TOP TEN ETF QUESTIONS FROM INSURERS FREQUENTLY ASKED QUESTIONS 1. How are ishares ETFs being utilized by insurers in general account portfolios? According to a 2014 report by Greenwich Associates, insurers have been increasingly holding ETFs for strategic, longer term periods. 45% of insurers polled plan to increase their use of ETFs in 2014, and they can do so in a variety of ways: Complement a strategic asset allocation Many insurers have limited international diversification outside their domestic markets. The breadth and depth of the ETF marketplace provides access to diversified exposures in those areas, such as international large, mid or small caps, regional property, single-country emerging market equity, or high yield debt. Put cash to work immediately ETFs offer an opportunity to invest cash instantly for instant exposure, while conducting research for new investment vehicles or ideas. Manage liquidity Using ETFs to help manage liquidity is one of the primary ETF strategies employed by institutional investors. For insurers with frequent cash flows in and out of the portfolio, they may choose to put in place a liquidity sleeve using ETFs to avoid disrupting the portfolio s positioning and extra transactions costs. A sleeve is part of a portfolio where the core asset allocation is replicated with liquid instruments such as ETFs. This can be used as a buffer to absorb cash flow, rebalance the portfolio and pay any unanticipated claims. Implement tactical views Asset class weights are fixed regularly, with some flexibility versus the targeted allocation (typically 10% equity, +/- 2%) to capture short to medium term opportunities. ETFs low cost and operational simplicity ensure that they can be used to take advantage of these opportunities, without creating noise in the strategic portfolio. ETFs can also be used to implement a more reactive tactical overlay in response to range bound markets. Low-cost exposure to niche asset classes An insurer may not have access to the skill in-house to engage in security selection in niche markets. Alternatively, the investment team may hold the view the risk-adjusted return in a particular region may be higher through beta exposure, rather than through stock selection. ETFs can offer direct access to diversified exposure in single-country emerging market equities, high yield debt, and thematic exposures. In addition, since ETFs cover such a broad range of indices, they can be used in place of listed futures or CDX contracts. Gain efficiency in small portfolios ETFs can offer single trade diversification, even at low notional amounts. Insurers can bring scale to the management of smaller accounts by trading an entire portfolio as a single unit, on an exchange.
2. How are ishares ETFs efficient vehicles? What are the benefits of this? ETFs employ a unique pooled vehicle structure in which an investor is shielded from the trading activity of other investors while simultaneously benefitting from the scale of a pooled vehicle. In traditional pooled structures, when investors redeem their shares, portfolio managers may need to sell securities to deliver cash, possibly triggering a capital gain or loss that must be passed on to all other holders of the fund. When ishares ETFs are redeemed, the authorized participant, such as an institutional broker/dealer, delivers the underlying securities from ishares through an in-kind transfer. The in-kind creation/redemption mechanism enables the associated transaction costs to be borne outside of the fund, minimizing the impact to other holders of the ishares ETF. Additionally, because most ishares ETFs are index funds, they have relatively low portfolio turnover rates, making them more efficient vehicles for the portfolio manager to manage. Operationally, this in-kind transferability can be very advantageous to the investor. It can allow insurers to quickly transition out of legacy credit portfolios with thousands of line items, into just a few ETFs in a single-day trade. This can allow insurers to exit bonds in a cost efficient manner, while still maintaining exposure and even improving their portfolio s liquidity profile. From a tax perspective, the in-kind creation and redemption mechanism helps insulate ishares ETF holders from unintended tax consequences. The ishares experienced portfolio management team also actively seeks to avoid capital gains distributions in an effort to minimize tax consequences. 1 3. How can ishares ETFs be advantageous for small portfolios (less than $200mm)? Insurers can use ETFs to obtain or reduce exposure without having to commit a minimum AUM with an asset manager. Implementing ETFs in smaller portfolios can offer a cost effective and efficient route to diversified market exposure. Cost effective Management fees (MF) or an ETF s total expense ratio (TER) are not the sole elements to look at when comparing costs. It is important to consider a concept called the total cost of ownership (TCO) which incorporates additional factors such as entry/exit and rebalancing costs, and securities lending revenue. ETFs tend to have lower entry/exit costs than index or mutual funds. Rebalancing costs for ETFs can be influenced by the portfolio manager s capabilities and by the underlying asset class. In general, the larger the asset manager, the easier it is to minimize these costs through crossing opportunities and trade aggregation. The portfolio manager s capabilities also influence the level of securities lending revenue generated, and this revenue plays a part in lowering the Total Cost of Ownership. Operationally efficient ETFs allow the investor to easily trade an entire portfolio as a single unit, in a single trade. The ETF structure enables the investor to enter and exit positions quickly and efficiently as the ETF helps reduce the impact of costs such as foreign taxes and commissions across all of the securities. 4. If I can own a separate account for less than 10 bps, why would I buy an ETF for more? The primary reason to use ETFs relative to separate accounts is overall flexibility and convenience. ETFs can give you access to any position without a minimum investment size, while separate accounts typically require $50mm. In addition, separate accounts can often take at least a month to set up while ETFs, bought and sold on exchanges, can be accessed quickly. An insurance company looking to establish an investment in an asset class could use an ishares ETF to obtain exposure while constructing a long-term portfolio. For example, because of illiquidity in municipal bond markets, it can take a significant amount of time to build a diversified portfolio. While the portfolio is being developed, the insurance company can gain their desired municipal bond beta exposure by purchasing an ishares ETF. ishares municipal bond ETFs aim to hold the most liquid names, providing a cost effective interim beta allocation. Another ETF solution is for insurers is to use them while searching for a new manager or replacing an existing manager. 1. All regulated investment companies 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 investments can be tax efficient as well.
5. How are insurers utilizing Smart Beta ETFs? The ishares smart beta products offer the potential for attractive risk-adjusted returns with the benefits of passive investing. Insurers are utilizing the ishares Factor ETFs as a means for replacing active managers with disappointing performance, making their beta work harder for them, and minimizing risk. Factor strategies Smart Beta strategies target attributes, or factors, which cannot be isolated through traditional index strategies. Factors are drivers of risk and return that are common to many securities. ishares Factor ETFs allow you to expose your portfolio to specific risk factors such as volatility, momentum, quality, value, and size. Factors indices mechanically tilted towards these factors represent an efficient and transparent solution to achieve this purpose. Specifically, minimum volatility solutions are growing in popularity with insurers as a way to reduce the risk of their broad equity exposure in their portfolio. 6. What is the true liquidity of an ETF? Investors often look to an ETF s trading volume to gauge liquidity. However, due to the creation/redemption mechanism, ETF ADV is not representative of all available liquidity. Since the supply of outstanding ETF shares may be continuously increased or decreased, an ETF s liquidity is enhanced by the liquidity of the underlying securities held by the ETF. ETFs have two primary layers of liquidity that can be accessed: ETF liquidity: Includes secondary market liquidity of the ETF (displayed liquidity) and ETF market depth (non-displayed) Underlying liquidity: Liquidity of the securities that are held in the ETF, and accessed through the creation/redemption process Authorized Participants help create and maintain displayed and non-displayed liquidity, and also interact with underlying liquidity. They are typically large institutional intermediaries who create and redeem ETF units directly with an ETF provider to access the primary market. In this market, an investor s subscription order ultimately leads to the purchase of the underlying exposure and to an increase in the fund s AUM. Equally, an investor s redemption order leads to the liquidation of part of the fund s assets in the underlying financial markets, and a decrease in the fund s AUM. The secondary market encompasses trading between the market-maker/broker and the investor, both on exchange and OTC. In this market, an investor s buy order may be fulfilled simply by an existing ETF holder willing to sell, or from a broker s inventory. 7. What can cause the price of a fixed income ETF to diverge from the net asset value (based on bid side marks) of the underlying securities? ETF market prices can diverge from the ETF net asset value (NAV) and the value of bond market indices. Various factors drive these divergences, including differences in how value is determined in each market. Net asset values and index levels are based on the value of individual bonds as determined by the index provider, whose calculation may reflect actual transactions but often times requires estimated values for bonds that may not regularly trade. Fixed income ETF prices are actionable market clearing levels representative of the fund s entire underlying portfolio as agreed upon by the buyer and seller. There are four main drivers of market price divergences to NAV in fixed income ETFs: NAV calculation Net asset values (NAV) for fixed income ETFs are calculated using (often stale) bid side pricing of the funds underlying bonds ETF supply and demand The balance of exchange flow drives where the ETF trades relative to the underlying bond market. Selling pressure drives the ETF closer to the bid side of the market (NAV). Buying pressure drives the ETF price closer to the offer side of the bond market. Cost of share creation If demand exceeds exchange liquidity, new shares will likely be created. The cost of creation is approximately the underlying bond market bid/offer spread. The ETF price incorporates the marginal cost of share creation Underlying market volatility and liquidity NAV calculations do not account for portfolio execution costs. In volatile or illiquid markets, the difference between the average bond price and a portfolio execution may be significant
8. How can BlackRock assist in selecting and purchasing ETFs? Trading guidance ETFs can be bought and sold on an exchange through your broker. For trading guidance, BlackRock s Capital Markets team can help you in five key ways: Support best execution by helping source liquidity and recommending the most capable executing brokers Run real-time customized total trade cost analyses Convey in-depth product knowledge to help facilitate ETF due diligence and differentiate comparable products Provide ETF market insight pieces and trading research including primary market flow analysis Facilitate fluid primary and secondary market trading of ishares ETFs Customized portfolio analysis Especially with regards to fixed income, there is a strong incentive to use a flexible strategy. Dynamic asset allocation can be implemented using fixed income ETFs across different sectors, duration, and quality exposures. ETFs offer almost all exposures with direct and diversified access, and usually cheaper transaction costs. To receive more granular and customized analyses on your portfolio allocation, BlackRock can offer services by its dedicated Multi-Asset Portfolio and Investment Consulting team, a unique and complimentary service designed to support institutional investors. The group is comprised of five team members, including CFA charter holders, with a range of backgrounds such as portfolio management, investment consultancy and actuarial analysis. Some of the team s services include (but are not limited to): Firm-specific customized analytics including, but not limited to, risk management, asset allocation, and blending active and passive strategies Objective feedback and insight regarding ishares ETFs and other investment products Tailored solutions to address a firm s unique objectives 9. What analytics can I use to look through to bond exposure, risk analysis, etc.? ishares has worked with fixed income analytics providers to provide look-through analytics on underlying ETF bond portfolios. These tools allow insurance companies to analyze the underlying holdings of fixed income ETFs alongside their existing bond portfolios. In other words, investors can view a portfolio that includes both ETFs and individual bonds as a portfolio consisting entirely of individual securities. Additionally, many insurers use Bloomberg s new portfolio optimization tool, which allows the user to analyze and replicate an existing cash bond portfolio using ishares ETFs. ETF Analysis Tools ishares TAP on Aladdin ishares facilitates model portfolio construction, risk assessment and sector selection. BondEdge BondEdge clients deepen portfolio management capabilities via a look-through into select ishares fixed income ETFs. Bloomberg YAS The Bloomberg yield and spread analysis (YAS) tool enables users to analyze yield spread and interest rate sensitivity. Originally developed for individual bonds, YAS has been enhanced for analyzing select ishares fixed income ETFs. FactSet FactSet users who hold ishares ETFs in their portfolios have the ability to look through the ETF position into the underlying holdings, including exposure to rates, credit, investment grade, and high yield credit. Soon to follow will be ishares municipal and inflation linked ETFs.
10. What is the regulatory and accounting treatment for fixed income ETFs? Insurance companies operating within the United States fall under the purview of state governments for both financial statement preparation and regulatory oversight. They should take 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. Generally Accepted Accounting Principles (GAAP): Followed by publicly-traded companies for financial statement reporting to the US Securities and Exchange Commission (SEC). Generally speaking, SAP standards are more conservative than GAAP, as GAAP takes a going-concern approach to financial statement preparation. Risk-Based Capital (RBC) requirements: Provides a capital adequacy standard, based on standards set by the. BlackRock offers 61 designated ETFs, the most of any ETF provider. These designations have allowed insurers to benefit from favorable risk-based capital (RBC) treatment. Your ishares representative is available to discuss how designated ishares ETFs are reported on the balance sheet and schedule D filing, as well as how to calculate RBC. Designations for ishares ETFs Ticker ishares ETF Name Fixed Income AGG ishares Core U.S. Aggregate Bond ETF 1 GOVT ishares Core U.S. Treasury Bond ETF 1 SHV ishares Short Treasury Bond ETF 1 SHY ishares 1-3 Year Treasury Bond ETF 1 IEI ishares 3-7 Year Treasury Bond ETF 1 IEF ishares 7-10 Year Treasury Bond ETF 1 TLH ishares 10-20 Year Treasury Bond ETF 1 TLT ishares 20+ Year Treasury Bond ETF 1 ISHG ishares 1-3 Year International Treasury Bond ETF 1 IGOV ishares International Treasury Bond ETF 1 AGZ ishares Agency Bond ETF 1 GBF ishares Government/Credit Bond ETF 1 GVI ishares Intermediate Government/Credit Bond ETF 1 ILTB ishares Core Long-Term USD Bond ETF 1 CSJ ishares 1-3 Year Credit Bond ETF 1 FLOT ishares Floating Rate Bond ETF 1 QLTA ishares Aaa - A Rated Corporate Bond ETF 1 CMBS ishares CMBS ETF 1 MBB ishares MBS ETF 1 GNMA ishares Core GNMA Bond ETF 1 MUB ishares National AMT-Free Muni Bond ETF 1 CMF ishares California AMT-Free Muni Bond ETF 1 NYF ishares New York AMT-Free Muni Bond ETF 1 SUB ishares Short-Term National AMT-Free Muni Bond ETF 1 TIP ishares TIPS Bond ETF 1 STIP ishares 0-5 Year TIPS Bond ETF 1 TFLO ishares Treasury Floating Rate Bond ETF 1 ICSH ishares Liquidity Income ETF (Active Fund) 1 LQD ishares iboxx $ Investment Grade Corporate Bond ETF 2 SLQD ishares 0-5 Year Investment Grade Corporate Bond ETF 2 QLTB ishares Baa - Ba Rated Corporate Bond ETF 2 Ticker ishares ETF Name Fixed Income CRED ishares Core U.S. Credit Bond ETF 2 CIU ishares Intermediate Credit Bond ETF 2 CLY ishares 10+ Year Credit Bond ETF 2 ENGN ishares Industrials Bond ETF 2 AMPS ishares Utilities Bond ETF 2 MONY ishares Financials Bond ETF 2 LEMB ishares Emerging Markets Local Currency Bond ETF 2 GTIP ishares Global Inflation-Linked Bond ETF 2 NEAR ishares Short Maturity Bond ETF (Active Fund) 2 EMB ishares J.P. Morgan USD Emerging Markets Bond ETF 3 CEMB ishares Emerging Markets Corporate Bond ETF 3 ITIP ishares International Inflation-Linked Bond ETF 3 BYLD ishares Yield Optimized Bond 3 HYG ishares iboxx $ High Yield Corporate Bond ETF 4 SHYG ishares 0-5 Year High Yield Corporate Bond ETF 4 HYXU ishares Global ex USD High Yield Corporate Bond ETF 4 GHYG ishares Global High Yield Corporate Bond ETF 4 QLTC ishares B - Ca Rated Corporate Bond ETF 4 EMHY ishares Emerging Markets High Yield Bond ETF 4 Ticker ishares ibonds ETF Name Term Maturity IBCB ishares ibonds Mar 2016 Corporate ex-financials ETF 1 IBCC ishares ibonds Mar 2018 Corporate ex-financials ETF 1 IBCD ishares ibonds Mar 2020 Corporate ex-financials ETF 1 IBCE ishares ibonds Mar 2023 Corporate ex-financials ETF 1 IBDA ishares ibonds Mar 2016 Corporate ETF 2 IBDF ishares ibonds Dec 2016 Corporate ETF 2 IBDB ishares ibonds Mar 2018 Corporate ETF 2 IBDC ishares ibonds Dec 2018 Corporate ETF 2 IBDH ishares ibonds Dec 2018 Corporate ETF 2 IBDD ishares ibonds Mar 2020 Corporate ETF 2 Ticker ishares ETF Name - Equity PFF ishares S&P U.S. Preferred Stock P2 Please visit www.ishares.com/insurance for more information or to contact your ishares insurance team representative.
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. Buying and selling shares of ishares Funds will result in brokerage commissions. While ishares funds do not have minimum investment requirements, an investor must purchase whole shares. Diversification may not protect against market risk or loss of principal. Shares of the ishares Funds may be sold throughout the day on the exchange through any brokerage account. However, shares may only be redeemed directly from a Fund by Authorized Participants, in very large creation/redemption units. There can be no assurance that an active trading market for shares of an ETF will develop or be maintained. The ishares Funds are distributed by BlackRock Investments, LLC (together with its affiliates, BlackRock ). This material does not constitute any specific legal, tax or accounting advice. Please consult with qualified professionals for this type of advice. 2014 BlackRock. All rights reserved. ishares and BLACKROCK are registered trademarks of BlackRock. All other marks are the property of their respective owners. is-13888-1014 * Not FDIC Insured * No Bank Guarantee * May Lose Value Designations 1 is assigned to obligations exhibiting the highest quality. Credit risk is at its lowest and the issuer s credit profile is stable. This means that interest, principal or both will be paid in accordance with the contractual agreement and that repayment of principal is well protected. An 1 obligation should be eligible for the most favorable treatment provided under the Financial Conditions Framework. 2 is assigned to obligations of high quality. Credit risk is low but may increase in the intermediate future and the issuer s credit profile is reasonably stable. This means that for the present, the obligation s protective elements suggest a high likelihood that interest, principal or both will be paid in accordance with the contractual agreement, but there are suggestions that an adverse change in circumstances or economic, financial or business conditions will affect the degree of protection and lead to a weakened capacity to pay. An 2 obligation should be eligible for relatively favorable treatment under the Financial Conditions Framework. 3 is assigned to obligations of medium quality. Credit risk is intermediate and the issuer s credit profile has elements of instability. These obligations exhibit speculative elements. This means that the likelihood that interest, principal or both will be paid in accordance with the contractual agreement is reasonable for the present, but an exposure to an adverse change in circumstances or economic, financial or business conditions would create an uncertainty about the issuer s capacity to make timely payments. An 3 obligation should be eligible for less favorable treatment under the Financial Conditions Framework. 4 is assigned to obligations of low quality. Credit risk is high and the issuer s credit profile is volatile. These obligations are highly speculative, but currently the issuer has the capacity to meet its obligations. This means that the likelihood that interest, principal or both will be paid in accordance with the contractual agreement is low and that an adverse change in circumstances or business, financial or economic conditions would accelerate credit risk, leading to a significant impairment in the issuer s capacity to make timely payments. An 4 obligation should be accorded stringent treatment under the Financial Conditions Framework. 5 is assigned to obligations of the lowest credit quality, which are not in or near default. Credit risk is at its highest and credit profile is highly volatile, but currently the issuer has the capacity to meet its obligations. This means that the likelihood that interest, principal or both will be paid in accordance with the contractual agreement is significantly impaired given any adverse business, financial or economic conditions. An 5 Designation suggests a very high probability of default. An 5 obligation should incur more stringent treatment under the Financial Conditions Framework. 6 is assigned to obligations that are in or near default. This means that payment of interest, principal or both is not being made, or will not be made, in accordance with the contractual agreement. An 6 obligation should incur the most severe treatment under the Financial Conditions Framework. P2 is assigned to obligations of high quality. Credit risk is low but may increase in the intermediate future and the issuer s credit profile is reasonably stable. This means that for the present, the obligation s protective elements suggest a high likelihood that interest, principal, or both will be paid in accordance with the contractual agreement, but there are suggestions that an adverse change in circumstances or economic, financial, or business conditions will affect the degree of protection and lead to a weakened capacity to pay. An P2 obligation should be eligible for relatively favorable treatment under the Financial Conditions Framework. Preferred stock ETFs assigned a designation with the valuation indicator P will be subject to different accounting and regulatory treatment than -designated fixed income ETFs. Source for definitions:, Publicly Traded Securities Listing Definitions. Preliminary Designations are the intellectual property of the National Association of Insurance Commissioners () and are redistributed here under License. A Preliminary Designation is an opinion of the Securities Valuation Office (SVO) of the probable credit quality designation that would be assigned by the SVO to an investment if purchased by an insurance company and reported to the SVO. A Preliminary Designation is only one of the regulatory factors considered by the SVO as part of its analysis of probable regulatory treatment under the Regulatory Treatment Analysis Service. A full discussion of such other regulatory factors is set forth in the RTAS Letter provided to ishares. A Preliminary Designation cannot be used to report the ETF to state insurance regulators. However, the purchasing insurance company may obtain an Designation for the ETF by filing the security and final documents for the ETF with the SVO. The indication of probable regulatory treatment indicated by a Preliminary Designation is not a recommendation to purchase the ETF and is not intended to convey approval or endorsement of the ETF Sponsor or the ETF by the.