Nimble Portfolio Management Evolves With Expectations of Prolonged Volatility

2

excerpt from Managing Market Volatility in 2021 What institutional investors did in 2020 – and what they learned

iCRMH0221U/S-1506416-1/7

MethodologyIn Q3 2020, Institutional Investor’s Custom Research Lab surveyed 766 institutional investment decision makers in North America, Europe, the Middle East, Africa, Asia-Pacific, and Latin America, on how they navigated market volatility in 2020. The research process also included interviews of more than a dozen well-qualified sources at insurers, endowments, family offices, foundations, pensions, and asset management firms. Throughout this report, the phrase “asset manager” is used to refer to survey respondents and interview sources who work for asset management firms, serving their clientele of asset-owning institutions.

The demographic highlights of the research cohort are below.

Institution Type (n=766) Titles (n=766)

Asset management firm 34% Chief investment officer 18%

Insurance company 20% VP or director of investment 15%

RIA firm/financial advisory firm 10% Equity or fixed income

investment analyst13%

Public pension 9% Risk officer 13%

Endowment 6% Portfolio manager 11%

Family office 6% Product specialist 11%

Private pension 5% Director of research 10%

Hedge fund 4% Equity or fixed income trader 9%

Foundation 4%

Multiemployer / Taft-Hartley plan

2%

Location (n=766) Assets Under Management (n=766) North America 36% More than US$50 billion 26%

Europe, Middle East, and Africa 29% US$10 billion to US$50 billion 27%

Asia-Pacific 21% US$5 billion to US$10 billion 9%

Latin America 14% US$1 billion to US$5 billion 22%

US$500 million to US$1 billion 8%

Less than US$500 million 8%

This chapter excerpted from the Managing Market Volat i l i t y in 2021 research repor t 2

iCRMH0221U/S-1506416-2/7

WITH ETFs, PORTFOLIO CONSTRUCTION EVOLVESFor nearly as long as ETFs have existed, institutional investors have pointed to a few attributes that underpin the growth of their use – liquidity, transparency, and efficiency. In order to reposition their portfolios for what 68% of respondents in this study expect to be prolonged volatility, institutional investors are placing increased importance on those characteristics (n=766).

Speed – a combination of ease of use and timely asset exposure – is highly desired, with 49% of institutional investors saying the ability to quickly alter portfolio holdings is more important today than it was one year ago (see Fig. 1). The expectation of volatility puts a premium on liquidity, with 29% of respondents saying it is more important now than it was a year ago. Transaction costs are more important to 22% of institutional investors. Connect the dots, and it becomes apparent that in repositioning their portfolios for volatility, institutional investors are likely to continue to use ETFs, the core traits of which are considered essential during periods of prolonged volatility.

ONE-ON-ONE“We do a lot of tactical asset allocation plays in fixed income markets by managing overall duration positioning. We can take on risk assets at a very granular sector level – private corporates, investment-grade corporates, securitized assets, emerging-market debt – and there are so many ETFs with plenty of liquidity that it’s very easy to get granular with asset allocation, both strategically and tactically.”

– Senior Analyst, Asset Manager

“The variety of ETF vehicles that have come to the market allows us to do a lot more in terms of positioning portfolios.”

– Portfolio Manager, Insurance Company

Fig. 1: Faced with Volatility, Nimble Portfolio Management Is Increasingly Important

How important are the following compared to this time one year ago? (n=692)

More important No change Less important

Ability to alter portfolio

holdings quickly

Liquidity

Transaction costs

34% 17%

42% 29%

47% 31%

Operational risk 17% 48%

49%

29%

22%

35%

Which of the following statements best describes your expectations for repositioning your portfolio

over the next 18 months? (n=766)

68% Likely to reposition for continued heightened volatility

31% Likely to

reposition for recovery

1% Unlikely to reposition in the next 18 months

This chapter excerpted from the Managing Market Volat i l i t y in 2021 research repor t 3

iCRMH0221U/S-1506416-3/7

ETFs IN MULTI-ASSET STRATEGIESNearly all asset managers in the study employ multi-asset strategies, which as their name suggestsallow portfolios to be managed using a range of asset classes, sectors, and styles. The wide varietyand number of ETFs available today make them a natural fit in multi-asset strategies, and institutionalinvestors in the study say they sometimes deploy ETFs as a substitute for individual securities or derivatives.

The top reason asset managers cite for using ETFs in their multi-asset strategies is the transparency ofthe underlying holdings (58%) – likely because transparency has become increasingly important to institutional investors. The asset managers in the survey, which include hedge funds, also appreciate the trading flexibility (55%), liquidity (54%), and cost efficiencies (53%) that ETFs bring to their multi-asset strategies (see Fig. 2).

ONE-ON-ONE“As a multi-asset investor, there’s not always an actively managed strategy to access every asset class that I want access to. Sometimes ETFs are the only way to get exposure to the asset class I want, and that combined with their liquidity makes them an easy choice.”

– Portfolio Manager, Asset Manager

Fig. 2: Why Asset Managers Use ETFs in Multi-Asset Strategies

Which of the following make ETFs useful components of a multi-asset strategy? (n=341)

Transparency of holdings

Trading flexibility

Liquidity

Cost efficiencies

Ready access to assets that meet risk/return

requirements

55%

54%

53%

42%

58%

Ready access to assets aligned with benchmarks

32%

Does your organization use ETFs as a component of a multi-asset strategy? (n=362)

65% currently use ETFs

5% are unlikely to

use ETFs

30% are likely

to consider using ETFs

This chapter excerpted from the Managing Market Volat i l i t y in 2021 research repor t 4

iCRMH0221U/S-1506416-4/7

ONE-ON-ONE“In some separate accounts where we’re not allowed to use derivatives and we want liquidity, we will use ETFs.”

– Portfolio Manager, Asset Manager

USING ETFs TO REPLACE OR COMPLEMENT DERIVATIVES IN MULTI-ASSET STRATEGIES To meet return objectives in a low-yield, high-valuation environment, institutional investors and their managers sometimes use derivatives and leverage to avoid concentrating risks in traditional equities. The combination of hedge and leverage can be especially useful during heightened volatility – which, as noted earlier, is something a majority of institutional investors expect to continue for the next 18 months.

Trading over-the-counter (OTC) derivatives can be opaque and involves counterparty risk in a largely unregulated venue. Avoiding that risk is a key reason that many institutional investors use ETFs in combination with or instead of derivatives. Among respondents, 82% say they already use or are considering using ETFs as a substitute for (or complement to) derivatives (see Fig. 3).

Quick market access (63%) and liquidity (62%) are the primary reasons institutional investors use ETFs in the role of derivatives, but more than half (55%) cite a reason unique to the derivative scenario: avoidance of derivative analysis and counterparty negotiation required for single transactions. Interestingly, cost efficiency is less of a concern in this scenario than in some other use cases (see Fig. 4).

Fig. 4: Why Institutional Investors Use ETFs to Replace or Complement DerivativesWhich of the following make ETFs a good complement/replacement for derivatives? (n=612)

Quick market exposure/access

Liquidity

Avoidance of derivative analysis and counterparty negotiation

Transaction costs

62%

55%

30%

63%

Does your organization use ETFs as a complement to or replacement for derivatives in your portfolio? (n=746)

Fig. 3: Institutional Investors See ETFs as Viable Alternative to Derivatives

Yes

No, and we’re unlikely to do so in the future

No, but we’re likely to do so in the future

30%

18%

52%

This chapter excerpted from the Managing Market Volat i l i t y in 2021 research repor t 5

iCRMH0221U/S-1506416-5/7

KEY TAKEAWAYS » With prolonged heightened volatility anticipated, institutional investors want their

portfolio management capabilities to be nimbler. » ETFs create much-needed flexibility in multi-asset strategies, as they offer brisk market

access and exposure. » Use of ETFs to replace derivatives is driven in part by a desire to avoid the analysis and

counterparty negotiation required for single securities.

Derivatives and ETFs aren’t necessarily an either/or proposition for institutional investors, and how they might use both depends on the scenario. Queried on their preference for derivatives versus ETFs in various applications, 612 eligible survey respondents expressed support for complementary strategies that include both ETFs and derivatives:

» 52% use both derivatives and ETFs for tactical adjustments to their portfolios. » 48% use both during transitional periods between asset managers.» In transition periods, 32% of institutional investors use ETFs exclusive of derivatives, while

11% use derivatives without using ETFs. For those who don’t use ETFs in place of or alongside derivatives (n=134) , the reason is typically regulatory or organizational restrictions (87%).

» 33% of institutional investors use both when rebalancing their portfolios.

The use of ETFs alongside derivatives is an indication that institutional investors are willing to explore new and creative uses for exchange traded funds.

This chapter excerpted from the Managing Market Volat i l i t y in 2021 research repor t 6

iCRMH0221U/S-1506416-6/7

All text and content of this research report are the exclusive property of Institutional Investor. The research and commentary in this document are intended to highlight results, trends, and patterns among respondents in this study. In no event should the content of this report be construed to constitute an investment recommendation or managerial advice.

1120 Avenue of the Americas, 6th Floor, New York, NY 10036 InstitutionalInvestor.com

Copyright © Institutional Investor LLC 2021 All rights reserved.

Reprinted with permission of Institutional Investor, January, 2021. The opinions expressed in this reprint are intended to provide insight or education and are not intended as individual investment advice. We do not represent that this information is accurate and complete, and it should not be relied upon as such.

Carefully consider the 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.

International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/developing markets and in concentrations of single countries.

There can be no assurance that performance will be enhanced or risk will be reduced for funds that seek to provide exposure to certain quantitative investment characteristics ("factors"). Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. In such circumstances, a fund may seek to maintain exposure to the targeted investment factors and not adjust to target different factors, which could result in losses.

A fund's use of derivatives may reduce a fund's returns and/or increase volatility and subject the fund to counterparty risk, which is the risk that the other party in the transaction will not fulfill its contractual obligation. A fund could suffer losses related to its derivative positions because of a possible lack of liquidity in the secondary market and as a result of unanticipated market movements, which losses are potentially unlimited. There can be no assurance that any fund's hedging transactions will be effective.

There can be no assurance that an active trading market for shares of an ETF will develop or be maintained.Transactions in shares of ETFs may result in brokerage commissions and will generate tax consequences. All regulated investment companies are obliged to distribute portfolio gains to shareholders.

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. Diversification and asset allocation may not protect against market risk or loss of principal.

Shares of iShares ETFs may be bought and sold throughout the day on the exchange through any brokerage account. Shares are not individually redeemable from the ETF, however, shares may be redeemed directly from an ETF 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 strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.

The iShares Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”).

This study was sponsored by BlackRock. BlackRock is not affiliated with Institutional Investor or any of their affiliates.

iSHARES and BLACKROCK are registered trademarks of BlackRock. All other marks are the property of their respective owners.

iCRMH0221U/S-1506416-7/7