Bond Market Challenges Continue to Drive Demand for Fixed-Income ETFs

(1)

GREENWICH

Bond Market Challenges Continue to

Drive Demand for Fixed-Income ETFs

(2)

CONTENTS GRAPHICS Fixed-Income Trading Environment

Over the Past Two Years 4

Reasons for Using Bond ETFs Alongside

Individual Bonds 5

Bond ETFs as Substitutes for Derivatives 5 Expected Use of Bond ETFs Over Next 12 Months 6 Expected Changes to Fixed-Income Sector

Allocations Over the Next Year 6

Fixed-Income ETF Applications by Institution Type 7 Top Reasons Institutions Use Fixed-Income ETFs 8 Largest Single Trade Using a Fixed-Income ETF 9 Reasons Institutions Don’t Currently Use

Fixed-Income ETFs 9

Preferred Fixed-Income ETF Provider 10

© 2015 Greenwich Associates, LLC. Javelin Strategy & Research is a division of Greenwich Associates. All rights reserved. No portion of these materials may be copied, reproduced, distributed or transmitted, electronically or otherwise, to external parties or publicly without the permission of Greenwich Associates, LLC. Greenwich Associates®, Competitive Challenges®, Greenwich Quality Index®, Greenwich ACCESS™, Greenwich AIM™ and Greenwich Reports® are registered marks of Greenwich Associates, LLC. Greenwich Associates may also have rights in certain other marks used in these materials.

RESEARCH GOALS AND METHODOLOGY Between January and March 2015, Greenwich Associates

interviewed 128 U.S.-based institutional investors about their use and perceptions of fixed-income exchange-traded funds. The respondent base included 37 investment managers (firms

managing assets to specific investment strategies/guidelines), 27 registered investment advisers, 50 institutional funds (pensions, endowments and foundations), and 14 insurance companies. The sample population comprised 60 current active users of fixed-income ETFs and 68 non-users in order to determine current and future use of fixed-income ETFs by active users, as well as the current reasons non-users don't actively use fixed-income ETFs and their expected future interest.

Cover Photo ©istockphoto.com/shaunl

39% 29% 21% 11% RIAs Institutional funds Investment managers Insurers Respondents Executive Summary 3

Institutions Struggle with Diminished Liquidity 4

Bond ETFs as a Liquidity Solution 5

ETF Growth Trajectory 5

Increased Broker Support Would Boost ETF Use 6 Portfolio Restructuring Fuels ETF Demand 6 Institutions See Potential in Fixed-Maturity ETFs 8 Versatility Drives Expansion in Use 8

Barriers to ETF Use are Falling 9

Top Fixed-Income ETF Providers 10

(3)

Executive Summary

With global fixed-income markets still facing challenges in the wake of the global financial crisis, bond exchange-traded funds (ETFs) are taking on an increasingly vital role in institutional portfolios.

For institutional investors, the legacy of the crisis has included structural developments making it more challenging for institutions to execute trades and manage their fixed-income allocations. Stricter regulations on banks have forced many fixed-income dealers to rein in their traditional role as market makers. At the same time, a dramatic increase in bond issuance has not been matched by an equal rise in secondary market trading volume.

These structural developments are making it harder for institutions to execute trades and manage their fixed-income allocations. More than half the institutions taking part in Greenwich Associates 2015 U.S. Fixed-Income ETF Study that have experienced liquidity problems say these issues have had a direct impact on their investment processes.

While institutions of all types have struggled with reduced liquidity in bond markets, ETFs have not suffered the same fate. Since 2008, bond ETF liquidity has grown more than four and a half times or at an annual growth rate of 33%. Among a subset of the largest ETFs, growth in liquidity has significantly outstripped asset growth, implying that there is a sizable population of investors actively trading and driving the velocity of these funds.1

Overall, 59% of fixed-income ETF investors in the study reported that they have increased their usage since 2011, with growing numbers of institutional investors turning to ETFs as a liquidity enhancement tool. Investors are increasing their ETF use by employing bond ETFs alongside individual bond holdings, or in

place of futures and other derivatives. Institutions are also using ETFs to create overlays and liquidity sleeves designed to enhance overall portfolio liquidity.

Increasingly, institutions also are turning to ETFs to more readily achieve fundamental investment goals. For the past several years, investors have been adjusting portfolios in response to historically low yields, the potential for a prolonged rising rate cycle and to better weather spikes in volatility. As institutions shorten duration, diversify portfolios and seek out sources of attractive return by shifting assets to specialized and niche investments, they have found ETFs to be highly flexible tools to address both long-term strategic and short-long-term tactical investment objectives.

Greenwich Associates data suggests that the growth of ETF usage by institutions is expected to be robust in the years ahead. One-quarter of the institutions in the study—and 40% of the investment managers—plan to increase their use of bond ETFs in the coming 12 months. Further, many institutions now report they have traded ETFs in large sizes of over $50 million. Among these frequent fixed-income ETF traders, over 90% say they were satisfied with their trading experience, and nearly all said they would trade ETFs again.

The need for new approaches and growing familiarity of the products appears to have sped up the adoption of bond ETFs. This momentum is likely to continue as institutions revisit internal investment guidelines and limits that had previously capped investors’ use of ETFs. Given these dynamics, Greenwich Associates expects fixed-income ETF usage will continue to build as institutional investors meet the realities of a challenging fixed-income marketplace with new and broader allocations to this highly adaptable vehicle.

For more information on this study, to obtain additional copies of the study or to participate in future studies, please contact Greenwich Associates at ContactUs@greenwich.com or +1 203.625.5038.

(4)

Institutions Struggle with

Diminished Liquidity

A loss of liquidity in global fixed-income markets has set the stage for what could be significant increases in institutional use of bond ETFs.

Stricter capital reserve requirements imposed on banks in the wake of the global financial crisis have prompted fixed-income dealers to slash inventories and dramatically cut back on the amount of capital devoted to market making. From the start of debates about Basel III, Dodd-Frank, and other post-crisis regulations, market participants expressed concerns that these alterations to the market structure— however warranted in terms of reducing systemic risk—threatened to sap liquidity from global bond markets.

Over the past two years, it appears that those fears have been realized. One-third of the institutional investors participating in Greenwich Associates 2015 U.S. Fixed-Income ETF Study say trading, liquidity and sourcing securities in fixed income have all become more challenging in the past two years. In contrast, only 5% said liquidity had become less challenging. Interestingly, 43% of investment managers, who as a group are generally more active

traders than insurance companies and institutional funds, were the segment with the highest portion of those reporting markets had become challenging. One investment manager succinctly described the challenges: “There is a lack of dealer inventory, high costs and volatility.”

Fifty-three percent of institutions that have experienced these challenges—and two-thirds of the investment managers—say new difficulties with liquidity have affected their investment processes. Study participants report that they are now being forced to take liquidity concerns into account when making investment decisions.

A study respondent representing an institutional fund said his firm has become much more conscious of the costs associated with low liquidity levels and the resulting spread widening. “The volatility since 2008 makes us more concerned about when we need to sell things. What time of year? What quarter? Before the financial crisis it wasn’t much of a concern.” A representative of one investment manager said liquidity shortages have made his firm “less likely to make small, incremental changes to fixed-income portfolios.”

Diminished liquidity has prompted some institutions to alter their portfolio allocations. Several institutions in the study say they have reduced exposures to certain products such as corporate bonds, or shifted assets from fixed income to cash. Observed one investment manager, “You have to take into account that you want to move into the more liquid parts of the capital structure.” Another investment management respon-dent said, “In the secondary market for corporate securities, we reduced holdings compared to pre-crisis levels due to fluctuations in value and liquidity. Broker/dealers as counterparties no longer extend the same levels of capital.”

These challenges are also encouraging institutional investors to experiment with new approaches to portfolio management and fixed-income trading. An insurance company representative said his firm had “created a portion of the portfolio purely for liquidity,

basically using derivatives as a more liquid element of the portfolio.” Another investment manager explained that the tougher liquidity environment had prompted his firm to upgrade its trading desk to enable it to “act as a price maker versus a price taker at times.”

Fixed-Income Trading Environment Over the Past Two Years

Note: 1_{Based on 119 respondents in 2015.}2_{Based on 40 respondents in 2015.}

Source: Greenwich Associates 2015 U.S. Fixed-Income ETF Study

No

48% 53%Yes

Challenges in Trading, Liquidity or Sourcing Securities

in Fixed-Income Markets1 Have Challenges Affected _{Investment Process?}2

Fixed-Income Trading Environment Over the Past Two Years

More challenging

About the same

Less challenging

34%

61%

(5)

Bond ETFs as a Liquidity Solution

Institutions’ need for new means of accessing fixed-income exposures in an increasingly challenging market environment is stoking demand among institutional investors for ETFs, which are seen as a more liquid alternative to sourcing bonds.

One-third of the institutional ETF users in the Greenwich Associates study are employing ETFs in overlays or liquidity sleeves specifically designed to enhance portfolio liquidity and flexibility and/or reduce implementation and trading costs. In general, institutions are employing ETFs within portfolios alongside individual bond holdings. The 53% of ETF users that employ this approach say they do so for three main reasons: easy exposures, increased liquidity and diversification.

Although sizable shares of institutions cite each of these factors as important, changes to market structure and subsequent liquidity reductions seem to be focusing investors’ attention on ETF liquidity. Since 2008, trading volumes of the five largest credit ETFs have grown 75x. This growth significantly outpaced the rise in total fund assets which have climbed 17x. The rapid growth in ETF trading volume versus fund assets implies that there is a population of frequent traders driving the increased velocity of these fixed-income ETFs.

In contrast, the investment grade and high-yield credit market has grown about 1.7x in trading volume, but with assets climbing faster at 2.1x. 2

Participants in the study suggest that used alongside individual bond holdings, ETFs can provide institutions with a buffer during increasingly common liquidity shortages. One investment manager put it simply by saying, “We use ETFs to fill out when we can’t find individual bonds.”

The study also shows that ETFs are now being considered by institutions that have used derivative-based fixed-income products to circumvent the liquidity issues in the market. Over one-quarter of institutional investors in the study—and a larger share of investment managers—use derivatives such as credit-default swaps, treasury futures or total-return swaps to gain fixed-income exposure. Some 58% of those investors said they have considered or would consider using bond ETFs as an alternative means of gaining those exposures.

ETF Growth Trajectory

Based on the study, growth of ETF usage is expected to be robust. One-quarter of the institutions in the study—and 40% of the investment managers—plan to increase their use of bond ETFs in the coming 12 months, while none of the respondents said

More liquidity Ease of exposure

Diversification

Use for duration management/transition Depends on business/client requirement

Easy to use/access Use as a placeholder/replacement 38% 34% 19% 19% 16% 9% Tactical asset allocation 9% 6% 6% 3% Ability to use instead of individual bonds

Good value/low cost

0% 25% 50%

Note: Based on 32 responses: 3 institutional funds, 12 RIAs, 13 investment managers, and 4 insurance companies in 2015.

Source: Greenwich Associates 2015 U.S. Fixed-Income ETF Study Reasons for Using Bond ETFs Alongside Individual BondsReasons for Using Bond ETFs Alongside Individual Bonds

Note: 1_{Based on 128 respondents in 2015.}2_{Based on 36 respondents in 2015}

who use derivatives.

No

72% 28%Yes

Use Derivatives (Credit Default Swaps, Treasury Futures, Total Return Swaps)

to Gain Fixed-Income Exposure1

Would Consider Using Fixed-Income ETFs as Alternative to Gain Fixed-Income Exposure2

Bond ETFs as Substitutes for Derivatives

Yes 58% No 42%

(6)

both more common among institutional investors and more important within institutional portfolios. Overall, 59% of fixed-income ETF users reported that they have increased ETF usage since 2011.

While current ETF investors are increasing usage, many investors who have not traded ETFs before are also considering an allocation in their portfolios. About half of institutions that do not currently use ETFs have considered or are considering using ETFs.

Portfolio Restructuring Fuels

ETF Demand

Although liquidity is becoming an increasingly impor-tant driver of institutional ETF investment, the current yield environment is also contributing to the need for investors to make adjustments in their port-folios—and thereby creating new demand for ETFs. Institutions say they are regularly employing ETFs because they are easy to use, provide quick access to exposures and offer single-trade diversification. Given institutions’ concerns about liquidity, it is no surprise that investors are looking for ways to maintain flexibility ahead of any major shifts. “We can’t be as nimble because it takes longer to source bonds,” said one RIA, explaining why his organization is investing more fixed-income assets in ETFs.

they expected to reduce their ETF allocations. Over 70% of investors expect to step up their ETF usage between 1–10%, with more than a quarter anticipating increases of over 15%.

This expected increase represents a sizable jump from 2013, a finding that suggests ETFs are becoming

Expected Use of Bond ETFs Over Next 12 Months

Note: 1_{Based on 58 respondents in 2015; 0% expected to decrease bond ETF}

use. 2_{Based on 11 respondents in 2015 who plan to increase use of bond ETFs}

in next 12 months.

Stay the same 76% Increase 24%

Expected increase or decrease1 _{expected magnitude of change}Of those expecting to increase,2

Expected Use of Bond ETFs Over Next 12 Months

Over 20% 1–5% 45% 27% 18% 0% 9% 16–20% 11–15% 6–10%

Expected Changes to Fixed-Income Sector Allocations Over the Next Year

Note: Based on 128 responses: 50 institutional funds, 37 investment managers, 27 RIAs, and 14 insurance companies in 2015.

Decrease

Proportion of institutions expecting allocations to: Increase 23% 24% 22% 20% 15% 14% 9% 7% 5% 9% 9% 1% 14% 9% 19% 4% High yield Emerging markets Short duration or rate hedged International developed Municipal U.S. Treasuries Asset-backed Investment-grade credit/corporate

Expected Changes to Fixed-Income Sector Allocations Over the Next Year

Increased Broker Support Would Boost ETF Use

Two-thirds of the institutions in the Greenwich Associates study say their brokers do not actively quote markets in fixed-income ETFs. Presumably as a result of this lack of coverage—and the fact that 38% of institutions execute fixed-income ETF trades through their equity trading desks—more than half of institutions say their preferred fixed-income broker is different from their preferred bond broker for the same asset class.

The simple act of getting more brokers to quote bond ETFs as part of their fixed-income offerings would result in at least some uptick in institutional usage, as about 15% of the institutions said they would implement more of the funds into their portfo-lios if more brokers were actively quoting bond ETFs.

(7)

their portfolios. Ahead of an expected uptick in interest rates, institutions were shortening duration while exploring niche segments of the bond market and shifting from core to core-plus and specialized products to seek yield. Those changes have continued over the past 12 months. For the second consecutive year, the study finds that dramatic changes unfolding in institutional portfolios—in response to both secular changes to market structure and cyclical shifts in market conditions—are generating demand for ETFs. Twenty-seven percent of the institutions in the 2015

study made significant changes to their portfolios last year—including a third of investment managers and more than 40% of insurance companies. The most common change was shortening duration, which was reported by 1 in 5 institutions that altered their portfolios. The next most common changes: reducing overall fixed-income allocations on the one hand, and increasing them on the other.

The study results suggest this dynamic will remain in place in the coming year, with institutions continuing to make significant sector shifts in their portfolios and continuing to use ETFs in doing so. Given the level of portfolio restructuring already accomplished, it is likely that these changes will be less extreme than those seen in 2013. Nevertheless, approximately 25% of the institutions plan to shorten duration in the next 12 months, a quarter plan to increase allocations to high yield, and roughly 1 in 5 each plan to increase allocations to emerging markets and to corporate credit. As they implement these changes to their portfolios, institutions are employing ETFs for an array of functions that range from the broadly strategic to the narrowly tactical. The two most common uses for bond ETFs among these investors are “obtaining passive exposures in core portfolios”—a strategic function—and “making tactical adjustments” to portfolios. Institutions’ other main uses spread across strategic and tactical functions, ranging from portfolio completion to cash equitization/interim beta and manager transitions.

Many institutions rely on ETFs as a key source of strategic market exposures. More broadly, institutions are using ETFs to gain exposures in areas in which they lack experience or simply prefer not to analyze and invest in individual bonds. Institutional investors are moving to diversify their portfolios both as basic risk management and as a means of locating sources In our 2014 report, Institutional Investors Turning

to Fixed-Income ETFs in Evolving Bond Market,

Greenwich Associates highlighted the extent to which institutional investors were employing ETFs as a tool for implementing significant changes to

Fixed-Income ETF Applications by Institution Type

Institutional funds Insurers RIAs Investment managers ETF overlay/ Liquidity sleeve Portfolio completion Hedging Cash equitization/ Interim beta Passive exposure in the core Tactical adjustments 80% 57% 64% 76% 30% 57% 41% 43% 20% 0% 27% 19% 60% 14% 64% 62% 40% 57% 73% 81% 10% 43% 45% 33% 0% 50% 100% Rebalancing Transitions 70% 71% 59% 76% 10% 43% 32% 38%

Fixed-Income ETF Applications by Institution Type

(8)

Versatility Drives Expansion in Use

Year-over-year comparisons of the top reasons investors use ETFs demonstrate institutions are becoming more aware of the versatility, simplicity and potential cost benefits they offer. When asked why they use fixed-income ETFs, investors in the study respond with a wide-ranging list including “easy to use” (cited by 97%), “quick access” (93%), “single-trade diversification” (87%), “liquidity” (85%), “lower trading costs versus cash bonds” (60%), and for 63% the “ability to avoid the need for single-security analysis.” It’s interesting to note that since Greenwich Associates last interviewed investors for this study in 2013, that final factor—avoiding the need for single-security analysis—has surpassed “lower trading costs” in mentions as a primary reason for using bond ETFs. This shift suggests that while cost reduction remains an important reason for using the funds, institutional investors are increasingly recognizing other key benefits. As more investors recognize these diverse benefits, the study results show that institutions are trading ETFs in large scale. About 1 in 5 study participants have executed ETF trades larger than $50 million, and about 30% have completed trades between $11 million and $50 million in size. Twelve percent of institutions have traded in excess of $100 million at a time. These proportions suggest that average of attractive returns in the low-yield environment.

Institutions cite ETFs’ single-trade diversification as one of the main reasons for employing the funds. They also rank the broader diversification benefits of ETFs as one of most important reasons for using the funds alongside individual bond investments. One investment manager said his firm relies on ETFs for “diversification access to sectors like credit where it

can be tough to diversify and manage duration.” Often, portfolio diversification means investing in unfamiliar territory—whether in a new geographic market or product type. As one RIA noted, “On the one hand we have the expertise to buy some individual bonds and we think we can do that and add value, but on the other hand there are a lot of spaces in fixed income where we don’t want to do that, where we don’t have the expertise. For example, in international we have individual bonds maybe for the U.S. portfolio, but we would use an ETF to gain exposure for a sector we don’t cover or have expertise in.”

Institutions are also integrating ETFs into more routine functions within their bond portfolios. Almost 70% of the institutional ETF users employ ETFs for portfolio rebalancing. Twenty percent of institutions—and a quarter of investment managers— use ETFs in hedging. Those applications are in addition to the one-third of institutional users employing ETFs in liquidity enhancement programs like overlays and liquidity sleeves.

Quick access Easy to use

Single-trade diversification

Avoid need for single security analysis Lower trading costs vs. cash bonds

Liquidity

0% 50% 100%

Note: Based on 60 responses in 2015 and 59 responses in 2013. Top Reasons Institutions Use Fixed-Income ETFs 2015 2013 97% 81% 93% 78% 87% 63% 85% 73% 80% 60% 56% 41%

Top Reasons Institutions Use Fixed-Income ETFs

Institutions See Potential in Fixed-Maturity ETFs

Three-quarters of the institutions in the study say they are open to the idea of using fixed-maturity ETFs in their portfolios. These institutions cite the predictability of returns, the ability to manage duration and the diversification of funds as reasons they would consider using fixed-maturity ETFs. (Most institutions that have not considered fixed-maturity ETFs say simply that the funds don’t fit with their investment strategies.) Institutions think fixed-maturity ETFs could be even more useful than traditional bond ETFs in target-based strategies, general duration management, bond laddering, and in meeting the specific needs of certain clients.

(9)

Nevertheless, concerns about low ETF trading volume or assets have become much less acute in the institutional market in the face of the impressive growth of ETF trading volumes. Since the onset of the financial crisis in 2008, fixed-income ETF trading volumes have grown more than 4.5x, or at an annual rate of 33%. Over the same period, total U.S. fixed-income ETF industry assets have grown to $297 billion from $57 billion in 2008. In Q4 2014 an average of more than $5.1 billion in fixed-income ETFs traded on exchange every day, up 43% from $3.6 billion in Q4 2013.3

Investors are starting to understand that exchange-reported volumes often understate available ETF liquidity—since new ETF shares can be created or redeemed as needed to support larger institutional transactions. Given ETFs’ growing acceptance by larger investors, Greenwich Associates expects concerns about limited trading volumes or assets to subside as the market continues to mature.

Institutional adoption of ETFs has also been slowed by internal rules and investment guidelines that limit institutional investment in the funds. Like concerns about low trading volumes in ETFs, Greenwich Associates expects these impediments to gradually fall by the wayside. Around the world, institutional investors are re-evaluating traditional portfolio management practices. Investment markets, products and strategies are becoming ever faster and more ETF trade size is on the rise—a logical outcome if

institutions are starting to more regularly employ ETFs as a liquidity enhancement tool.

Almost all the institutions executing these trades report a positive experience. Ninety-three percent of respondents say they were satisfied with their trading experience, and an impressive 98% say they would trade ETFs again. These data reinforce findings from Greenwich Associates research on ETF use in fixed income, equities and other classes showing that institutions that experiment with an ETF for a specific task generally report a favorable experience and soon start finding additional, new applications for the funds throughout their portfolios.

Barriers to ETF Use are Falling

Although the study results point to continued strong growth in institutional ETF usage, adoption of the funds is hardly universal and ETF allocations vary widely even among users. Traditionally, one of the primary reasons institutions hesitated before investing in ETFs were concerns about low trading volumes or assets. Even today those worries stand at the top of the list when institutions are asked to name the factors preventing them from increasing their ETF usage.

0% 20% 40%

Largest Single Trade Using a Fixed-Income ETF

$6–$10 million $0–$5 million

$11–$50 million

More than $100 million $51–$100 million 33% 17% 31% 7% 12%

Largest Single Trade Using a Fixed-Income ETF

93% of respondents say they were satisfied with their trading experience, and an impressive 98% say they would trade ETFs again.

Internal limits

Low trading volumes or assets

Constant maturity profile of many ETFs vs. declining maturity of bonds

Expenses Investment guidelines Regulatory limits Lack of understanding/familiarity 48% 28% 27% 20% 15% 12% ETFs not supported on trading/

PM platform 8%

8%

0% 25% 50%

Note: Based on 60 responses: 10 institutional funds, 22 investment managers, 21 RIAs, and 7 insurance companies in 2015.

Source: Greenwich Associates 2015 U.S. Fixed-Income ETF Study Reasons Institutions Don’t Currently Use Fixed-Income ETFs

Reasons Institutions Don’t Currently Use Fixed-Income ETFs

(10)

who expressed concerns the year before. While some of those concerns are based on issues of liquidity and prices, the institutions say a meaningful share of the worries stem from a general lack of understanding about how ETFs work.

Internally, a full 92% of study participants say they feel comfortable trading fixed-income ETFs, and 40% of the small group of respondents who said they feel uncomfortable attribute that feeling to their own lack of experience or knowledge about ETFs.

Only 15% of institutions say concerns about expenses are slowing their ETF usage. That finding suggests institutions have come to understand that, although fixed-income ETF fees are at times higher than those of some other products, transaction cost savings actually make ETFs a highly cost-efficient solution. Spreads on highly liquid, corporate-bond ETFs average 1 basis point, compared to a trading spread of 25 basis points or more for underlying corporate bonds.4

Together these findings suggest that many of the traditional roadblocks to ETF investments among institutional investors are giving way, setting the stage for continued and perhaps even accelerating growth.

Conclusion

Institutional fixed-income investors find themselves in an increasingly challenging new era. Regulations have forced global bond dealers to reduce their inventories and market-making activities, sapping liquidity from the market. Meanwhile, historically low interest rates are forcing investors to look farther afield for yield, while simultaneously preparing for a long-expected pick-up in rates and volatility.

The structural issues in fixed-income markets are contributing to the proliferation of ETFs within institutional portfolios. Over the past 12 months, institutions’ need for liquidity has been a primary driver of fixed-income ETF demand. With trading volumes in bond ETFs increasing rapidly while bond market liquidity recedes, demand for ETFs as a liquidity enhancement tool will likely remain strong. Institutional demand for bond ETFs will also continue getting a lift from ongoing efforts to restructure portfolios in response to tough conditions in global fixed-income markets. Over the past several years, institutions implementing such changes have complex. Institutions face huge challenges in funding

their liabilities or distribution schedules, and these challenges have been intensified by historically low interest rates that inflate the value of liabilities while eroding returns from the fixed-income portfolios that make up such large shares of institutional assets. Greenwich Associates annual research among institutions globally shows that in this tough new environment, investors are becoming more willing than ever before to experiment with and adopt new products and approaches that help them meet their goals. For some institutions, part of that process will be adjusting or eliminating internal limits and reworking internal investment guidelines to provide more flexibility.

Perceptions about ETFs are changing. Only 13% of institutions participating in the study say their clients or investment committees express concerns about ETFs, which is an improvement compared to the 19%

Top Fixed-Income ETF Providers When institutions seek out a fixed-income ETF provider, they look first at the quality and breadth of the firm’s product offerings and then at the liquidity of the provider’s products. Based largely on those attributes, the fixed-income ETF users participating in Greenwich Associates study name iShares/ BlackRock as their preferred provider of bond ETFs. Fifty-seven percent of study participants named iShares/BlackRock as their bond provider of choice in 2015. The institutions also named iShares/BlackRock as the industry’s leading provider of fixed-income ETFs based on the firm’s reputation, product offerings and dedicated fixed-income ETF service model.

Vanguard iShares/BlackRock 57% 24% State Street/SPDRs Other 9% 11%

Note: Based on 46 respondents expressing a preference: 8 institutional funds, 18 investment managers, 14 RIAs, and 6 insurance companies in 2015. Source: Greenwich Associates 2015 U.S. Fixed-Income ETF Study Preferred Fixed-Income ETF Provider

0% 20% 40% 60%

(11)

GREENWICH

ASSOCIATES

Consultant Andrew McCollum advises on the investment management market in the United States.

The data reported in this document reflect solely the views reported to Greenwich Associates by the research participants. Interviewees may be asked about their use of and demand for financial products and services and about investment practices in relevant financial markets. Greenwich Associates compiles the data received, conducts statistical analysis and reviews for presentation purposes in order to produce the final results. Unless otherwise indicated, any opinions or market observations made are strictly our own.Reprinted with permission of Greenwich Associates, LLC, April, 2015. The opinions expressed in this reprint are intended to provide insight or education and are not intended as individual investment advice.

found ETFs to be effective and versatile tools for both achieving strategic exposures and making quick tactical adjustments to their portfolios.

As investors adopt ETFs to help them meet these challenges, institutions, investment committees and clients are becoming more comfortable with the funds. As a result, Greenwich Associates expects growing numbers of institutions to employ ETFs as a portfolio management and construction tool alongside individual bonds. As fixed-income ETF adoption becomes commonplace, Greenwich Associates expects many institutions will revisit

investment guidelines that in the past served to limit their use of ETFs—setting the stage for wider institutional use, growing trading volumes and new portfolio applications in the years ahead.

For more information on this study, to obtain additional copies of the study or to participate in future studies, please contact Greenwich Associates at ContactUs@greenwich.com or +1 203.625.5038.

RELATED GREENWICH REPORTS

Institutional Investors Turning to Fixed-Income ETFs in Evolving Bond Market (2014)

ETFs: An Evolving Toolset for U.S. Institutions (2014) Canadian Institutions Look to ETFs for Both

Strategic and Tactical Applications (2014)

ETFs: Broad Usage Increases Amongst European Institutional Investors (2014)

Endnotes

1 Trading volume compiled from Bloomberg and based on cumulative monthly ADV from the period 12/31/2007–12/31/2014.

2 Fund assets and trading volume compiled from Bloomberg. Trading volumes based on cumulative monthly ADV from the period 12/31/2007– 12/31/2014. “Five largest credit ETFs” determined by ranking the total net asset value of the funds as of 12/31/14.

3 Fixed-income ETF industry assets and trading volume compiled from Bloomberg. Trading volumes based on cumulative monthly ADV from the period 12/31/2007–12/31/2014.

4 Bid/Ask spreads compiled from Bloomberg, Markit, Barclays, and NYSE Arca as of 12/31/14.

(12)

Reprinted with permission of Greenwich Associates, LLC, April, 2015. The opinions expressed in this reprint are intended to provide insight or education and are not intended as individual investment advice.

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 or, if available, the summary prospectuses which may be obtained by visiting www.iShares.com or www.blackrock.com. Read the prospectus carefully before investing. Investing involves risk, including possible loss of principal.

Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. Non-investment-grade debt securities (high-yield/ junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher-rated securities.

Transactions in shares of ETFs will result in brokerage commissions and will generate tax consequences.

All regulated investment companies are obliged to distribute portfolio gains to shareholders. 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.

Information on non-iShares ETF securities is provided strictly for illustrative purposes and should not be deemed an offer to sell or a solicitation of an offer to buy shares of any security other than the iShares Funds, that are described in this material. This study was sponsored by BlackRock.

The iShares Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”). BlackRock is not affiliated with

Greenwich Associates, LLC, or its affiliates.

iSHARES and BLACKROCK are registered

trademarks of BlackRock. All other marks are the property of their respective owners. iS-15414-0415