P4: ETF Funds: Latest Developments for Risk Management and Investment pot

Investment Symposium
March 2012




P4: ETF Funds: Latest Developments for Risk
Management and Investment




Allan Levin
Steve Mickle

Moderator
Allan Levin

Deutsche Bank
Fixed Income Exchange Traded Products
Fixed

Income

Exchange

Traded

Products
March 2012
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
— Exchange Traded Funds are listed investment funds, just like stock
— Fixed Income ETFs allow investors to obtain exposure to various
indices and market sectors through a cash investment.
Fixed Income ETFs
Overview
indices

and

market

sectors

through

a

cash

investment.
— Much of the liquidity in ETFs is generated by Authorized Participants
(“APs”) who have the ability to create shares of a fund and pass them
on to investors.
Some Notable ETF Providers
Available Asset Classes
iShares
PowerShares
Treasury
Inflation
Allan Levin
Investment Symposium / 26 March 2012
Deutsche Bank
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
1
StateStreet
Vanguard
ProShares
Direxion
Deutsche Bank
Agency MBS
Corporate
Specialty Products
Multi-Sector
Inverse & Leveraged

Fixed Income ETP Market has been Growing Rapidly
Now make up about 20% of the US ETF Market
Allan Levin
Investment Symposium / 26 March 2012
Deutsche Bank
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
3/15/2012 2:16:34 PM 2010 DB Blue template
2
Some of the Largest ETFs are Fixed Income
Six of the Largest 20 ETPs are Fixed Income ETFs
Allan Levin
Investment Symposium / 26 March 2012
Deutsche Bank
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
3/15/2012 2:16:34 PM 2010 DB Blue template
3
US ETP AUM by Investment Focus – Fixed Income
Approximately $210 Billion in Total as at February 2012
Market Share
Govt/Corp
Active 1.0%
Aggregate
14.5%
Convertible
0.4%
Corporate
Inflation
13.0%
Muni 4.8%
Mortgage

2.3%
6.2%
Deutsche Bank
Allan Levin
Investment Symposium / 26 March 2012
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
3/15/2012 2:16:34 PM 2010 DB Blue template
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Source: Deutsche Bank, BlackRock Investment Institute, Bloomberg, Reuters
20.0%
Emerging
markets 3.6%
Government
21.0%
High yield
13.3%
Sample of Active Fixed Income ETFs
Selected Large Fixed Income ETFs
Sector Total AUM $Bn Largest AUM $Bn ADV $mm
Aggregate 30 AGG 14.8 130
Corporates 42 LQD 19.8 205
High Yield 28 HYG 14.3 271
Inflation 27 TIP 22.5 150
EM 8 PCY 1.5 19
Mortgage 5 MBB 4.7 46
Deutsche Bank
Allan Levin
Investment Symposium / 26 March 2012
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
3/15/2012 2:16:34 PM 2010 DB Blue template

5
Source: BlackRock Investment Insitute, Bloomberg
Muni 11 MUB 2.8 41
Treasury 44 TLT* 3.3 903
Gov’tCorp 13 BSV 7.6 54
* TLT has the largest ADV, but has lower AUM than SHY ($10.5Bn)
2011 Exceptional Growth in Fixed Income ETPs
Strong Flows into Corporate ETFs
— $48bn of new asset gathering in the US
— $22bn of Inflows into Corporate Debt (esp IG), $9.5bn into Agg., $6bn into EM
— ETFs received 2.8x higher flows than the ten-fold larger mutual fund industry
— 42 New Fixed Income ETFs Listed in the US in 2011. Launches included
Inflation-linked, International & Actively Managed
Allan Levin
Investment Symposium / 26 March 2012
Deutsche Bank
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
3/15/2012 2:16:34 PM 2010 DB Blue template
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Source: BlackRock Investment Institute, Bloomberg, National Stock Exchange (NSX), Deutsche Bank
2011 was an Excellent Year for Treasuries & TIPS
Eight of the Ten Best Performing ETPs (14 of the 20 Best ETPs)
TOP 20 ETPs by performance 2011
ETP Name Issuer
A
sset Class Ticker TER Perf%
PowerShares DB 3x Long 25+ Year Treasury Bond ETN Deutsche Bank AG Fixed Income ETN LBND US 0.95% 117.80%
Daily 30-Year Treasury Bull 3X Direxionshares Fixed Income ETF TMF US 0.95% 107.60%
Dil Idi 2 B Sh
Di i h

EitETF
INDZ US
095%
78 70%
D
a
il
y
I
n
di
a
2
x
B
ear
Sh
ares
Di
rex
i
ons
h
ares
E
qu
it
y
ETF
INDZ

US
0
.
95%
78
.
70%
ProShares Ultra 20+ Year Treasury ProShares Fixed Income ETF UBT US 0.95% 71.30%
PIMCO 25+ Year Zero Coupon U.S. Treasury Index PIMCO Fixed Income ETF ZROZ US 0.15% 54.20%
Vanguard Extended Duration ETF Vanguard Fixed Income ETF EDV US 0.13% 47.30%
iPath US Treasury 10-year Bull ETN iPath (Barclays) Fixed Income ETN DTYL US 0.75% 46.20%
Daily 10-Year Treasury Bull 3X Direxionshares Fixed Income ETF TYD US 0.95% 43.90%
iPath US TSY Long Bond Bull ETN iPath (Barclays) Fixed Income ETN DLBL US 0.75% 42.90%
PowerShares DB Base Metals Double Short ETN Deutsche Bank AG Commodity ETN BOM US 0.75% 41.80%
iPath Short Enhanced MSCI Emerging Markets Index ETN iPath (Barclays) Equity ETN EMSA US 0.80% 41.30%
ProShares Ultra Utilities ProShares Equity ETF UPW US 0.95% 32.40%
ProShares Ultra 7-10 Year Treasury ProShares Fixed Income ETF UST US 0.95% 30.70%
iShares Barclays 20+ Year Treasury Bond Fund BlackRock Fixed Income ETF TLT US 0.15% 28.80%
iP th US T Fl tt ETN
iP th (B l )
Fi d I ETN
FLAT US
075%
26 80%
Allan Levin
Investment Symposium / 26 March 2012
Deutsche Bank
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
3/15/2012 2:16:34 PM 2010 DB Blue template

7
iP
a
th

US

T
reasury
Fl
a
tt
ener
ETN
iP
a
th

(B
arc
l
ays
)
Fi
xe
d

I
ncome
ETN

FLAT

US
0
.
75%
26
.
80%
SPDR Barclays Capital Long Term Treasury ETF State Street GA Fixed Income ETF TLO US 0.14% 25.90%
ProShares UltraShort MSCI Brazil ProShares Equity ETF BZQ US 0.95% 25.80%
Vanguard Long-Term Government Bond ETF Vanguard Fixed Income ETF VGLT US 0.15% 24.60%
PIMCO 15+ Year US TIPS Index Fund PIMCO Fixed Income ETF LTPZ US 0.27% 20.10%
PowerShares DB Base Metals Short ETN Deutsche Bank AG Commodity ETN BOS US 0.75% 19.70%
Source: Deutsche Bank, Bloomberg Finance LP, Reuters.
Fixed Income ETFs
Features and Risks
ETF holdings are published every day Tracking error
(due to bond selection,
Features Risks
Tradable intraday
Open-ended
rebalancing costs, etc.)
Bid-offer spread / management fee
Legal/fraud Risk
(Normal due diligence must be exercised
when investing in any fund managed by
someone else, including ETFs. However
ETF ll h i
Deutsche Bank

Allan Levin
Investment Symposium / 26 March 2012
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
ETF
s are genera
ll
y seen as
h
av
i
ng an
extremely low risk to fraud-type activities
due to the transparency of the fund.)
3/15/2012 2:16:34 PM
2010 DB Blue template
8
Exchange Traded Notes (ETNs)
Overview
Description of ETNs
— Exchange traded debt securities which provide a return specified by a
benchmark index
— Issued by a corporate institution, and so carry with them the risk of default by
an issuer, causing the issuer not to be able to make payments described in
the ETN prospectus
— Typically, has one final payment at maturity which is determined by formula
Deutsche Bank
Allan Levin
Investment Symposium / 26 March 2012
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
— Generally ETNs are creatable and redeemable on any business day. The

daily creation feature allows ETNs to be liquid even when traded volumes or
total amounts outstanding are low. The daily redemption feature generally
mitigates the long term credit exposure to the issuer, as any holder can
redeem shares of the ETN at the index NAV for that day
Exchanged Traded Notes ( ETNs )
Features and Risks
No Tracking Error Senior Unsecured Credit Exposure
Features Risks
Transparency
Tax Efficient
Liquidity
(short-term due to the ability to redeem)
Less liquidity outside of underlying’s
trading hours
Subject to an investor fee
Deutsche Bank
Allan Levin
Investment Symposium / 26 March 2012
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
Leverage available
Can be more flexible than ETFs
Non-Principal Protected
3/15/2012 2:16:34 PM
2010 DB Blue template
10
Recent Innovations in Fixed Income ETPs
as demonstrated by recent launches
Categories
— Inflation-Linked
— Floating Rate

— Sovereign Exposure
— Emerging Markets
Deutsche Bank
Allan Levin
Investment Symposium / 26 March 2012
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
— US Fixed Income Sectors
— Active Management
— Different Exposure Structures
Inflation-Linked ETPs
Focus on reducing “real duration” exposure
Shorter Duration TIPS Inflation Expectation ETPs
ETP Ticker ETP Ticker
Flexshares 3-Year TDTT
& 5-Year Targeted TIPS TDTF
iShares 0-5 Year TIPS STIP
Powershares DB Inflation INFL
& Deflation ETNs DEFL
Proshares 30-Year TIPS/TSY RINF
Spread FINF
Ph UltP10
Y
UINF
Deutsche Bank
Allan Levin
Investment Symposium / 26 March 2012
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
3/15/2012 2:16:34 PM 2010 DB Blue template
12
P

ros
h
ares
Ult
ra
P
ro
10
-
Y
ea
r
UINF
TIPS/TSY Spread SINF
Floating Rate Note ETPs
Earn a credit spread while mitigating interest rate exposure
Floating Rate Note ETPs
ETP Ticker
IShares Floating Rate Note FLOT
Market Vectors IG FRN FLTR
SPDR IG Floating Rate Note FLRN
Deutsche Bank
Allan Levin
Investment Symposium / 26 March 2012
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
3/15/2012 2:16:34 PM 2010 DB Blue template
13
Sovereign Bond ETNs
Summary of Sovereign Bond ETNs
ITLY 1 x Long Exposure to 10-year Italian Sovereign Bonds (10-year BTP Futures)

ITLT 3 x Long Exposure to 10-year Italian Sovereign Bonds
BUNL 1 x Long Exposure to 10-year German Sovereign Bonds (Bund Futures)
BUNT 3 x Long Exposure to 10-year German Sovereign Bonds
JGBL 1 x Long Exposure to 10-year Japanese Sovereign Bonds (10-year JGB Futures)
JBGT 3 x Long Exposure to 10-year Japanese Sovereign Bonds
JGBS 1 x Inverse Ex
p
osure to 10-
y
ear Ja
p
anese Soverei
g
n Bonds
Deutsche Bank
Allan Levin
Investment Symposium / 26 March 2012
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
14
p
yp g
JBGD 3 x Inverse Exposure to 10-year Japanese Sovereign Bonds
SBND 3 x Inverse Exposure to 25+ year US Treasuries (Ultralong bond futures)
LBND 3 x Long Exposure to 25+ year US Treasuries
Country or Regional Fixed Income ETPs
Diversified exposure to Sovereign and International Corporate Bonds
Country-Specific ETPs
ETP Ticker
Region-Specific ETPs
ETP Ticker

PIMCO Australia Bond AUD
PIMCO Canada Bond CAD
PIMCO Germany Bond BUND
PSh G S
GGOV
WisdomTree Asia Local Debt ALD
Market Vectors LatAm Ag. Bond BONO
Market Vectors Renminbi Bond CHLC
GhiYBd
RMB
Deutsche Bank
Allan Levin
Investment Symposium / 26 March 2012
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
3/15/2012 2:16:34 PM 2010 DB Blue template
15
P
ro
Sh
ares
G
erman
S
ov
GGOV
/ Sub-Sov Debt
G
uggen
h
e

i
m
Y
uan
B
on
d

RMB
Increasing Sectorization of Fixed Income
Diversified exposure to Sovereign and Corporate Bonds
Sector-based ETPs
ETP Ticker
Corporate Debt ETPs
ETP Ticker
Powershares Senior Loans BKLN
IShares GNMA Bonds GNMA
iShares CMBS Bonds CMBS
iShares Industrials Sector ENGN
iShares Utilities Sector Bonds AMPS
iShares Aaa-A Rated Corportes QLTA
Deutsche Bank
Allan Levin
Investment Symposium / 26 March 2012
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
3/15/2012 2:16:34 PM 2010 DB Blue template
16
Active ETFs
Combining Active Management and Fixed Income ETFs
PIMCO Total Return Exchange-Traded Fund (TRXT)

— Modeled on PIMCO’s flagship Total Return strategy
— Cannot use options, futures or swaps
— Daily disclosure of holdings
Deutsche Bank
Allan Levin
Investment Symposium / 26 March 2012
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
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17
Notes: 9pt, regular, bottom aligned, bottom margin only set at 0.2cm
(1) Footnote 9pt, regular, spacing 0pt
Source: 9pt, italic, spacing 0pt
Structural Innovation
Using INFL as an Example
Spread-based Performance
Targets Inflation Expectations as
DV01-Weighted Design
Designed so that a 0.01% change in the
indicated by the difference in yields
between Nominal Treasuries and TIPS
Market-implied Inflation Expectations
= Nominal Yield less Real Yield
Effectively, Long TIPS & Short Treasuries
Net Yield will results in a 10c change in
the Share Price
Either a 0.01% reduction in TIPS Real
Yields or a 0.01% increase in Treasury
Yields should move the Share price up
by 10c. E.g. from $50 to $50.10
Nti l f d li h htht

Deutsche Bank
Allan Levin
Investment Symposium / 26 March 2012
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
3/15/2012 2:16:34 PM 2010 DB Blue template
18
N
o
ti
ona
l
o
f
un
d
er
l
y
i
ng c
h
osen suc
h

th
a
t

DV01 is exactly 10c. Accordingly, actual
notional of TIPS and Treasuries backing

the ETP may change over time.
Summary
Fixed Income Exchange Based Products
— Exceptionally Strong Growth in Fixed Income ETPs
— Excellent Returns in 2011 – especially Treasuries and TIPS
— Both ETNs and ETFs are available
Deutsche Bank
Allan Levin
Investment Symposium / 26 March 2012
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
— Number of Recent Developments, including:
— Inflation-linked Products & Floating Rate Notes
— Sovereign & Emerging Market ETPs
— Sector-based and Active Funds
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Allan Levin
Investment Symposium / 26 March 2012
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
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ETF Funds: Latest
Developments for Risk
Management and Investment
SOA Investment Symposium
Monday, March 26
th
2012
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
1,500
2,000
3,000
4,000
Growth of exchange traded funds
Increasing institutional adoption of ETPs
$
B)
u
tional Users
# of Institutional Users has
grown at a ~20% CAGR
0
500
1,000
0
1,000
2,000
2000 01 02
70
87

106
03 04 05 06 07 201108 09 10
236
311
432
619
157
542
789
1,009
1,065
Notable Statistics
• iShares is the lar
g
est ETF
p
rovider
,
with
$
445 billion of the
$
1
,
065 billion US ETF market and a 64% market
AUM (
$
Number of Instit
u
iShares AUM US ETP AUM Number of Institutional Users

FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
2
gp,$ $,
share of the fixed income US ETP market
• Largest range of exposures based on most widely held, institutionally relevant benchmarks
• Approximately 54% of ETP AUM held by institutional clients
• 5 of the 10 most actively traded US equities by dollar volume YTD were ETFs
• ETFs represent ~30% of US daily equity trading volume YTD
Sources: FactSet, Bloomberg, BlackRock ETF Research and Implementation Strategy, Thomson Reuters, NYSE Arca, Credit Suisse.
2009–2011 users estimated based on Ten-year CAGR and 2008 users. Statistics as of 11/30/11.
ETF applications in institutional portfolios
• Institutional investors often cite liquidity, flexibility and diversification opportunities as the main reasons for investing in
ETFs
• A recent Greenwich Associates survey indicates that nearly one-third of the institutions polled plan to increase their use
of ETFs over the next two years
*
• The table below shows the wide spectrum in which ETFs can help institutional investors meet specific objectives, from
short
-
term tactical allocations to long
-
term strategic applications
Greenwich survey highlights:
How institutions are using ETFs today
63%
51%
44%
44%
24%
Trans it i ons

Cash equitization/Interim beta
Rebalancing
Tactical adjustments
Core/Satellite
short
term

tactical

allocations

to

long
term

strategic

applications
“We recently replaced a small cap
growth manager due to
underperformance and we used an ETF
that provided passive exposure while
we conducted a formal search for
another active manager. In an
underperformance situation, using
ETFs is a better solution than leaving
the money with the manager.” – large
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
3

22%
12%
10%
7%
Portfolio completion
Hedging
ETF overlay/liquidity sleeve
Other
* Source: 2011 Greenwich Associates - U.S. ETF Research. Base: 41 institutional funds. Interviews conducted between February and April 2011
institutional fund*
Transparency
Diversification
Liquidity
Benefits of iShares ETFs
• ETFs offer immediate ex
p
osure to a basket or
g
rou
p
of securities for
• ETFs offer two sources of liquidity
 Liquidity measured by secondary market trading volume
 The liquidity of the underlying assets via the creation and redemption process
• Investors can generally see the ETF composition at any given time
Flexibility
Diversification
Cost-
Effectiveness
Securities

• ETFs offer a cost-effective route to diversified market exposure
• The average annual total expense ratio (TER) for equity ETFs listed in the US is 49 bps
versus 75 bps for domestic equity index funds and 134 bps for active domestic equity
funds
*
•
ETF units and underlying assets can be lent out to potentially offset holding costs
• ETFs are listed on exchanges and can be traded at any time the market is open
• Pricing is continuous throughout the day
pgp
diversification through a single trade
• Broad range of asset classes, including equities, bonds, commodities,
investment themes, etc.
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
4
Securities

Lending
*Source: Morningstar, BlackRock Investment Institute, as of 12/31/11. ETF TER is for all US listed equity ETFs
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.
ETF

units

and

underlying

assets

can

be

lent

out

to

potentially

offset

holding

costs
Tax Efficiency
• In-kind creation and redemption mechanism helps insulate ETF holders from
unintended tax consequences
• Experienced portfolio management team actively seeks to minimize capital gains
The innovative mechanism of iShares ETFs
The creation/redemption process distinguishes ETFs from mutual funds and closed-end funds and
enables the unique benefits of ETFs
Investor /
Buyer
Brokerage Account
Market Maker /
Authorized Participant

iShares
On Exchange
ETF
Liquidity
Underlying
Portfolio
Liquidity
In-kind delivery
underlying
portfolio basket
Two Sources of Liquidity
ETF
Cash
Deliver ETF Shares
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
5
The creation/redemption process is the conductor of liquidity between ETFs and their underlying assets
Insurance applications of iShares ETFs
Insurance ETF investment strategies
 Surplus assets portfolio strategy: equity
core/satellite; portfolio completion
General Account
 Reserve assets portfolio strategy:
alternative to derivatives to achieve benchmark
exposure; quality/sector exposure
Funds Asset Management
 Equity: tactical/macro strategies; portfolio
completion; transition management; equitizing
cash balances
 Fixed income: alternative to derivatives to

achieve benchmark exposure
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
6
Deferred Compensation
Plans
 Equity: core/satellite; portfolio completion;
transition management
 Fixed income: liability investment strategies
ETFs offer access to all sectors of the fixed income market
14 providers now offer 168 fixed income ETFs
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
77
Source: BlackRock and Bloomberg as of 12/31/2011
Fixed income ETF trading volume
• The first Fixed Income ETFs (TLT, SHY, IEF, AND LQD) were launched in 2002 by iShares and today iShares
comprise 70% of the FI ETF trading volume
• Since 2008, fixed income ETFs trading volume has grown at 56% CAGR
1
• During the financial crisis of 2008, trading volume grew 194% as fixed income ETFs were used as a liquid,
transparent pricing mechanism to the underlying securities
Fixed Income ETF Monthly $ Trading Volume
$40
$50
$60
$70
$80
$90
$100
$110
$120

$130
$ Billions
Total Trading Volume
iShares' Trading Volume
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
8
Source: BlackRock and Bloomberg as of 12/31/2011
1
Based on growth in trading volume Q4 2008-Q4 2011
$0
$10
$20
$30
Jun-03
Sep-03
De
c-
0
3
Mar
-04
Jun-04
Sep-04
De
c-
0
4
Mar
-05
Jun-05

Sep-05
De
c-
0
5
Mar
-06
Jun-06
Se
p
-06
Dec
-
0
6
Mar
-07
Jun-07
Se
p
-07
Dec
-
0
7
Mar
-08
Jun-08
Se
p

-08
Dec
-
0
8
Mar
-09
Jun-09
S
ep
-
0
9
Dec
-
0
9
Mar
-10
Jun-10
S
ep
-
1
0
Dec-10
M
ar
-11
Jun-11

S
ep
-
1
1
Dec-11
225
200
250
b
ps)
iShares Bid/Offer
Market Bid/Offer (est.)
Fixed income ETFs: Intersection of exchange & OTC liquidity
1
2
3
2
11
35
111
26
8
3
0
50
100
150
AGG LQD HYG TIP TLT SHY
Bid/Offer Spread (

b
Mar ket

Bid/Of fer

(est.)
Barclays
Barcla s
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
9
Source: BlackRock, Bloomberg Barclays Capital.
*October 2011 average Underlying Bid/Offer spreads for Aggregate, Investment Grade Corporate and High Yield proxied by Barclays Capital Liquidity Cost Scores
Barclays
Capital U.S.
Aggregate Bond
Index
iBoxx $ Investment
Grade Corporate
Bond Index
iBoxx $ High
Yield Corporate
Bond Index
Barclays
Capital U.S.
TIPS Index
Barclays

Capital U.S.
20+ Year
Treasury Bond

Index
Barcla
y
s

Capital 1-3
Year Treasury
Bond Index
iShares Avg. Daily
Volume ($MM)*
$118 $166 $268 $94 $1,303 $160
Underlying
Market
Understanding fixed income ETF trading behavior
Four drivers of premiums/discounts in fixed income ETFs:
 NAV
– Underlying bonds marked to the Bid side of OTC bond market to calculate ETF NAV
– ETF trades at market clearing price
 ETF Supply & Demand
– Balance of exchange flows drive where ETF trades relative to underlying bond market
– Sales: ETF moves closer to bid side of bond market (NAV)
– Purchases: ETF moves closer to offer side of bond market (potential share creation)
 Cost of Share Creation
– If demand > exchange liquidity, new shares will likely be created
– Cost of creation is approximately the underlying bond market bid/offer spread
– ETF price incorporates the marginal cost of share creation
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
10
 Fixed Income Market Volatility & Liquidit
y

– NAV = average bid of the underlying bonds in the portfolio; does not account for a portfolio execution
– In volatile/illiquid markets the difference between the average bond price and a portfolio execution may be
significant. Average price ≠ price of the average
– This leads to premiums or discounts outside of average underlying market bid/offer spread
Understanding fixed income ETF trading behavior
ETF Premium to NAV
ETF Creation Cost
Portfolio
Mid-Market Price
Sell Pressure Buy Pressure
Portfolio Bid (NAV) Portfolio Offer
ETF Bid/Offer
（Liquidity Layer)
Arbitrage
Region
Arbitrage
Region
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
11
 Arbitrage activity anchors ETF pricing to underlying value
 If the ETF price moves too far above the offer side of underlying portfolio, market participants can short
the ETF and purchase the underlying bonds
 If the ETF price moves too far below the bid side of underlying portfolio, market participants can
purchase the ETF and short the underlying bonds
Although market participants may generally take advantage of differences between the NAV and trading price of ETF shares, there is no guarantee that they will do so.
With short sales, an investor faces the potential for unlimited losses as the security’s price rises.
ETF price discovery case study: The financial crisis
iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD) helped investors discover the “fair value” of
the underlying US investment grade corporate bonds during the liquidity crisis of September 2008.
300

1
2
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
12
Sources: Bloomberg, TRACE, BlackRock, as of 9/30/08. For more information on price discovery, please see the white paper Understanding Bond ETF Premiums &
Discounts, available to institutional investors at www.ishares.com.
1. The light blue band represents the price volatility of the underlying bonds in the portfolio. It is calculated as the rolling 10-hour cross-sectional volatility of the prices of the
100 securities in the portfolio. A cross-sectional average is calculated using a simple average (equally weighted). The volatility is graphed -1x and +1x around the value of
the portfolio, calculated using the last trade price (price line).
2. The value of the portfolio is calculated using the last price of each bond multiplied by the par held plus accrued interest and cash. Whenever a bond did not trade, the last
trade is carried forward. Past performance does not guarantee future results.
0
100
200
Volume (Million)
Compare volume and
“
on
-
screen
”
Secondar
y

Layers of liquidity
iShares Capital Markets Group can assist clients with accessing each layer of liquidity.
Compare

volume

and

on
screen

bid/offer data to total potential
liquidity
y
Market
ADV
• Generate Transaction Cost Analysis (TCA)
and provide limit order guidance
• Help source liquidity through relationships
with 200+ specialist market makers
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
13
Identify available liquidity
through 47+ APs via the
creation/redemption process
For illustrative purposes only.
There can be no assurance that an active trading market for shares of an ETF will develop or be maintained.
Accounting and Regulatory Overview
•Risk-Based Capital (RBC) requirements: Provides a capital adequacy standard, based on standards set by the National Association of
Insurance Commissioners (NAIC).
•
Statutory Accounting Principles (SAP):
Followed by all US
domiciled insurance companies for preparation of financial statements submitted
Insurance companies operating within the United States fall under the purview of state governments for both
financial statement preparation and regulatory oversight, taking the following into consideration:

•
Statutory

Accounting

Principles

(SAP):
Followed

by

all

US
-
domiciled

insurance

companies

for

preparation

of

financial

statements

submitted

to individual state regulatory bodies. SAP standards are set forth by the NAIC and are designed to assess an insurance company’s solvency and
ability to pay claims in the near-term.
•Generally Accepted Accounting Principles (GAAP): Followed by publicly-traded companies for financial statement reporting to the US
Securities and Exchange Commission (SEC). The Financial Accounting Standards Board (FASB) sets GAAP in the United States.* Some
privately-held insurance companies choose to report financial results on both a GAAP and SAP basis. Generally speaking, SAP standards are
more conservative than GAAP, as GAAP takes a going-concern approach to financial statement preparation.
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
14
Note that any consideration of the information provided should be performed in conjunction with a full review of the applicable accounting/regulatory rules and the related guidance.
Additionally, you should consult your accountant and/or auditor.
*The International Accounting Standards Board (IASB) and FASB have been working together since 2002 to achieve convergence of IFRS and US generally accepted accounting
principles (GAAP). For additional information, please refer to
NAIC designations for fixed income iShares ETFs
Fund Ticker
NAIC
Designation
Fund Ticker
NAIC
Designation
10+ Year Government/Credit Bond Fund GLJ 1 Floating Rate Note FLOT 1
Barcla
y
s 0-5 Year TIPS Bond Fund STIP 1 S&P California AMT-Free Muni CMF 1
Below are examples of fixed income ETFs that have received NAIC designations, allowing for favorable financial statement and regulatory treatment.
y
Barclays 10-20 Year Treasury TLH 1 S&P National AMT-Free Municipal Bond Fund MUB 1

Barclays 1-3 Year Credit Bond Fund CSJ 1 S&P New York AMT-Free Muni NYF 1
Barclays 1-3 Year Treasury Bond Fund SHY 1 S&P Short Term Nat’l AMT-Free Muni SUB 1
Barclays 20+ Year Treasury Bond Fund TLT 1 S&P/Citigroup 1-3 Year International Treasury Bond Fund ISHG 1
Barclays 3-7 Year Treasury IEI 1 S&P/Citigroup International Treasury Bond Fund IGOV 1
Barclays 7-10 Year Treasury Bond Fund IEF 1 10+ Year Credit Bond Fund CLY 2
Barclays Agency Bond Fund AGZ 1 Barclays Credit Bond Fund CFT 2
Barclays Aggregate Bond Fund AGG 1 Barclays Intermediate Credit Bond Fund CIU 2
Barclays Government/Credit Bond Fund GVI 1 Global Inflation-Linked GTIP 2
Barcla
y
s Intermediate Government/Credit Bond Fund GBF 1 iBoxx $ Investment Grade Cor
p
orate Bond Fund LQD 2
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
15
National Association of Insurance Commissioners Securities Valuation Office (SVO) Advanced Rating Service (“ARS”) / Emerging Investment Vehicle (“EIV”) application; Schedule D
Treatment, Debt Statutory Classification, NAIC Designation, inclusion on the ETF List in Section 20 of the Appendix of the Purposes and Procedures Manual of the NAIC Securities Valuation
Office.
y
p
Barclays MBS Bond Fund MBB 1 International Inflation-Linked ITIP 3
Barclays Short Treasury Bond Fund SHV 1 JPMorgan USD Emerging Markets Bond Fund EMB 3
Barclays TIPS Bond Fund TIP 1 iBoxx $ High Yield Corporate Bond Fund HYG 4
Impact of NAIC designations: RBC calculation
• Risk-based capital (RBC) rules specify how much capital an insurance company must have to ensure that it has sufficient capital to withstand
contingences. To ensure that there is enough capital to deal with adverse developments, the RBC regime specifies how much capital a
company must have to "cover" asset risks, as well as other business risks.
• ETFs are assigned an "asset risk“ based on its applicable classification.
• For example, owning $1 of an ETF categorized as common stock means a Life Insurance Company must have $0.30 of capital to back
the risk emanatin

g
from ownin
g
the e
q
uities. Ownin
g
$1 of an ETF rated as NAIC 1, on the other hand, re
q
uires a Life Insurance
Description
Fixed income ETF with
NAIC designation
Fixed Income ETF with no
NAIC designation Equity ETF
Rated as Bond Common Stock Common Stock
NAIC 1 P&C - 0.3%, Life – 0.4% N/A N/A
NAIC 2 P&C – 1.0%, Life – 1.3% N/A N/A
NAIC 3 P&C – 2.0%, Life – 4.6% N/A N/A
NAIC 4 P&C – 4.5%, Life – 10.0% N/A N/A
ggq g q
Company to maintain only $0.004.
• The RBC calculation is not actually an arithmetic total. Instead, there is a "covariance adjustment" to reflect that the various classes of risk are
uncorrelated.
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
16
NAIC 5 P&C – 10.0%, Life – 23.0% N/A N/A
NAIC 6 P&C – 30.0%, Life – 30.0% N/A N/A
Common Stock N/A P&C - 15%, Life – 30% P&C - 15%, Life – 30%
Note that any consideration of the information provided should be performed in conjunction with a full review of the applicable accounting/regulatory rules and the related guidance.

Additionally, you should consult your accountant and/or auditor.
For further information, please refer to www.naic.org
.
Source: www.naic.org
Impact of NAIC designations: SAP Accounting
Financial Statement Treatment
Description Fixed income ETF with NAIC designation Fixed Income ETF with no NAIC designation Equity ETF
Valuation Original cost Market value Market value
Unrealized Gain/Loss
N/A
Difference between market value and
Difference between market value and
Statutory Accounting Principles (SAP) are set forth by the NAIC and are designed to assess an insurance company’s solvency and ability to pay
claims in the near-term.
Unrealized

Gain/Loss

Recognition
N/A

Difference

between

market

value

and

original cost reflected in surplus
Difference

between

market

value

and

original cost reflected in surplus
Schedule D Treatment
Reporting Schedule Part 1 Part 2 Section 2 Part 2 Section 2
Reporting Schedule sub-section Long Term Issuer Obligations Mutual Funds Mutual Funds
Carrying Value If Asset Valuation Reserve (AVR)
*
is not utilized:
► NAIC 1-2: report at cost
► NAIC 3-6: report the lower of cost or fair value
If AVR is utilized:
► NAIC 1-5: report at cost
► NAIC 6: report the lower of cost or fair value
Market value Market value
Book Yield Report as “zero” N/A N/A
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
17
Maturit
y

Leave blank N/A N/A
Par Value Report as “zero” N/A N/A
Amount Received Report all distributions received in cash or additional
shares
Report all distributions received in cash or
additional shares
Report all distributions received in cash or
additional shares
When Paid (Coupon Months) Leave blank N/A N/A
Source: 2011 Official Annual Statement Instructions, published by the NAIC
Note that any consideration of the information provided should be performed in conjunction with a full review of the applicable accounting/regulatory rules and the related guidance.
Additionally, you should consult your accountant and/or auditor.
*AVR is a reserve set up by an insurance company against the possibility of credit losses on its investments. It is widely used by life insurance companies but is not available to P&C
companies.
ETF Classification: GAAP Accounting
Description ETFs classified as “available for sale” ETFs classified as “trading securities”
Valuation, per ASC 320 (formerly FAS 115) Fair value Fair value
Fair Value Pricing, per ASC 820 (formerly
FAS 157) levels
Generally level 1* Generally level 1*
ASC 320 (formerly FAS 115) provides guidance on how to classify investments in debt and equity securities
FAS

157)

levels
Unrealized Gain/Loss Recognition, per
ASC 320
Reported as “other comprehensive income”; does not affect income
statement

Reported as earnings on the income statement
• Fixed Income ETFs are considered equity instruments under GAAP and therefore can only be classified as “trading securities” or “available for
sale”.
†
• Intent is the key to determine whether to classify an ETF as a “trading security” or “available for sale”. Investments that are bought and held
principally for the purpose of selling them in the near term (thus held for only a short period of time) shall be classified as trading securities. Trading
generally reflects active and frequent buying and selling, and trading securities are generally used with the objective of generating profits on short-
term differences in price. If generating profits based on short-term differences in price is not the intent, then investments can be classified as
“available for sale”.
‡
FOR INSTITUTIONAL USE ONLY – NOT FOR PUBLIC DISTRIBUTION
18
* An ETF will be eligible for level 1 pricing if it has a “readily determinable fair value” as defined in the ASC Master Glossary. Therefore, under normal circumstances, ETFs are
classified as level 1. Source: AICPA Trends and Techniques Publication, 2011.
† All ETFs, including fixed income ETFs, do not meet the definition of “Debt Security”, as defined in the ASC Master Glossary and thus are not eligible for fixed income classification.
Source: AICPA Trends and Techniques Publication, 2011.
‡ Information is based on the definition of “Security Classifications” from ASC 320. Source: AICPA Trends and Techniques Publication, 2011.
Note that any consideration of the information provided should be performed in conjunction with a full review of the applicable accounting/regulatory rules and the related guidance.
Additionally, you should consult your accountant and/or auditor.
Carefully consider the iShares Funds' investment objectives, risk factors, and charges and
expenses before investing. This and other information can be found in the Funds'
prospectuses, which may be obtained by calling 1-800-iShares (1-800-474-2737) or by
visiting www.iShares.com. Read the prospectus carefully before investing.
Investing involves risk, including possible loss of principal.
Bonds and bond funds will decrease in value as interest rates rise. An investment in the Fund(s) is not insured or guaranteed
by the Federal Deposit Insurance Corporation or any other government agency.
There can be no assurance that an active trading market for shares of an ETF will develop or be maintained.
The information provided is not intended to be a complete analysis of every material fact respecting any strategy and has
been presented for educational purposes only.
Asset allocation models and diversification do not promise any level of performance or guarantee against loss of principal.

Shares of iShares Funds are bought and sold at market price (not NAV) and are not individually redeemed from the Fund.
Mutual funds and iShares Funds are obliged to distribute portfolio gains to shareholders by year-end. These gains may be
generated due to index rebalancing or to meet diversification requirements. Trading shares of the iShares Funds will also
generate tax consequences and transaction expenses. Certain traditional mutual funds can be tax efficient as well.
When comparing stocks or bonds and iShares Funds, it should be remembered that management fees associated with fund
investments, like iShares Funds, are not borne by investors in individual stocks or bonds. The annual management fees of
iShares Funds may be substantially less than those of most mutual funds. Buying and selling shares of iShares Funds will
lt i b k i i b t th i f l l f h l ff t th t
resu
lt

i
n
b
ro
k
erage comm
i
ss
i
ons,
b
u
t

th
e sav
i
ngs
f

rom
l
ower annua
l

f
ees can
h
e
l
p o
ff
se
t

th
ese cos
t
s.
Neither BlackRock Institutional Trust Company, N.A., and its affiliates nor SEI and its affiliates provide tax advice. Please
note that (i) any discussion of U.S. tax matters contained in this communication cannot be used by you for the purpose of
avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed
herein; and (iii) you should seek advice based on your particular circumstances from an independent tax advisor.
Index returns are for illustrative purposes only and do not represent actual iShares Fund performance. Index performance
returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest
directly in an index. Past performance does not guarantee future results.
The iShares Funds are not sponsored, endorsed, issued, sold or promoted by Cohen & Steers Capital
Management, Inc., Dow Jones Trademark Holdings, LLC, European Public Real Estate Association (“EPRA®”),
FTSE International Limited (“FTSE”), JPMorgan Chase & Co., MSCI Inc., Markit Indices Limited, Morningstar, Inc.,
The NASDAQ OMX Group, Inc., National Association of Real Estate Investment Trusts (“NAREIT”), New York

Stock Exchange, Inc., Russell Investment Group or Standard & Poor’s, nor are they sponsored, endorsed or issued
by Barclays Capital. None of these companies make any representation regarding the advisability of investing in the
Funds. Neither SEI, nor BlackRock Institutional Trust Company, N.A., nor any of their affiliates, are affiliated with
the companies listed above.
Neither FTSE nor NAREIT makes any warranty regarding the FTSE NAREIT Real Estate 50/
Residential/Retail/Mortgage or Industrial/Office Index; all rights vest in NAREIT. Neither FTSE nor NAREIT makes
any warranty regarding the FTSE EPRA/NAREIT Developed Real Estate ex-US/North America/Europe/Asia Index;
all rights vest in FTSE, NAREIT and EPRA. All rights in the FTSE Developed Small Cap ex-North America Index
vest in FTSE. "FTSE®” is a trademark jointly owned by the London Stock Exchange Plc and The Financial Times
Limited and is used by FTSE under license.
The iShares Funds are distributed by SEI Investments Distribution Co. (“SEI”). BlackRock Fund Advisors (“BFA”)
serves as the investment advisor to the Funds. BFA is a subsidiary of BlackRock Institutional Trust Company, N.A.,
neither of which is affiliated with SEI.
©2012 BlackRock Institutional Trust Company, N.A. All rights reserved. iShares® is a registered trademark of
BlackRock Institutional Trust Company, N.A. BlackRock® us a registered trademark of BlackRock, Inc. All other
trademarks, servicemarks or registered trademarks are the property of their respective owners. iS-6332-0212
Not FDIC Insured • No Bank Guarantee • May Lose Value
Thank You
ETF Funds: Latest Developments for
Risk Management and Investment
Elliot Noma
Garrett Asset Management, LLC.
Recent innovations
 Expansion into new markets

Structures to tap new opportunities

Structures

to

tap

new

opportunities
 Use in structured products
Expansion into new markets
 Fixed income for emerging markets
Structures to tap new opportunities
 Total return bond funds
Iflti t ti f d

I
n
fl
a
ti
on pro
t
ec
ti
on
f
un
d
s
 Buy-and-hold leveraged funds