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By Paul Justice, CFA | 09-17-2010 03:18 PM

ETFs a Window Into the Bond 'Sausage Factory'

BlackRock's Matt Tucker describes the challenges in the evolution of the fixed-income ETF and what's behind ETF deviations from benchmark values.

Paul Justice: Perhaps no one in the ETF industry knows more about fixed-income products than Matt Tucker of iShares. I'm Paul Justice from Morningstar. I'm joined by Matt today to discuss the fixed-income landscape and the products that he has helped bring to market as managing director at iShares.

Matt, thank you for joining me.

Matt Tucker: Thanks, Paul, for having me.

Justice: You've got an incredible challenge and opportunity ahead of you in developing the fixed-income landscape, something that was probably unaddressed early in the ETF evolution.

You're really leading that effort. Would you mind talking about how you've come up with some of the product strategies and where you've seen great successes in the industry and what challenges that you've overcome from the early stages?

Tucker: Sure. I think when you bring it back to the growth in really the evolution of the fixed-income ETF market, it helps highlight some of the initial challenges that we faced.

If we think about the issues you faced just in fixed income, it's an over-the-counter market. You can't see price transparency. It's harder to execute. It's not an exchange market. So, actually taking that market and repackaging it on to the exchange through the ETF created a lot of challenges. How do you deal with a lack of price transparency? How do you deal with accrued interest, which is something that we take for granted in fixed income but was a fairly novel idea in equity markets to actually introduce that as part of valuation.

So, as we've gotten through those challenges, we've been able to bring to investors' products that at first were relatively plain vanilla, liquid corporate bonds and Treasuries, and now, we've evolved the structure to bring out things like high yield, emerging markets, and international global sovereign.

So, I think that as you've seen us improve the technology around the fixed-income ETF, it's allowed us to provide investors access to more and more asset classes.

One of the big innovations that I would love to highlight is just this idea of really breaking apart the creation of redemption basket, and I'm sure for a lot of your audience, they are fairly familiar with the ETF structure.

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