notable statistics3 US ETP AUM has risen from $70.6 billion in 2000 to $2 trillion in 2014. US ETPs had ~$124 billion of inflows in 2014 iShares is the largest ETP provider in the US, with $763 billion of the $2 trillion in 2014, representing a 38% market share ETFs represented ~25% of U.S. daily equity trading volume in 20143 1.
2.
3.
"ETP" (or exchange traded product) as referred to above means any portfolio exposure security that trades intraday on a US exchange. ETPs include exchange traded funds (ETFs) registered with the SEC under the Investment Company Act of 1940 (open-end funds and unit investment trusts or UITs) and certain trusts, commodity pools and exchange traded notes (ETNs) registered with the SEC under the Securities Act of 1933. Statistics as of 12/31/14 unless otherwise noted. 10-year CAGR as of December 31, 2014. ETP flows and assets are sourced using shares outstanding and net asset values from Bloomberg. Inflows for years prior to 2010 are sourced from Strategic Insights Simfund. Asset classifications are assigned by the BlackRock based on product definitions from provider websites and product prospectuses. Other static product information is obtained from provider websites , product prospectuses, provider press. The 10-year CAGR for Equity and Fixed Income ETPs are calculated by BlackRock. Source: NYSE Arcavision.
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Growth has been steady in both ETFs and mutual funds Since 2000, cumulative asset flow into US ETFs has been less than half that of traditional open-end mutual funds A notable difference in the growth patterns is the negative flows in mutual fund assets during the financial crisis and a slight increase in ETFs – likely due to: • ETF liquidity in difficult-to-trade markets • Intraday trading of ETFs, which allows investors to react in real time • Ability to short ETFs
Cumulative Net Asset Flow Net Asset Flow ($bn)
$4,000,000 $3,381,878
$3,500,000 $3,000,000 $2,500,000 $2,000,000
$1,442,089
$1,500,000 $1,000,000 $500,000
US Mutual Funds
Jul-14
Jan-14
Jul-13
Jan-13
Jul-12
Jan-12
Jul-11
Jan-11
Jul-10
Jan-10
Jul-09
Jan-09
Jul-08
Jan-08
Jul-07
Jan-07
Jul-06
Jan-06
Jul-05
Jan-05
Jul-04
Jan-04
Jul-03
Jan-03
Jul-02
Jan-02
Jul-01
Jan-01
Jul-00
Jan-00
$0
US ETFs
There can be no assurance that an active trading market for shares of an ETF will develop or be maintained. With short sales, an investor faces the potential for unlimited losses as the security’s price rises. January 200 to July 2014 Source: Morningstar, BlackRock as of July 31, 2014. Universe includes existing and closed US-domiciled, USD-denominated funds.
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ETF growth has outpaced indexed mutual funds Comparing the growth in ETF net asset flow to indexed open-end mutual funds shows a very different story
Cumulative Net Asset Flow $1,600,000 $1,442,089
Net Asset Flow ($bn)
$1,400,000 $1,200,000 $1,000,000
$941,893
$800,000 $600,000 $400,000 $200,000
Indexed Mutual Funds
Jul-14
Jan-14
Jul-13
Jan-13
Jul-12
Jan-12
Jul-11
Jan-11
Jul-10
Jan-10
Jul-09
Jan-09
Jul-08
Jan-08
Jul-07
Jan-07
Jul-06
Jan-06
Jul-05
Jan-05
Jul-04
Jan-04
Jul-03
Jan-03
Jul-02
Jan-02
Jul-01
Jan-01
Jul-00
Jan-00
$0
US ETFs
January 200 to July 2014 Source: Morningstar, BlackRock as of July 31, 2014. Universe includes existing and closed US domiciled, USD denominated funds classified as “Indexed” by Morningstar (some ETFs are not in this category). ETF data excludes funds classified as “Actively Managed.”
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Growth of Fixed Income ETFs
US Fixed Income ETF AUM is Over $270B 300
Total AUM ($B)
International/EM
Assets have climbed 380% since 2008 as investor adoption has increased and existing users have broadened their usage
250
Municipals Mortgage
200
High Yield 150
Investment Grade Credit Govt/Credit
100
Inflation-Linked Government
50
Aggregate 0 2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Jun-14
Other
Fixed income ETF usage has grown significantly, solving many challenges of trading in the OTC market Growth in fund size, breadth of bond market exposures, and liquidity have continued to drive increased adoption of ETFs A wide cross section of investors, such as endowments and foundations, asset managers, insurance companies, and pension funds are now pioneering new investment approaches using ETFs
Source: BlackRock and Bloomberg as of 6/30/14.
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