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Matt Tucker, CFA
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Matthew Tucker, CFA, Managing Director, is a member of the Product Strategy Team within BlackRock's Fixed Income Portfolio Management Team. He leads the product strategy effort for exchange - traded funds, and leads the platform's efforts in North and Latin America iShares. His team focuses on... More
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  • What Investors Should Know About Bond Index Construction
     
    From the iShares Blog

    To index or not to index, that is the question. Or at least that’s the question many investors ask themselves when evaluating how to invest their money. Over the past decade we have seen a surge in investors answering “Index!” ETFs, most of which seek to track an index, have been a big part of this shift. 
    Most people are familiar with the popular indexes in the market like the S&P 500 and the Dow. Of course, the majority of indexes people are familiar with are of the equity variety — their bond market cousins don’t have the same visibility with most investors.  Today I want to talk about what bond indexes are and how they are put together, focusing on the US and then covering international in a future post.
    There are a large number of different US bond indexes out there, and they are all built a little bit differently, but the vast majority of them are rules-driven. This means that an index provider publishes a set of rules, and all of the bonds that meet those rules are included in the index. That’s it.  In this way fixed income indexes tend to be very objective, and their constituencies are fairly well understood and even predicable.  There is typically an index committee that creates the rules and provides oversight, but they have no say in the actual bonds that are selected. This is very different than some equity indexes (the S&P 500, for example), where a committee hand picks constituents based upon some objective criteria along with more subjective measures.
    OK, so bond indexes are rules driven.  What are the rules?  There is a lot of variety here, but there are four big ones that apply to most:
    1. A maturity requirement: Only bonds within a specified maturity range are included.  For example, the Barclays Capital US Aggregate Bond Index includes bonds that have at least one year remaining until maturity.  Other indexes focus on specific ranges of maturities, such as the Barclays Capital US 1-3 Year Treasury Bond Index. 

    2. A size requirement: Bonds have to be of a certain size – this ensures that very small and hard to access securities are not included.  Minimum amount outstanding rules for indices can vary a bit by market, but are typically greater than $100 million outstanding.

    3. A credit rating requirement: Only bonds of a specified credit quality are included. Investment grade indices, for instance, would only include investment grade bonds, those rated BBB or better. High yield indices, meanwhile, include bonds rated BB and below. 

    4. A rebalancing frequency: Bond indexes typically rebalance monthly.  At the calendar end of each month, the index provider takes the index’s rules, applies them to all the bonds in the market and voila!  The new index constituents are determined.  Importantly, if a bond no longer meets an index’s rules, it will still remain in the index until the end of the month when the rebalancing takes place.
    So what does this all mean for investors? Index rules give us a roadmap for how events in the market will impact a bond index and, as a result, an index fund that seeks to track it. If you buy an investment grade index fund, for instance, and a bond is downgraded to below investment grade, it will likely come out of index and, therefore, it will likely come out of the fund at the end of the current month.
    In addition, investors should make sure they know the index’s rules before investing in a bond index fund, as those rules largely determine the types of securities the fund will be investing in. Bond index rules can be a bit arcane, but a familiarity with the basics will help you better choose between investment options. 
    Bonds and bond funds will decrease in value as interest rates rise. Indexes are unmanaged and one cannot invest directly in an index.
    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 clicking the Prospectuses link. Read the prospectus carefully before investing.
    Investing involves risk, including possible loss of principal.
    The iShares Funds (“Funds”) are distributed by SEI Investments Distribution Co. (“SEI”). BlackRock Fund Advisors (“BFA”) serves as the investment advisor to the Funds. The iShares Blog contributors are affiliated with BlackRock Fund Distribution Company (“BFDC”), which assists in the marketing of the Funds. BFA and BFDC are affiliates of BlackRock Institutional Trust Company, N.A. (“BlackRock”), none of which is affiliated with SEI.
    The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications or other transactions costs, which may significantly affect the economic consequences of a given strategy.
    The information provided is not intended to be tax advice. Investors should be urged to consult their tax professionals or financial advisors for more information regarding their specific tax situations.
    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.
    This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular.
    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”), iBoxx®, JPMorgan Chase & Co., MSCI Inc., 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.
    ©2010-2011 BlackRock. All rights reserved. iShares® is a registered trademark of BlackRock Institutional Trust Company, N.A. BlackRock® is a registered trademark of BlackRock, Inc.  All other trademarks, servicemarks or registered trademarks are the property of their respective owners.
    Aug 18 5:02 PM | Link | Comment!
  • Investor Question: Greek Bonds in ETFs
    As the Greece situation continues to develop, I’ve been hearing a lot of client questions about the exposure to Greek debt in some of our iShares fixed income ETFs.  With good reason, too – investors are wondering whether downgraded Greek bonds will be removed from the funds in which they currently reside.  It’s a fair question, and it really highlights some of the points I made in my last post on index construction.  Of course, last time I focused on US indexes (which are fairly straightforward).  The Greece example gives me a good excuse to cover index rules for non-US bond indexes.

    In many ways, international bond indexes are similar to their US counterparts. The four big index rules that we discussed before still largely apply. But international indexes also have an additional wrinkle: varying rules on classifying countries as developed or emerging markets.  In other words, one index provider’s emerging country is another’s established player.

    Luckily, there are three common methods that most fixed income index providers use to determine whether a country is emerging or developed.  Some providers classify countries using the World Bank’s reporting of average income level in a country.  For example, JP Morgan’s Emerging Market Bond Indexes define an emerging market as a low- or middle-income country, using the World Bank’s data to ascertain which countries fall into that category. Other providers use the Bank of International Settlements’ (NASDAQ:BIS) country classifications.  And finally, an index provider might use a committee to determine if a country is developed or emerging based on a range of criteria such as liquidity, income standards, ratings and other factors.  This last method is used by the Barclays Capital Index family.

    Of course, most definitions of “emerging vs. developed” are based on the idea that emerging market countries move to developed market status through time. However, this may not always be the case – and Greece is a possible example. While Greece is generally still thought of as being part of the developed world, Greek debt was downgraded by Standard & Poor’s in July 2011 to CCC, a firmly speculative rating. Unfortunately, there isn’t a consistent view among index providers of how this downgrade will impact Greece’s classification as a country.  Instead, the treatment of Greece varies by provider and by index methodology.  Here’s a look at how the Greece situation is currently being handled by various types of international fixed income indexes:

    1. Investment grade global indexes – Since Greek debt is no longer considered investment grade, it was removed from investment grade global indexes (such as the Barclays Capital International Treasury Bond Index) at the end of June 2010.
    2. Developed market indexes – Since Greece is still considered developed by the World Bank and BIS, Greek debt is still included in developed market bond indexes (such as the S&P/Citigroup International Treasury Bond Index).
    3. Indexes that cover both developed and emerging markets — Greece is still in these indexes (such as the BofA Merrill Lynch Global Diversified Inflation-Linked Index), and likely won’t be dropped by them unless the country actually defaults by missing a coupon or maturity payment.

    While the jury is still out on the ultimate classification of Greece, it’s clear that the rules around country classification are themselves a bit undeveloped.  Familiarization with them can help bond index fund investors better know what they own.

    Aug 01 11:45 AM | Link | Comment!
  • Video: The Biggest Market Event You’ve Never Heard Of

    From the iShares Blog
    The annual Russell Index Reconstitution happened on June 24th, and as always it was one of the biggest market events of the year.  Why?  In addition to the huge amount of trading volume that it creates, it also represents a sizeable challenge for the index funds that seek to track the Russell indices.  In part one of our latest Blue Room Chat, Head of iShares Portfolio Management Greg Savage breaks down this year’s “Recon”, covering the notable index additions and assessing the significance of trading activity on that day.

    Tune in next week to get the scoop on what fund managers must to do manage around the Russell Reconstitution, and why investors should care.

    Link to the video: http://youtu.be/27L-AO0xkEE

    Jul 08 1:59 PM | Link | Comment!
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