iShares, Ariz. Pension Team Up For New ETFs

April 18, 2013

iShares, the largest ETF provider in the world, today is launching five factor-based ETFs that mark two major milestones for the firm—three of the funds are being seeded with $100 million each by a pension fund, the Arizona State Retirement System, while the other two are the firm’s first real foray into active management.

More broadly, the whole suite of factor-based products being rolled out today is the result of a first-ever product development collaboration between iShares with end clients, from inception of an idea to construction to launch, Mark Carver, director and investment strategist at iShares, told IndexUniverse.

The actively managed element of this rollout also has the markings of the first real integration of parent company—and known global active manager—BlackRock into the until-now-all-passive iShares product line.

The funds being launched today include the iShares MSCI USA Momentum Factor Index Fund (MTUM), the iShares MSCI USA Size Factor ETF (SIZE) and the iShares MSCI USA Value Factor ETF (VLUE), which are constructed around the broad, market-capitalization-weighted MSCI USA Index.

Separately, iShares is also rolling out today two actively managed, factor-based funds: the iShares Enhanced U.S. Large-Cap ETF (IELG) and the iShares Enhanced U.S. Small-Cap ETF (IESM)—the firm’s first real foray into active strategies, Carver said.

Arizona Pension Fund And ETFs

The Arizona State Retirement System is the one seeding the three MSCI-linked ETFs with $100 million each.

For perspective, in its most recent 13F filing, submitted in February, the Arizona pension fund reported $6.8 billion of invested assets. That would put today’s seeding commitment at a sizable 5 percent of that pie.

Arizona’s decision to join iShares in the creation of these strategies is reflective not only of the growing ETF usage among large institutional investors, but also of pension funds’ increasing willingness to consider lower-cost passive instruments as they struggle to meet mandates in the current economic environment.

MTUM, SIZE and VLUE come with a price tag of only 0.15 percent in annual fees—a relatively low price tag for “enhanced beta” strategies even by ETF standards. They also will allow clients like pension funds the benefits of real-time tradability, as these institutions look to express tactical views.

What’s more, demand for factor-based strategies—these so-called enhanced beta that carve up the investment universe on the basis of specific factors; in this case, momentum, risk and value—is picking up pace as investors look for diversification at a time when correlations among assets are rising. Correlation among factors is often quite low.

“The attraction to factor investing generally is the ability to do return enhancement or risk reduction, or in some cases, both,” iShares’ Carver said. “The individual factors will be used to express a tactical view.”

The iShares MSCI USA Momentum Factor Index Fund (MTUM) tracks an MSCI benchmark that picks securities from the market-capitalization-weighted MSCI USA Index, with a focus on those that show higher momentum.

That momentum metric is measured by a stock’s price movement over the previous six to 12 months based on daily returns, the fund’s prospectus said. Stocks are then assigned a momentum score, which is then multiplied by a company’s free-float market capitalization to determine the weighting each security is assigned in the portfolio.

The iShares MSCI USA Size Factor ETF (NYSEArca: SIZE) tracks an index that “reweights” the securities comprising the broader MSCI USA Index in an effort to have those with relatively smaller average market capitalization and lower risk profiles represent a larger percentage of the mix.

Risk, in this case, is measured as historical variance over a three-year period of weekly return data, with those with the lowest variance ranking highest in the portfolio, the fund’s prospectus said. In the end, the methodology is designed to show lower realized volatility relative to the parent MSCI index.

Finally, the iShares MSCI USA Value Factor ETF (NYSEArca: VLUE) applies the same reweighting concept to the broader MSCI USA Index, but hones in on stocks that show lower market value relative to “certain accounting measures of value,” such as book value, three-year moving average of sales, earnings and cash earnings, according to the fund’s prospectus.

The new ETFs will join the iShares MSCI USA Index Fund (NYSEArca: EUSA), which has gathered $159 million since it came to market in mid-2010. EUSA has an annual expense ratio of 0.15 percent.

BlackRock Enters The iShares Picture

iShares, which boasts nearly $600 billion of U.S.-listed ETF assets and commands roughly a third of the entire U.S. ETF market, first won approval from regulators to market actively managed ETFs two years ago.

But when it comes to iShares’ decision to go this route, Carver noted it had nothing to do with taking a stand on the debate between passive versus active management—active management allows for flexibility around portfolio construction, he said.

“In the case of [the] enhanced [suite], it’s unique because for the first time we are bringing the full capabilities of BlackRock—research capabilities—into the ETFs done with collaboration from clients,” Carver said.

That collaboration with RIA clients came in the form of a consortium of 60 firms that provided feedback throughout much of the development of these products. BlackRock provided the active management and research expertise.

The “enhanced” suite of ETFs comprising IELG and IESM are built off a two-part process that begins with securities selection—the scoring of stocks on measures of quality, value and size—followed by portfolio construction, at which point certain “constraints” are applied such as keeping the exposure long-only and avoiding sector concentration, Carver said.

“We expect the iShares enhanced suite will be used more as a strategic long-term holding,” he concluded.

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