Index Methodology and Rule Book

Transcription

1 Index Methodology and Rule Book BlackRock Investment Grade Enhanced Bond Index BlackRock High Yield Defensive Bond Index JULY 14, 2017

2 Table of Contents BlackRock Smart Beta Corporate Bond Indices... 1 Introduction... 3 Creating Monthly Index Composition... 3 Defining the Investible Universe BlackRock Investment Grade Enhanced Bond Index... 4 Defining the Investible Universe BlackRock High Yield Defensive Bond Index... 5 Analytics and Index Construction... 7 Bond Level Analytics, Transaction Costs, and Factors... 7 Index Construction... 8 Finalized Index... 9 Calculation and Maintenance Index Calculation Index Maintenance and Publication Index Calculation Formulas Governance Index Methodology Changes Restatement Process Glossary Appendix A Holiday Schedule... 17

3 BlackRock Smart Beta Corporate Bond Indices Alex Golbin, CFA Jabari Magnus, CFA, CFP BlackRock is a global leader in investment management, risk management, and advisory services, and manages in excess of $5 trillion for institutional and retail clients around the globe 1. Decades of investment research, as well as active and passive portfolio management experience, have informed BlackRock s approach to Smart Beta ( Factor ) indexing. BlackRock Index Services, LLC s Smart Beta index strategies are based on factors that possess a strong conceptual foundation risk premiums, market structure impediments, and behavioral anomalies and are supported by empirical analysis. In fixed income, BlackRock s Smart Beta index strategies are driven by macro factors such as interest rate and credit exposure, as well as style factors such as value and momentum that are often associated with equity markets. These Smart Beta index strategies seek to mitigate or diversify risk, enhance risk-adjusted returns, or deliver higher income relative to traditional market capitalization-weighted exposures. Publishing indices designed to systematically capture these results enables BlackRock to provide investors with investable, objective, and transparent alternatives to market capitalization-weighted index strategies. BlackRock Investment Grade Enhanced Bond Index and BlackRock High Yield Defensive Bond Index The Investment Grade Enhanced and High Yield Defensive Corporate Bond Indices are designed with the aim of avoiding riskier, often overpriced securities by screening out those with relatively high probabilities of default (a proprietary measure of credit quality) from their respective broad initial universe ( Investible Universe ) of bonds. The remaining securities are then weighted so that the indices are more heavily weighted towards bonds with attractive default-adjusted spreads (a measure of value), while controlling for other risks and limiting turnover. 1 As of December 31 st,

4 The objective of the BlackRock Investment Grade Enhanced and High Yield Defensive Bond indices is to provide enhanced risk-adjusted returns relative to the comparable capitalization-weighted indices for the U.S. investment grade corporate bond market and the U.S. high yield corporate bond market, respectively. The investment thesis underpinning these strategies is based on the premise that many fixed income investors reach for yield, driving up the prices of riskier bonds. Investor demand for higher yielding bonds may result in a mispricing of credit risk, whereby bonds associated with lower credit quality may be overpriced relative to similarly rated bonds associated with higher credit quality. BlackRock believes that portfolios that avoid bonds issued by the riskiest issuers may produce higher risk-adjusted returns than portfolios that include bonds from the riskiest issuers. By introducing value as a diversifying factor, the indices may provide opportunities for higher yield and improved total return versus market capitalization weighted indices. Although both indices screen out bonds that are perceived as the riskiest by removing those with the highest probability of default, the BlackRock High Yield Defensive Bond Index places a greater emphasis on the screening process. As such, it may provide increased opportunities for downside protection during periods of widening corporate bond spreads. After the screening process, both indices will tilt toward a measure of value. The tilt towards value offers both indexes the opportunity to capture upside in periods when corporate bond spreads are tightening. The BlackRock Investment Grade Enhanced Bond Index places more emphasis on the tilt towards value and thus has the potential to offer higher yield than a market capitalization weighted index covering the investment grade bond market. BlackRock s empirical research confirms the efficacy and sustainability of these strategies over time. After taking into account modelled transaction costs, these indices may provide opportunities to meet the strategy objectives of higher total and risk-adjusted returns. Furthermore, the defensive nature of the indices may provide opportunities for lower risk, favourable upside/downside capture ratios and lower drawdowns as compared to market capitalization weighted indices, especially in the case of the BlackRock High Yield Defensive Bond Index due to its heavier value factor weighting. 2

5 Introduction The indices illustrate and leverage BlackRock s deep experience in fixedincome investment and risk management. In this document, we outline the systematic, rules-based methodology for the construction of the BlackRock Investment Grade Enhanced Bond Index and the BlackRock High Yield Defensive Bond Index (the Indices ). The investment objective of the Indices is to offer riskadjusted returns that are expected to be superior to the Investible Universe for the respective USD denominated investment grade corporate bond and USD denominated high yield corporate bond markets. At the end of each month, the investment grade and high yield Investible Universes are constructed through filtering processes that result in two broad sets of bonds, each characterizing its respective universe. Included in each Investible Universe are all bonds eligible for consideration in the respective index. Next, through proprietary optimization processes, each index will allocate more weight to those bonds with higher expected returns while also reducing allocation to bonds with higher exposure to risk factors and transaction costs. The approximate size of the market the BlackRock Investment Grade Enhanced Bond Index and BlackRock High Yield Defensive Bond Index represent, as measured by their respective Investible Universe, is USD 4.5 trillion and USD 1 trillion respectively 2. Creating Monthly Index Composition Creating the monthly composition for the Indices follows the index construction process described in the following section. On the fixing date 3, the Investible Universe is defined and then the index constituent weights are determined through the optimization process. A key objective in construction of the Investible Universe is striking a balance between including enough securities to attempt an accurate representation of the market, and avoiding costlier-to-trade, less liquid securities in an effort to make the index more investible. Incorporated into the optimization process are specific risk and default metrics based on analytics calculated using the end-of-day ( EOD ) price for each bond in the Investible Universe. 2 As of February 28 th, The date of the data used to derive the Investible Universe and the date on which the index composition is finalized. The fixing date for the Indices is three business days before the last business day of the month. 3

6 The indices start with filtering the corporate bond universe down to the Investible Universe. BlackRock Investment Grade Enhanced Bond Index The objective of the BlackRock Investment Grade Enhanced Bond index is to provide enhanced risk-adjusted returns relative to the comparable capitalization-weighted indices for the U.S. investment grade corporate bond market. Key criteria defining the Investment Grade Corporate bond Index: Rated investmentgrade (Baa3/BBB- or higher) by at least one nationally recognized statistical rating organization ( NRSRO ) out of three selected by the Index Services Governance Committee. If rated by three agencies, the median rating should be used, if rated by two agencies, the lower of the two ratings is used, if rated by one agency, that rating is used 4. I. Defining the Investible Universe for the BlackRock Investment Grade Enhanced Bond Index A. Inclusion Criteria a. Currency: US Dollar denominated with coupon payments in US Dollars. Bonds issued by non-us corporations are eligible provided they are SEC registered. b. Rated investment grade (Baa3/BBB- or higher) c. Corporate bonds from the following sectors: industrials, financials, and utilities. d. Minimum amount outstanding: $250 million. e. Term: At least 12 months until final maturity. f. Coupon Type: Fixed rate bonds, zero coupon bonds, and bonds with predetermined step-up coupons are eligible. g. Callable/Putable: Bonds with calls and puts are allowed. h. Extendable Bonds: Bonds with extendable maturities. i. Private Placements: 144(a) bonds with Registration Rights. j. Medium-term notes: Eligible if they are publicly underwritten. k. Bonds must be issued on or before index fixing date and settled on or before the last business day of the month. l. Bonds of issuers from qualifying countries 5. B. Specific Exclusions a. Called Bonds: Will be excluded as of call date. b. Certain Tax Haven Issues 6 c. Dividends Received Deduction ( DRD ) and Qualified Dividend Income ( QDI ) eligible securities d. Non-corporate credit (including sovereign, supranational, agency, and local government debt) e. Convertible bonds f. Bonds with warrants g. Inflation linked bonds h. Eurodollar Bonds i. Index-linked bonds j. Fixed to floating rate bonds k. Reg-S bonds l. Contingent Capital Securities m. Bonds issued by BlackRock, Inc., The PNC Financial Services Group, Inc., and Intercontinental Exchange, Inc. 4 This process establishes a composite rating used in the filtering process. 5 List of Included Countries for Investment Grade Investible Universe: Australia, Belgium, Canada, Finland, France, Germany, Ireland, Italy, Japan, Luxembourg, Netherlands, Norway, Spain, Sweden, United Kingdom, United States. 6 If the guarantor or parent company is from a country that is not in the List of Included Countries for Investment Grade Investible Universe, a bond issued in a tax haven country will be excluded. 4

7 The resulting set of bonds will constitute the Investible Universe for the BlackRock Investment Grade Enhanced Bond index. n. Private Placements (other than the previously described 144a securities) o. Structured notes p. Floating rate bonds q. Non-callable perpetual bonds r. Defaulted bonds s. Payment-In-Kind ( PIK ) bonds t. Toggle Notes u. Municipal bonds v. Preferred equities w. Covered Bonds x. Bonds with par values of 25 or 50 BlackRock High Yield Defensive Bond Index The objective of the BlackRock High Yield Defensive Bond index is to provide enhanced risk-adjusted returns relative to the comparable capitalizationweighted indices for the U.S. high yield corporate bond market. Key criteria defining the High Yield Corporate bond Index: Rated below investment-grade (Ba1/BB+ or lower) by at least one NRSRO out of three selected by the Index Services Governance Committee. If rated by three agencies, the median rating should be used, if rated by two agencies, the lower of the two ratings is used, if rated by one agency, that rating is used 7. II. Defining the Investible Universe for the BlackRock High Yield Defensive Bond Index A. Inclusion Criteria a. Currency: Bonds must be US Dollar denominated with coupon payments in US Dollars. Bonds issued by non-us corporations are eligible provided they are SEC registered. b. Rated below investment grade (Ba1/BB+ or lower). c. Corporate bonds from the following sectors: industrials, financials, and utilities. d. Minimum amount outstanding: $150 million. e. Term: At least 12 months until final maturity. f. Coupon Type: Fixed rate and zero coupon bonds. Bonds with predetermined step-up coupons are eligible. g. Callable/Putable: Bonds with calls and puts are allowed. h. Extendable Bonds: Bonds with extendable maturities. i. Private Placements: 144(a) bonds. j. Medium-term notes: Eligible if they are publicly underwritten. k. Bonds must be issued on or before index fixing date and settled on or before the last business day of the month. l. Bonds of issuers from qualifying countries 8 7 This process establishes a composite rating used in the filtering process. 8 List of Included Countries for High Yield Investible Universe: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, Luxembourg, Netherlands, Norway, Spain, Sweden, United Kingdom, United States. 5

8 B. Specific Exclusions The resulting set of bonds will constitute the Investible Universe for the BlackRock High Yield Defensive Bond index. a. Called Bonds: Will be excluded as of call date. b. Certain Tax Haven Issues 9 c. Bonds with a composite rating of D. d. DRD and QDI eligible securities e. Non-corporate credit (including sovereign, supranational, agency and local government debt) f. Convertible bonds g. Bonds with warrants h. Inflation linked bonds i. Eurodollar Bonds j. Index-linked bonds k. Fixed to floating rate bonds l. Reg-S bonds m. Contingent Capital Securities n. Bonds issued by BlackRock, Inc., The PNC Financial Services Group, Inc., and Intercontinental Exchange, Inc. o. Non -144a Private Placements p. Structured notes q. Floating rate bonds r. Non-callable perpetual bonds s. Defaulted bonds t. PIK bonds u. Toggle Notes v. Municipal bonds w. Preferred equities 9 If the guarantor, parent or ultimate parent company is from a country that is not in the List of Included Countries for High Yield Investible Universe, a bond issued in a tax haven country will be excluded. 6

9 Analytics and Index Construction I. Bond Level Analytics, Transaction Costs, and Factors BlackRock s robust portfolio management systems allows for the ability to leverage a comprehensive fixedincome analytics platform. A. Compute Bond Metrics a. Duration: Sensitivity of a bond s price to a change in interest rates. The indices use option adjusted duration to account for any expected shortening of a bond s cash flows due to call provisions. b. Yield To Maturity ( YTM ): The internal rate of return on any investment that will make the present value of the cash flows equal to the price. c. Yield To Call ( YTC ): The internal rate of return on any callable investment that will make the present value of the cash flows equal to the price assuming the bond is called on the next call date. d. Yield To Worst: the lower of YTC and YTM. e. Option Adjusted Spread ( OAS ): The constant yield spread added to the treasury yield curve which equates a bond s market price to its discounted option-adjusted cash flows. f. Spread Duration: sensitivity of a bond s price to a change in spreads. g. Duration Times Spread ( DTS ): the product of spread duration and OAS divided by 100. B. Compute Proprietary Risk Factors, Default Analytics, and Transaction Cost Penalty on Investible Universe. a. The market risk of each bond is calculated using a factor risk model that breaks down a corporate bond s return into systematic and firm-specific factors. The risk, or volatility, of a corporate bond is made up of exposure to systematic risk factors (country, industry, maturity, liquidity) and companyspecific risk. A separate model for the Investment Grade Investible Universe and the High Yield Investible Universe is created through statistical regressions using data from the requisite broad population of US corporate bonds. The model outputs are an individual bond s total risk and its risk contribution to the relevant index with risk being expressed as annualized volatility. b. A Probability of Default ( PD ) estimate is calculated using a model enriched through incorporation of advanced statistical techniques and empirical data. The PD estimate is primarily determined by a company s financial health, industry characteristics, and market environment. The model inputs are accounting data, market data of equity and bond instruments, bond ratings, and other economic variables. The output of the model is an estimate of the probability of default for the issuer over the next twelve-month period. 7

10 c. Default Adjusted Spread scores are calculated using each bond s: i. OAS ii. iii. Probability of Default ( PD ) Recovery Rate Assumption ( RRA ). Whereby: Default Adjusted Spread = OAS PD x (1-RRA 10 ) Once Default Adjusted Spreads have been calculated for bonds across the Investible Universe, they are normalized to arrive at Default Adjusted Spread scores for each bond. d. Transaction Cost Penalty: Bond level transaction costs calculated using each bond s: i. Option Adjusted Duration ( OAD ) ii. OAS II. Index Construction A. Once the Investible Universe is established and all of the relevant analytics, factors, and risk metrics are calculated, the issuers in each Investible Universe are divided into their representative credit rating group. The issuers with the highest probability of default in each group are then screened out. For the BlackRock Investment Grade Enhanced Bond Index and BlackRock High Yield Defensive Bond Index, up to 20% and 30% respectively of the issuers within each rating group are screened out. B. Next, an optimization is used to maximize the aggregate default adjusted spread score while mitigating common factor exposures, specific risks, and transaction costs relative to each index s respective Investible Universe. C. Through various constraints, the optimization process is bounded in an effort to: 1.) keep the index s aggregate characteristics in line with that of the Investible Universe, 2.) reduce turnover, 3.) limit issuer concentration, and 4.) avoid less liquid issues. Key constraints include, but are not limited to: a. Long-only positions; no leverage or short positions used. b. Higher minimum amount outstanding thresholds versus Investible Universe i. $500 million for BlackRock Investment Grade Enhanced Bond Index ii. $350 million for BlackRock High Yield Defensive Bond Index 10 RRA is set at 40% 8

11 c. Deviation of Index weight comprised of bonds from a single Issuer versus issuer weight in the Investible Universe is limited as follows: i. For the BlackRock Investment Grade Enhanced Bond Index, an issuer s weight in the index cannot be more than 100 basis points ( bps ) underweight versus its weight in the investible universe or more than 50 bps overweight. ii. For the BlackRock High Yield Defensive Bond index, an issuer s weight in the index cannot be more than 200 bps underweight versus its weight in the investible universe or more than 75 bps overweight. d. Limit the deviation of Duration Times Spread ( DtS ) of the index versus the Investible Universe as follows: i. For the BlackRock Investment Grade Enhanced Bond Index, the DtS of the index cannot be less than 95% of that of the Investible Universe or more than 105%. ii. For the BlackRock High Yield Defensive Bond index, the DtS of the index cannot be less than 85% of that of the Investible Universe or more than 110%. e. Limit the deviation of the Duration of the index versus the Investible Universe as follows: i. For the BlackRock Investment Grade Enhanced Bond Index, the Duration of the index cannot be less than 100% of that of the Investible Universe or more than 110%. ii. For the BlackRock High Yield Defensive Bond index, the Duration of the index cannot be less than 100% of that of the Investible Universe or more than 105%. f. The monthly turnover is limited to less than 6% of index market value for each index on a one-way basis (buy or sell 12% in total). 11 III. Finalized Index The Indices are then constructed using the Investible Universe along with the weights computed for each bond. Only bonds in the Investible Universe as of the fixing date are eligible for inclusion in the Index. In addition to newly issued and redeemed or defaulted bonds as of the fixing date, the Investible Universe will also reflect increased issuance of existing securities, calls, tenders and repurchases. 11 This constraint may be exceeded in some months due to changes in index constituent bonds index eligibility status resulting from rating changes, maturity, calls, puts and other events. 9

12 The indices utilize BlackRock s scalable portfolio management production system to ensure reliable and accurate index calculation and maintenance. Calculation and Maintenance I. Index Calculation A. Pro-Forma Index Composition: A pro-forma index composition for each Index is made available every day for the three business days prior to month-end through month-end and reflects the index composition as of the fixing date with the current day s prices and corporate actions applied. Changes in the bond universe that occur up through the fixing day are eligible for inclusion in the pro-forma index compositions. This includes newly issued securities that are issued, but not necessarily settled, up through the fixing day. The pro-forma index compositions generated after EOD on the fixing date become the newly constructed index compositions at the open of the first calendar day of the new month. B. Bond Pricing a. Price Timing Frequency: The Indices use daily EOD (3pm EST) evaluated bid pricing from Interactive Data Corp. 12 b. Bonds are added to the Indices at the evaluated bid price plus an estimated transaction cost based on the spread of bid-offer prices from Interactive Data Corp. C. Reinvestment of cash flows: interest and principal payments earned by index components are held as cash in the index until month end. It is then reinvested in the newly constructed index composition across all components at their new respective weights at the start of the new month. D. Settlement Convention: During index rebalance, next-calendarday settlement will be assumed for all newly traded securities. E. Accrued interest: Accrued interest is calculated assuming nextcalendar-day settlement. The day-count convention applicable to the respective bond is used in calculating days of accrual. F. Return Calculation: Every day, the Index total return, price return, and coupon return are calculated. As noted, any coupon payments are simply kept as cash in the Indices until rebalance. In other words, the Indices assume no immediate reinvestment on the coupons. G. Index Level Precision: Index values are published to major market data vendors out to 4 decimal places. 12 1pm on days when markets close early; see Appendix for list of holidays and SIFMA website for current year s holiday schedule. 10

13 II. Index Maintenance and Publication A. Index Composition Changes: Bonds issued during the month as well as additions and deletions due to ratings changes are eligible for incorporation into the respective index at the next month. Similarly, changes to amounts outstanding due to tenders are not reflected until the next month s newly constructed index becomes effective. Maturities, defaults, and mandatory exchanges however, are reflected in the index intra-month. The resultant cash flows are kept in cash until the month end rebalance and reinvested in the newly constructed index composition the Indices do not assume reinvestment intra-month. B. Corporate Actions affecting index components are processed daily and incorporated into the index as per the methodology. C. Rebalancing Date: The newly constructed Indices go into effect at the open of the first calendar day of the month. The newly constructed index compositions are announced after end-of-day on the fixing date and are based on risk, default, and transaction cost analytics calculated using that day s prices. D. Weekend and Index Holiday Convention: The Indices will follow the yearly holiday calendar established by the Securities Industry and Financial Markets Association ( SIFMA ) 13. Index levels will remain unchanged on US holidays from the previous day (see Appendix for list of holidays and SIFMA website for current year holiday schedule). Interest accruals, coupon payments, and principal payments during a holiday or weekend will be incorporated into the index return calculation for the next business day. E. Weekend and Index Holiday Convention Rebalance Dates: If a month-end date or month-begin date falls on a weekend or a holiday, the index rebalance and any cash accruals are affected accordingly. a. For rebalance dates falling on a holiday or weekend, the last business day of the month will serve as the de-facto monthend date. Interest accruals, coupon payments, and principal payments through calendar month-end are incorporated into the index return calculation for the de-facto month-end date and will assume next-day settlement which will be the first business day of the next month. b. If the first calendar day of the month falls on a holiday or weekend, the newly constructed index compositions will take effect at the open of the first calendar day. Additionally, any interest accruals, coupon payments, and principal payments from the first calendar day of the month will be incorporated into the index return calculation for the first business day of the month. 13 SIFMA holiday schedule can be found on the following link: 11

14 F. Index Publication Convention: The daily total return level of the Indices are published on the Index Services LLC website and on major market data vendors. The daily holdings of the Indices will be published on the BlackRock Index Services LLC website. G. Extraordinary Events, Market Environments, and Disruptions: For circumstances that can potentially affect index production and publication, BlackRock Index Services, LLC will address on an ad-hoc basis. Solutions may include, but not be limited to, holding an index unchanged for the affected day. Index users will be kept informed through announcements and updates on the index website. III. Index Rebalance Timeline A. On the fixing date, accrued interest through the first calendar day of the next month is calculated for the current index composition as well as projected cash amounts that take into account coupon payments, calls and redemptions through month-end. Bond analytics, transaction cost penalties, and risk factors are calculated for the investible universe as of the fixing date using the current day s prices. The optimization process is run and incorporates projected cash to establish the pro-forma index composition. B. On the third-to-last and second-to-last business day of the month, the current day s prices are applied to the pro-forma index composition. Accrued interest for the pro-forma index composition is calculated through the first calendar day of the next month. C. On the last business day of the month, the current index composition is brought in line with the pro-forma index composition by adding/removing the necessary securities at their respective prices at the end of the current day. The newly rebalanced index becomes effective on the first calendar day of the next month. 12

15 Index Calculation Formulas Index Level Calculations Idx t = Idx t 1 (1 + TR t 100 ) TR t = [( EV t + CF b t BV t + CF b t 1 ) 1] 100 i i BV t = [Par t (Px t 1 i + AI t 1 ) MX i ] Idx t = Index Value on date t EV t = [Par t i (Px t i + AI t i ) MX i ] TR t = Total Return of index, in percentage, on date t BV t = Beginning dollar value of index at time t EV t = Ending dollar value of index at time t MX i = Multiplier of bond i; value that relates price units to market value units CF b t = MTD Cash flow (redemptions, coupon pmts, etc)of index as of date t Par t i = Amount of bond i in index expressed as par amount at time t Px t i = Price of bond i expressed as percentage of par at time t AI t i = Accrued interest of bond i expressed in percentage terms at time t Component Calculations Wgt t i = Weight of bond i in index at time t BR t i = Total return of bond i at time t CF t i = MTD Cash Flow of bond i at time t Wgt i t = Par t i i i (Px t 1 + AI t 1 ) MX i 100 BV t + CF b t 1 BR i t = Px t i + AI i i t + CF t 100 i i Px t 1 + AI t 1 13

16 Governance The activities of BlackRock Index Services LLC (the Index Services Group ), the administrator and provider of the Indices, are overseen by the Index Services Governance Committee ( ISGCo ). ISGCo provides oversight for activities pertaining to the calculation and dissemination of BlackRock proprietary indices, the interaction of the Index Services Group with other BlackRock business units, and any policies, procedures and business practices relating to the activities of the Index Services Group. ISGCo has two Sub-Committees: (1) Methodology and Operations ( M&O ) Sub-Committee and (2) Governance and Compliance ( G&C ) Sub-Committee with each committee meeting at least quarterly. Index Methodology Changes Any proposed changes to the index methodology are reviewed by the M&O sub-committee. The M&O sub-committee may, at its sole judgement and discretion, solicit comments through a consultation with index stakeholders on any proposed changes. Whether or not the M&O sub-committee solicits comments through a consultation will depend on the impact of the proposed changes on the index methodology and the index stakeholders. In all cases, any changes to the index methodology are made in the sole judgment and discretion of M&O sub-committee. Any proposed changes to the Index Methodology must be consistent with ensuring the Index maintains an accurate and relevant representation of the economic reality and strategy it seeks to measure. In reviewing proposed index methodology changes, the M&O sub-committee will: (1) ensure material changes meet listing requirements; and (2) report to the G&C sub-committee methodology changes. Should the M&O sub-committee determine that a change to the index methodology be advisable, and approve such change, then BlackRock Index Services Group will make the appropriate announcement through posting on its affiliated webpages and/or issuing a press release. Such announcement will contain the effective date of such amendment and may also include other details related to the pending change, including for example: Description of the situation prompting the proposed change Details of the change to the Index Methodology Confirmed changes will be announced with sufficient time for index stakeholders to make any necessary adjustments to their processes as well as any follow-on announcements they will need to make. Restatement Process In the event an index value is incorrectly calculated, the Indices will follow a prescribed process to recalculate and republish if necessary. Once an error is identified, The Index Services Group will review the circumstances surrounding the error and its impact. If the error is determined to be not significant, The Index Services Group may, at its sole judgement and discretion, decide to correct the data related to the error and recalculate the affected index values. If the error is determined to be significant, The Index Services Group may, at its sole judgement and discretion, decide to issue a restatement announcement describing the error and any associated corrections. When determining the significance of the error, The Index Services Group will take into consideration the impact to index stakeholders. 14

17 Glossary Callable Bond A bond that can be redeemed or called by the issuer on or after a specific date. Interest payments on these bonds are generally higher to compensate buyers for reinvestment risk as issuers will tend to redeem them when prevailing interest rates fall so they can reissue/refinance at a lower rate. Callable Perpetual Bond A perpetual bond that has an embedded call feature. Most perpetual bonds, which are bonds that are arranged to pay interest in perpetuity, have an embedded call whereby the issuer can redeem any time after an initial period, usually not less than five years. Common Factor An independent variable against which security returns may be regressed and can explain some portion of returns for a large set of securities within or across asset classes. Examples of a Common Factor include market capitalization, industry, price-to-book, or any other metric for which a large group of securities has a measure. Contingent Capital Securities ( CoCos ) Convertible bonds that convert to equity as a result of a given threshold in the issuer s capital structure. CoCos typically convert in situations opposite to when traditional bonds convert. Where traditional convertible bonds will typically convert when the underlying stock price is rising, CoCos are typically set up to convert when the issuer s capital structure is deteriorating. Covered Bond Bonds backed by specific public sector loans or mortgage loans. Dividend Received Deduction ( DRD ) Securities that allow the holder to deduct any associated distribution from the holder s income. EOD End-of-Day Eurodollar Bonds Bonds issued in US Dollars by an overseas company and held in an overseas institution both outside the U.S. and the issuer s country of domicile. Extendable Bonds Bonds which contain options for one or more opportunities to defer repayment of the bond s principal while continuing to make interest payments during time of deferral. Additionally, the bond holder may have the option to exchange the bond for one with a longer maturity at an equal or higher interest rate. Fixed Rate Coupon Coupon or interest payment on a bond that remains fixed at a given rate throughout the term of the bond. Fixing Date Date used to establish investible universe and associated bond data such as price, duration, convexity, etc. For the BlackRock Bond Indices, the fixing date is three business days before the last business day of the month. Index-Linked Bonds Bonds where payment of income on the principal is tied to a specific price index such as the Consumer Price Index. Inflation linked bonds Bonds where the principal to be repaid at maturity is indexed to inflation or deflation on a daily basis over the life of the bond. Issuer Company, government, government-sponsored entity, or any other entity accessing capital markets and that sells newly created bonds to raise money for funding operations. Medium Term Notes ( MTN ) Bonds that usually mature in five to 10 years from the time they are issued. They are often issued under a shelf-registration program whereby each issuance does not require the full SEC registration process to be completed. An MTN program will typically use a master set of disclosure documents as well as documents covering the selling and distribution arrangements. Optimization Process by which securities are selected for a portfolio from a larger set such that the portfolio will produce the best risk-adjusted expected return using the least amount of securities possible. 15

18 Payment-in-Kind Bond A bond that pays interest in additional bonds rather than cash. These are considered a type of deferred coupon bond and usually issued by firms in financial distress. Sometimes referred to as PIK bonds. Private Placement A bond or other security that is sold to a small number of usually large, qualified investors (Qualified Institutional Buyers ( QIBs ) for example) without being registered with the SEC. Putable Bond A bond where the holder can demand the issuer redeem on or after specific dates before maturity. The interest payments will be lower than prevailing interest rates as the option to force redemption has value to the holder. Qualified Dividend Income ( QDI ) Securities where the dividend or coupon payment distribution qualifies for taxation at the capital gains rate rather than regular income rates. Reg-S Bonds Bonds offered and sold outside the U.S. and thus not subject to SEC registration requirements. As such, offering participants (the issuer, banks involved in offer or their affiliates) cannot engage in direct selling efforts nor can offers and sales be made to U.S. persons, including U.S. persons physically located outside the U.S. Regular Settlement The process through which securities and required funds are exchanged. This involves the buyer s and seller s brokers, custodians, banks, and central clearing organizations. Sometimes referred to as Regular Way settlement and takes three days from the day the securities are traded until the securities and funds are in the respective investor s accounts. Sinking Bonds Often referred to as Sinkable Bonds or Sinking Fund Bonds. These are bonds backed by funds set aside to ensure principal and interest payments are made as promised and often accompanied by call schedules covering the life of the bond. Specific Risk An element of risk unique to a specific security or company. This is usually exhibited as the unexplained variation in a regression. For example the difference between the actual, observed returns on a given security and the returns predicted by a best-fit regression model. Step-up Coupon Coupon or interest payment on a bond that can increase by a given increment at some point or points over the life of the bond. Subordinated Issues Bonds or notes that rank below other debt in terms of claims on the issuers assets in the event of a bankruptcy or liquidation. Toggle Notes Notes or bonds where the issuer has the option of deferring a coupon payment, but only at a higher interest rate. All deferred payments must be settled by the bond s maturity. Sometimes referred to as toggles. Transaction Costs costs associated with buying or selling a bond. For the calculation of Index returns, it is represented by an estimate based on the difference between the bid and offer price. Zero Coupon Bonds that do not have a coupon or make periodic interest payments. They sell at a discount to par value and pay out par value at maturity. The discount equates to interest paid by the issuer and is amortized over the holding period of the bond. 144(a) Bonds Privately placed bonds that can trade under SEC rule 144(a). This rule allows privately placed bonds to trade among QIBs without the minimum two-year holding period assuming other provisions are met. 16

19 Appendix A Holiday Schedule The Indices will follow the SIFMA Recommended Holiday Schedule for Financial Markets. Below are the days when the Indices are typically not calculated and the index values from the previous day are carried over. Depending on what date of the month and/or day of the week a holiday falls, it may or may not be observed. Also, a holiday may have an early closing day just before or after the holiday. Please see the SIMFA website for exact days and dates for the current year. New Year s Day Martin Luther King Day Presidents Day Good Friday Memorial Day U.S. Independence Day Labor Day Columbus Day Veterans Day Thanksgiving Day Christmas Day 17

20 The BlackRock Investment Grade Enhanced Bond Index and the BlackRock High Yield Defensive Bond index The BlackRock Indices ) commenced ongoing calculation on [DATE]. BlackRock Index Services, LLC ( Index Services ), a subsidiary of BlackRock, Inc. designs, sponsors and publishes the BlackRock Indices for use in portfolio benchmarking, and portfolio management. The BlackRock Indices, allocations and data are subject to change. The BlackRock Indices do not guarantee future income or protect against loss of principal. There can be no assurance that an investment strategy based on the BlackRock Indices will be successful. Indices are unmanaged and one cannot invest directly in an index. Exposure to an asset class or trading strategy or other category represented by an index is only available through investable instruments (if any) based on that index. Index Services does not issue, sponsor, endorse, market, offer, review or otherwise express any opinion regarding any fund, exchange traded fund, derivative or other security, investment, financial product or trading strategy that is based on, linked to or seeks to provide an investment return related to the performance of any Index Services' index (collectively, Index Linked Investments ). Index Services makes no assurance that any Index Linked Investments will accurately track index performance or provide positive investment returns. Index Services is not an investment adviser or fiduciary and makes no representation regarding the advisability of investing in any Index Linked Investments. Index returns do not represent the results of actual trading of investable assets/securities. Index Services maintains and calculates indices, but does not manage actual assets. Index returns do not reflect payment of any sales charges or fees an investor may pay to purchase the securities underlying the index or Index Linked Investments. The imposition of these fees and charges would cause the performance of an Index Linked Investment to be different than the Index Services index performance. This information is the property of BlackRock, Inc. and /or its subsidiaries (collectively, "BlackRock"). It is provided for informational purposes only. Although BlackRock shall obtain information from sources that BlackRock considers reliable, none of the BlackRock, its subsidiaries or any other third party involved in, or related to, compiling, computing or creating the information (collectively, the "BlackRock Parties") guarantees the accuracy and/or the completeness of any of this information. BlackRock does not guarantee that any of the BlackRock Indices will not deviate from its stated methodology. All BlackRock indices and data are the exclusive property of BlackRock and may not be used in any way without the express written permission of BlackRock. Reliance upon information in this material is at the sole discretion of the reader. The information may not be used to verify or correct other data, to create indices, risk models, or analytics, or in connection with issuing, offering, sponsoring, managing or marketing any securities, portfolios, financial products or other investment vehicles. Historical data and analysis should not be taken as an indication or guarantee of any future performance, analysis, forecast or prediction. None of the information or BlackRock index or other product or service referenced herein constitutes an offer to buy or sell, or a promotion or recommendation of, any security, financial instrument or product or trading strategy. Further, none of the information or any BlackRock index is 18

21 intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. The information is provided "as is" and the user of the Information assumes the entire risk of any use it may make or permit to be made of the information. NONE OF BLACKROCK PARTIES MAKES ANY WARRANTIES OR REPRESENTATIONS AND, TO THE MAXIMUM EXTENT PERMITTED BY LAW, EACH BLACKROCK PARTY HEREBY EXPRESSLY DISCLAIMS ALL IMPLIED WARRANTIES, INCLUDING WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE. WITHOUT LIMITING ANY OF THE FOREGOING AND TO THE MAXIMUM EXTENT PERMITTED BY LAW, IN NO EVENT SHALL ANY OF THE BLACKROCK PARTIES HAVE ANY LIABILITY REGARDING ANY OF THE INFORMATION FOR ANY DIRECT, INDIRECT, SPECIAL, PUNITIVE, CONSEQUENTIAL (INCLUDING LOST PROFITS) OR ANY OTHER DAMAGES EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES. The foregoing shall not exclude or limit any liability that may not by applicable law be excluded or limited BlackRock, Inc. All rights reserved. BLACKROCK, BlackRock Investment Grade Enhanced Bond Index and BlackRock High Yield Defensive Bond Index are registered and unregistered trademarks of BlackRock, Inc. or its subsidiaries. All other marks are the property of their respective owners. For additional information, usage and licensing opportunities for the BlackRock Indices, please contact BLKIndexServices@blackrock.com. 19