How to index invest  in the new world 08/10/2012 1

08/10/2012
How to index invest in the new world
Pollyanna Rhodes
BlackRock
Selecting Best Beta
Pollyanna Rhodes
October 2012
FOR FINANCIAL PROFESSIONAL USE ONLY.
NOT TO BE RELIED UPON BY INDIVIDUAL INVESTORS.
1
08/10/2012
Agenda
 Expanding world of beta
 The case for indexing
 Total Expense Ratio vs. Total Cost of Ownership
 The BlackRock difference
 What makes us different
Expanding World of Beta
Themes behind the growth
Growth in access opportunities
• Exposure to new markets, segments and asset
classes
l
US Index Fund Market Share
20.0%
17.0%
14.0%
11.0%
2009
2008
2007
2006
2005
2004
2003
2002
2000
• Delivery through “new instruments”
2001
8.0%
Growth in beta tools probability 20-25%
% of Total Fund AUM
Growth in the use of beta
Global ETF AUM
• Investors are altering the way in which they use
and view beta
350
250
200
150
100
50
2011
2010
2009
2008
2007
2006
2005
2004
Fixed Income ETFs
Commodity ETFs
Mar 2012
Equity ETFs
2003
2002
2001
0
2000
USD
D/
Billio
on
300
2
08/10/2012
How the fund landscape could look post-RDR
The market barbell
The real alpha
p players
p y
‘Mediocre’ Middle
The real beta players
p y
Active
Market
Passive
BFM UK Special Situations
BGF Euro Corporate Bond
BCIF UK Equity Tracker
iShares MSCI World
A shift towards either end of the market
Expanding Access to Beta
e.g. Growth of Beta Access Within Equities
Private
Equity
Property
Commodities
Frontier
Markets
Alternative
Weight
High Yield
‘Screened’
Strategies
Market
Segments
Emerging
Markets
Global Small
p
Cap
Convertible
Bonds
Inflation
Core Beta
For illustration purposes only.
3
08/10/2012
Why index a portion of your portfolio?
FOR PROFESSIONAL INVESTORS ONLY –
FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY
How the indexing landscape has changed
Tracker Funds – AUM and Sales (£m)
45,000
40,000
35,000
30,000
25,000
20,000
15,000
10,000
5 000
5,000
0
-5,000
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Tracker Fund AUM
Source: Investment Management Association
4
08/10/2012
A similar story for EFPs
Global ETP Market Growth (US$, Bn.)
European ETP Market Growth (US$, Bn.)
$1,800
5000
$1,600
4500
$350
2500
$300
2000
4000
$1,400
3500
$1,200
3000
$1,000
$250
1500
$200
2500
$800
2000
$600
1500
$400
$150
1000
$100
500
1000
$50
$200
500
2011
May-12
2010
2009
2008
2007
2006
2005
2004
2003
2002
0
2001
$0
2000
0
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
May-12
$0
ETF Equity Assets
ETF Fixed Income Assets
ETF Commodity Assets
ETF Equity Assets
ETF Fixed Income Assets
ETF Commodity Assets
Source: BlackRock Investment Institute – ETF Research, Bloomberg. May 2012
FOR PROFESSIONAL INVESTORS ONLY – FOR PROFESSIONAL CLIENTS
Why indexing in the first place?
Active funds do generate alpha but it varies substantially over time…
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
%
0.0%
2001
2002
2003
2004
% of all funds outperforming
2005
2006
% Equity
2007
2008
2009
2010
% Fixed Income
Source: Morningstar, Bloomberg, BlackRock. 1 year returns as at 31 December 2010. Universe includes European Domiciled Funds benchmarked against a
selection of common equity and fixed income indices
5
08/10/2012
Why indexing in the first place?
Active funds do generate alpha but it is not consistent
40.0%
35.0%
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
2001
2002
2003
Year 1
2004
Year 2
2005
2006
2007
2008
Year 3
Source: Morningstar, Bloomberg, BlackRock as at 31 December 2010. Universe includes European Domiciled Funds benchmarked against a selection of
common equity and fixed income indices
Is the investors’ risk/return
profile consistent with active
product features?
NO
INDEX
YES
What is the most appropriate indexing
methodology for the client’s investment time
horizon, liquidity needs, exposure and income
requirements?
INDEX
Are there skilled managers
that can consistently add
value in a market?
Does your client want income or accumulation?
Does your client need daily or intra day
liquidity?
INDEX
When to use indexing
Investors should conduct due diligence on
index managers and understand their
investment methodology, for example
physically replicating ETFs, derivative
replicating ETFs or accumulation vs. income
generating index funds.
YES
Are the cost implications in
linewith expected net return
target?
YES
ACTIVE
Investors should conduct due
diligence on active managers
and understand their investment
methodology
Products should be reviewed on a periodic basis to identify
any gaps or deviations from the original strategy.
6
08/10/2012
Implementing Core / Satellite Strategies
Core - passively managed vehicles, such as ETFs or
traditional index pooled funds lend themselves ideally
to the core component of an investment portfolio due
to four main reasons:
• Broad diversification by closely mirroring asset class
benchmarks
Active
Strategy 3
ETFs/
Index
Funds
Active
Strategy
1
St
t
• Consistent performance relative to a benchmark
• Low costs
• Improved risk management
Active
Strategy 2
Satellites - are typically more specialised investments
which serve as active tools to deliver additional
returns (alpha). ETF satellites have a number of
advantages:
Portfolio
• Precise exposure to a wide range of discrete market
sectors, specific styles or market capitalisations
indices.
ETF
Satellite
ETF
Satellite
• Exposure to selected market segments at low costs
• Eliminating security selection or manager selection
risk
ETF
Satellite
Total Expense Ratio vs. Total Cost of
Ownership
p
FOR PROFESSIONAL INVESTORS ONLY –
FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY
7
08/10/2012
Total Cost of Ownership
Passive Market Growth = More Passive Providers
New Providers = More Competition
New Providers More Competition = Lower TERs
= More Competition
Lower TER
=
Lower Total Costs
Total Cost of Ownership
The true cost of owning an ETF
• Total Cost of Ownership:
– Is NOT just TER.
– Can be broken down into both internal as well as external factors
factors.
Internal factors
Physical
replicating
funds
Derivative
replicating
funds
External factors
• Total Expense Ratio (TER).
• Rebalancing costs.
• Trading spreads.
• Securities lending revenue.
• Total Expense Ratio (TER).
+
• Creation/redemption.
• Brokerage fees.
=
Total
Cost of
Ownership
• Tax.
• Swap spread.
• Securities lending revenue.
• BlackRock believes Total Cost of Ownership is an accurate measure of investing in
an ETF.
8
08/10/2012
TER vs. TCO Case Study: Top 5 European FTSE 100 ETFs
TCO = Tracking Difference + Trading Cost
80
80
70
70
60
60
50
40
40
35
30
30
30
30
20
10
Basis Points (bps)
Basis Points (bps)
Total Expense Ratio
76
68
52
48
50
40
40
35
30 29
30
30
30
ETF 4
ETF 5
20
10
0
0
ETF 1
ETF 2
ETF 3
ETF 4
TER
ETF 5
ETF 1
ETF 2
ETF 3
TER
TCO
TER can sometimes be misleading when gauging TCO
Source: BlackRock, Bloomberg. Data as at end of March 2012.
The BlackRock Difference
FOR PROFESSIONAL INVESTORS ONLY –
FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY
9
08/10/2012
Indexing of BlackRock
Seeks to deliver
performance of
chosen index
through
risk
th
h rigorous
i
i k
management
Holds index
constituents at their
index weights or a
p
representative
sample to minimise
tracking errors
Efficient building blocks in an asset allocation strategy
Low cost access to market returns
Intelligent Portfolio Management
Coordinated global trading platform and securities lending relationships
Consistent exposure to a chosen market
Index Funds vs. ETFs
ETFs
Index Funds
Costs
TER, creation/redemption fees, brokerage Management fees, creation/redemption
commissions
fees, and other costs (Admin etc.)
Pricing
g
Real-time,, intradayy on exchange
g
Accessibility
On exchange, OTC
OTC
Transparency
Yes, typically daily disclosure of fund
holdings
Monthly holdings
Minimum trade size
1 share
Typically big, but may be smaller for
retail funds
End of dayy
Additional risk / operational ease Tracking difference, and possible
counterparty risk
Minor, counterparty risk if SL is
executed
Expiration maturity
No
No
Availability for lending
Yes, both inside and unit lending
Yes,, inside of the funds
Liquidity provided
Generally multiple dealers
With Fund Provider
Short positions possible
Yes
No
10
08/10/2012
Indexing in practice
Index replication methodology
Countries
Sectors
Stratified Sampling
Countries
Sectors
Full replication
Size
Size
Use Case
Use Case
• AUM is sufficient
• AUM not sufficient to fully
replicate
• Markets fully
investable
• Not fully investable
markets, illiquid assets
Product Universe
Investors can expand their portfolios beyond traditional investments
Equity
Developed
Emerging
Equity income
Regional
Size/Style/Yield
Corporate
Inflation-Linked
Emerging
Markets
High Yield
Currency
C
hedged
Fixed Income
Government
Other
Property
Alternatives
Commodities
Asia
Global Water
Precious Metals
UK
Global Forestry
Europe
Clean Energy
US
Infrastructure
Developed Markets
11
08/10/2012
The BlackRock Difference
Superior index tracking outcomes are best achieved through a disciplined &
pragmatic approach focused on managing return, risk and cost
Return
R t
• Performance as
planned with
value added
portfolio
management
• Designing and
building flexible
i
t
t
investment
solutions
Risk
Ri k
• Carefully
controlling
investment and
operational risk
processes
• Market leading
portfolio & risk
managementt
systems
Cost
C t
• Minimising
market trades
through internal
market place –
‘crossing’
• Global trading
platform and
h ensure
research
market trading
costs are low
12
08/10/2012
Appendix
Asset Class
Fund
UK
Equity
Fixed
Income
AMC
(%)
0.15
FTSE 100
0.15
UK Mid-Cap
0 15
0.15
Europe ex UK
0.15
Japan
0.15
Pacific ex Japan
0.15
North America
0.15
US
0.15
Emerging Markets
0.20
Global Property
0.20
UK Gilts All Stocks
0.15
Corp Bond 1-10 Yr
0.15
Corp Bond
0.15
Overseas Corp
Bond
0.15
Overseas Gov
Bond
0.15
Index-Linked Gilt
0.15
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not be available under the UK Financial Services Compensation Scheme on its default. The Companies are recognised schemes for
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g In addition,, investing
g in emerging
g g markets involves certain risks and
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13
08/10/2012
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