New iShares ETFs

The following is an article featured on Indexuniverse.com recent ally as part of my column, Efficient Investor.

IShares has just issued a dozen new unique ETFs which track the S&P Target Date Index Series and the Target Risk Index Series.  Below is a breakdown of the two categories with the tickers and expense ratios.

Target-Date Funds	Ticker	Cost
iShares S&P Target Date Retirement Income Fund	TGR	0.31%
iShares S&P Target Date 2010 Index Fund	TZD	0.31%
iShares S&P Target Date 2015 Index Fund	TZE	0.31%
iShares S&P Target Date 2020 Index Fund	TZG	0.31%
iShares S&P Target Date 2025 Index Fund	TZI	0.30%
iShares S&P Target Date 2030 Index Fund	TZL	0.30%
iShares S&P Target Date 2035 Index Fund	TZO	0.30%
iShares S&P Target Date 2040 Index Fund	TZV	0.29%

Risk-Based Funds	Ticker	Cost
iShares S&P Conservative Allocation Fund	AOK	0.31%
iShares S&P Moderate Allocation Fund	AOM	0.32%
iShares S&P Growth Allocation Fund	AOR	0.33%
iShares S&P Aggressive Allocation Fund	AOA	0.34%

Methodology

The S&P Target Date Index Series and Target Risk Index Series are composed entirely of iShares ETFs, similar to a fund of funds.  Each underlying ETF is chosen as a broad representation of an asset class. According to Standard and Poor’s Target Date Index Series methodology guide,

“The index series reflects the market consensus for asset allocations for different target date horizons.  In particular, each index is representative of the investment opportunity available to investors for the corresponding target date horizon, with asset class exposure driven by a survey of available target date funds for that horizon.”

This means that it is the two index series’ intention to provide a benchmark based on asset allocation opportunities available in the marketplace.  This is different from most indexes that systematically hold the entire or a representation of an investable universe, defined by an asset class, style, sector, industry, etc.  These indexes instead, represent aggregate asset allocations by each index’s mutual fund peer group.

To determine the asset-class weights for each target date and target risk index, S&P surveys mutual funds categorized as Target Date funds or Target Risk funds by the Lipper and Morningstar databases.  After surveying a category peer group, a trend line is fitted to the data points, only utilizing asset classes with more than 1%.  Measures are taken to solve an outlier effect without removing the number of funds used in the survey.  The indexes are rebalanced annually using the same surveying method.

The goal of these indexes is to represent allocation decisions among asset classes and not sector, style, or individual security selections. To represent an asset class allocation, iShares ETFs are used.  It is very clear that S&P intended and designed the indexes to become ETFs.  It is interesting that S&P choose ETFs as the underlying assets instead of the indexes that those ETFs track.  This makes the creation and redemption of the ETF simpler since hundreds of individual securities are represented by the underlying ETFs.

The expense ratios of the target date and target risk index funds listed above include the expense ratios charged by the underlying ETFs of each Fund.  The expense ratio fees of the underlying ETFs, which are all iShares products, are discounted when held by the fund.  Listed below are the ETFs S&P can employ for asset allocations that are determined for their Target Date Index and Target Risk Index Series.  Each index may or may not contain all these funds depending on their asset class inclusion in each index.

Asset Class	ETF	Ticker
US Large Cap	iShares S&P 500 Index Fund	IVV
US Mid Cap	iShares S&P MidCap 400 Index Fund	IJH
US Small Cap	iShares S&P SmallCap 600 Index Fund	IJR
International	iShares MSCI EAFE Index Fund	EFA
Emerging Markets	iShares MSCI Emerging Markets Index Fund	EEM
US REITs	iShares Cohen & Steers Realty Majors Idx Fund	ICF
Fixed Income	iShares Lehman Aggregate Bond Fund	AGG
Short Term Treasuries	iShares Lehman Short Treasury	SHV
TIPS	iShares Lehman TIPS Bond Fund	TIP

Target Date Indexing

Unlike other ETFs, target-date ETFs have an ending signified by their given target date.  The S&P Target Date Retirement Income Index Fund (TGR) is designed to be the endpoint for all target date funds. According to S&P, three years after an index’s target date, the target date index will than match the Retirement Income Index.  Once an ETF reaches its designated target date it will be rolled into the S&P Target Date Retirement Income Fund.  The ETFs tracking the indexes should follow this same method.

Opening Doors for ETFs

By creating ETFs made entirely of ETFs, highly diversified global portfolios diversified among asset classes and all sectors give investors a one stop shop for risk managed portfolios or risk appropriate portfolios.  For individual investors, the trading cost of trading several ETFs can be eliminated to one ETF, since the ETF is a representation of nine other highly diversified funds.  Also, these funds can act as an investable benchmark against their advisor’s performance or be used by individual investors who want exposure to asset classes like emerging markets and international but are not sure what their exposure should be given their risk tolerance.

These ETFs are designed by sponging off of mutual funds the aggregate of their asset allocation decisions while removing their market timing and stock picking decisions.  Interestingly, these ETFs depend on mutual funds for their allocation results and therefore are perfect substitutes, suited to outperform the average comparable mutual fund taking into account fees and expenses.

The question is not whether these ETFs will compete with mutual funds and advisors but where they will compete.  Target funds are very popular in retirement 401k plans, thought of as an autopilot approach.  With software being developed to trade ETFs on an omnibus trading platform, ETFs can now be offered in a complete way to plan participates.  The need for this kind of ETF has been clear and many companies and advisors have been offering target date and risk profiled model portfolios made from ETFs.  WisdomTree, a major frontrunner in offering ETFs in 401k plans with an omnibus trading platform, has been providing model portfolios for 401k plans constructed entirely of ETFs.  The similar iShares ETF products bring more transparency by providing a direct way to invest in the model.  The drawback to the ETF structure relative to an advisor’s model portfolio is that the iShares ETFs will change weightings as market prices change and weightings can be shifted away from the original allocation when you invest since the fund is rebalanced annually.  With WisdomTree’s models one can invest in the model allocations when they decide to invest.  The problem will be solved to an investor once the fund is rebalanced annually.

Without a doubt these 12 funds open doors to new ETF investors, provide direct competition to mutual fund assets in 401k plans, and prove that having an all ETF portfolio is accessible, cheap, and potentially optimal.  I am happy to say that these new advances in ETFs fit with traditional indexing strategies providing a framework for indexing to work with all platforms, for all investors, and at very cost effective prices.

To Be Fair

IShares is actually not the first to have target date funds, TDX Independence was.  Last year TDX Independence issued 4 target date funds and 1 retirement fund, TDX Independence In-Target ETF (TDX).  On average the TDX Independence funds are twice the price of the similar iShares products and are based on Zacks Investment Research Lifecycle Index series.  The index structure tries to select equity and fixed income securities that they believe will outperform the benchmarks.  This is very different from the S&P series which is more systematic and utilizes indexing principles.