260 and Counting: Why We Create New ETFs (CMBS, AGG, IVV, HDV, HYG)

Noel Archard:  “It was a Valentine’s Day present for the CMBS market.” That’s a quote from a Forbes.com article, referring to our new iShares Barclays CMBS Bond Fund, (NYSEArca:CMBS) which had an inception date of — you guessed it – February 14.

We certainly don’t expect these types of laudatory quotes every time a new fund is launched. But I’m highlighting it because it helps to answer a question I’m frequently asked: Why does iShares continue to launch so many new funds?

When ETFs were first introduced, they were mainly used by institutional investors. But 19 years later the universe of clients has expanded in breadth and depth. ETFs are now used by some of the largest endowments and pension funds in the country, as well as mutual fund companies, hedge funds, investment advisors, insurance companies and individual investors. In addition, one third of institutions and almost 50% of asset management firms polled in a 2011 Greenwich Associates survey indicated they plan to increase ETF usage by 2013.

While it might be amusing to think that our funds are developed by a group of product junkies who are locked in a room, dreaming of new ways to slice and dice the market, we actually develop them in response to requests from our clients.

For instance, investors may have started using ETFs to gain exposure to broad asset classes through funds like the S&P 500 Index Fund (NYSEArca:IVV) or the Barclays Aggregate Bond Fund (NYSEArca:AGG), or they used broad sector funds to avoid the mistakes made in the late ‘90s from a lack of portfolio diversification.

While the broad exposures continue to be attractive, some investors prefer to use ETFs to respond to shifting market conditions for both tactical and strategic needsFor examplein an environment where long-dated Treasuries are offering negative returns as measured against core inflation, investors may want access to a dividend focused fund like the iShares High Dividend Equity Fund (NYSEArca:HDV). Or they want an ETF that allows them to keep a diversified portfolio of fixed income securities that has little or no Treasuries but more corporate exposures.

As risk appetite reemerges, some investors are seeking high yield corporate bond ETFs like the iBoxx $ High Yield Corporate Bond Fund (NYSEArca:HYG). Or investors may want exposure to an asset class like commercial mortgage backed securities but they can only get access through an ETF. That explains a first-to-market fund like CMBS.

There’s also a reason you will see us do something like launch seven new fixed income ETFs in one day as we did on February 16. Clients like knowing that a full suite of products exist so they can shift their allocations in response to changing market conditions. So far this year, iShares has introduced 35 new funds, bringing our total product offering to more than 260 ETFs.

Launching a new ETF is not a no-cost endeavor and is not one that we take lightly. Funds require the partnership of multiple market participants, from the fund manager who manages the ETF and its underlying securities, to the trading partners who create and redeem units in an ETF or help to ensure a fund’s liquidity.

In a universe that now numbers more than 1,400 funds, it is true that many of the offerings will fail to resonate with most investors. That is natural – not every fund is meant to be used by every investor. Currently, the 100 largest ETFs account for 80% of total assets under management, according to data from Bloomberg, FactSet, and BlackRock. These big funds appeal to the majority of investors, while niche products are available for investors who are looking to implement tactical views. At iShares, we plan to continue building our suite of product so that a broad range of investors have the ability to develop a diversified portfolio that can be tailored to meet their specific investing needs.

Bonds and bond funds generally decrease in value as interest rates rise. Commercial mortgage-backed securities (“CMBS”) represent interests in “pools” of commercial mortgages and are subject to credit, prepayment and extension risk, and therefore react differently to changes in interest rates than other bonds. Small movements in interest rates may quickly and significantly reduce the value of CMBS. High yield securities may be more volatile, be subject to greater levels of credit or default risk, and may be less liquid and more difficult to sell at an advantageous time or price to value than higher-rated securities of similar maturity.  There is no guarantee that dividends will be paid.

Diversification may not protect against market risk.

Written By Noel Archard From The iShares Blog

Noel Archard, CFA is a Managing Director and Head of Product for   North America iShares. He currently heads the iShares product function   in the US, which is responsible for product research and development,   product management, the management of iShares in capital markets and   product services and analytics. Noel joined iShares in 2006, then part   of Barclays Global Investors (BGI), which merged with BlackRock in   December 2009. He spent over 10 years at The Vanguard Group, first   working with their brokerage service unit and then moving into their Exchange Traded Funds group.

Noel has a BS degree from Northwestern University and is a Chartered Financial Analyst charterholder (CFA). He is a member of the Financial Analysts of Philadelphia and the CFA Institute, and holds Series 7,  24,  63 and 65 securities licenses.

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