DECEMBER 31, 2017 ANNUAL REPORT. BlackRock Funds SM BlackRock Exchange Portfolio. Not FDIC Insured May Lose Value No Bank Guarantee

Transcription

1 DECEMBER 31, 2017 ANNUAL REPORT BlackRock Funds SM BlackRock Exchange Portfolio Not FDIC Insured May Lose Value No Bank Guarantee

2 The Markets in Review Dear Shareholder, In the 12 months ended December 31, 2017, risk assets, such as stocks and high-yield bonds, continued to deliver strong performance. The equity market advanced, month after month, despite geopolitical uncertainty and relatively high valuations, while bond returns were constrained by higher interest rates. Rising interest rates worked against high-quality assets with more interest rate sensitivity. Consequently, longer-term U.S. Treasuries posted modest returns, as rising energy prices, modest wage increases, and steady job growth led to expectations of higher inflation and interest rate increases by the U.S. Federal Reserve (the Fed ). The market s performance reflected reflationary expectations early in the reporting period, as investors began to sense that a global recovery was afoot. Thereafter, many countries throughout the world experienced sustained and synchronized growth for the first time since the financial crisis. Growth rates and inflation are still relatively low, but they are finally rising together. The Fed responded to these positive developments by increasing short-term interest rates three times and setting expectations for additional interest rate increases. The Fed also began reducing the vast balance sheet reserves that had accumulated in the wake of the financial crisis. In October 2017, the Fed reduced its $4.5 trillion balance sheet by only $10 billion, while setting expectations for additional modest reductions and rate hikes in By contrast, the European Central Bank ( ECB ) and the Bank of Japan ( BoJ ) both continued to expand their balance sheets despite nascent signs of sustained economic growth. The Eurozone and Japan are both approaching the limits of central banks ownership share of national debt, which is a structural pressure point that limits their capacity to deliver additional monetary stimulus. In October 2017, the ECB announced plans to cut the amount of its bond purchases in half for 2018, while the BoJ reiterated its commitment to economic stimulus until the inflation rate rises to its target of 2%. Emerging market growth also stabilized, as accelerating growth in China, the second largest economy in the world and the most influential of all developing economies, improved the outlook for corporate profits and economic growth across most developing nations. Chinese demand for commodities and other raw materials allayed concerns about the country s banking system, leading to rising equity prices and foreign investment flows. While escalating tensions between the United States and North Korea and our nation s divided politics are concerning, benign credit conditions, modest inflation, solid corporate earnings, and the positive outlook for growth in the world s largest economies have kept markets relatively tranquil. Rising consumer confidence and improving business sentiment are driving momentum for the U.S. economy. If the Fed maintains a measured pace of stimulus reduction, to the extent that inflation rises, it s likely to be accompanied by rising real growth and higher wages. That could lead to a favorable combination of moderately higher inflation, steadily rising interest rates, and improving growth in Further fueling optimism, Congress passed a sweeping tax reform bill in December The U.S. tax overhaul is likely to accentuate the reflationary themes already in place, including faster growth and rising interest rates. Changing the corporate tax rate to a flat 21% will create many winners and losers among highand-low tax companies, while the windfall from lower taxes could boost business and consumer spending. In this environment, investors need to think globally, extend their scope across a broad array of asset classes, and be nimble as market conditions change. We encourage you to talk with your financial advisor and visit blackrock.com for further insight about investing in today s markets. Sincerely, Rob Kapito President, BlackRock Advisors, LLC Total Returns as of December 31, 2017 U.S. large cap equities (S&P 500 Index) U.S. small cap equities (Russell 2000 Index) International equities (MSCI Europe, Australasia, Far East Index) Emerging market equities (MSCI Emerging Markets Index) 3-month Treasury bill (ICE BofAML 3-Month U.S. Treasury Bill Index) U.S. Treasury securities (ICE BofAML 10- Year U.S. Treasury Index) U.S. investment grade bonds (Bloomberg Barclays U.S. Aggregate Bond Index) Tax-exempt municipal bonds (S&P Municipal Bond Index) U.S. high yield bonds (Bloomberg Barclays U.S. Corporate High Yield 2% Issuer Capped Index) 6-month 12-month 11.42% 21.83% (0.01) Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. Rob Kapito President, BlackRock Advisors, LLC 2 T HIS P AGE I S N OT P ART O F Y OUR F UND R EPORT

3 Table of Contents The Markets in Review... 2 Annual Report: Fund Summary... 4 About Fund Performance... 6 Disclosure of Expenses... 6 Financial Statements: Schedule of Investments... 7 Statement of Assets and Liabilities... 8 Statement of Operations... 9 Statements of Changes in Net Assets Financial Highlights Notes to Financial Statements Report of Independent Registered Public Accounting Firm Important Tax Information Trustee and Officer Information Additional Information Page T ABLE OF C ONTENTS 3

4 Fund Summary as of December 31, 2017 BlackRock Exchange Portfolio Investment Objective BlackRock Exchange Portfolio's (the Fund ) investment objective is long-term growth of capital and consequent long-term growth of income. Portfolio Management Commentary How did the Fund perform? For the 12-month period ended December 31, 2017, the Fund underperformed its benchmark, the S&P 500 Index. What factors influenced performance? In sector terms, industrials and energy were the prime detractors from relative performance. Portfolio holding General Electric Co. had the most negative impact in industrials as shares declined more than 40% in the period. Aerospace & defense also weighed in the sector. Negative performance in energy was driven by weakness in equipment & services holding Schlumberger Ltd., which was the largest single detractor in the portfolio during the 12 months. Elsewhere, an underweight to information technology ( IT ) hindered the Fund s performance as the sector led market returns over the year with a gain near 40%. Consumer discretionary was a drag as well, primarily due to weakness in multiline retail holding Target Corp. and lack of exposure to internet & direct marketing retail. On the positive side, financials was the top contributor to relative performance, with strength notable among consumer finance and bank holdings. American Express Co. and JPMorgan Chase & Co. were standouts in the sector. The Fund s underweight to telecommunication services, real estate and utilities also aided results. In stock specifics, software holding Microsoft Corp. was the top portfolio contributor in the reporting period. Describe recent portfolio activity. During the 12-month period, the Fund s weighting increased within the IT sector, specifically software. Financials and health care saw increases as well. By contrast, the Fund s exposure to consumer discretionary and energy decreased, largely with respect to multiline retail and energy equipment & services. The weighting in telecommunication services also declined. Describe portfolio positioning at period end. As of period end, the Fund s largest sector overweight relative to the S&P 500 Index was in financials, followed by health care and consumer staples. The largest underweights were in consumer discretionary and IT. The views expressed reflect the opinions of BlackRock as of the date of this report and are subject to change based on changes in market, economic or other conditions. These views are not intended to be a forecast of future events and are no guarantee of future results. Portfolio Information TEN LARGEST HOLDINGS SECTOR ALLOCATION Security Percent of Net Assets Sector Percent of Net Assets Microsoft Corp % Berkshire Hathaway, Inc., Class B General Dynamics Corp JPMorgan Chase & Co Johnson & Johnson... 7 American Express Co Schlumberger Ltd Pfizer, Inc Exxon Mobil Corp Novartis AG - ADR... 3 Financials % Health Care Information Technology Consumer Staples Industrials Energy Short-Term Securities For Fund compliance purposes, the Fund's sector classifications refer to one or more of the sector sub-classifications used by one or more widely recognized market indexes or ratings group indexes, and/or as defined by the investment adviser. These definitions may not apply for purposes of this report, which may combine such sector sub-classifications for reporting ease BLACKR OCK A NNUAL R EPORT TO S HAREHOLDERS

5 Fund Summary as of December 31, 2017 (continued) BlackRock Exchange Portfolio $25,000 TOTAL RETURN BASED ON A $10,000 INVESTMENT $22,608 20,000 $19,242 15,000 10,000 5,000 Dec 07 Dec 08 Dec 09 Dec 10 Dec 11 Dec 12 Dec 13 Dec 14 Dec 15 Dec 16 Dec 17 BlackRock Shares (a),(b) S&P 500 Index (c) (a) Assuming transaction costs and other operating expenses, including investment advisory fees and administration fees, if any. (b) Under normal circumstances, the Fund invests largely in a diversified and supervised portfolio of common stocks or convertible securities. Shares of the Fund are not currently available for purchase. (c) An unmanaged index that covers 500 leading companies and captures approximately 80% coverage of available market capitalization. Performance Summary for the Period Ended December 31, Month Average Annual Total Returns (d) Total Returns 1 Year 5 Years 10 Years BlackRock Shares % 15.27% 12.52% 6.76% S&P 500 Index (d) See About Fund Performance on page 7 for a detailed description of performance related information. Past performance is not indicative of future results. Performance results may include adjustments made for financial reporting purposes in accordance with U.S. generally accepted accounting principles. Expense Example Beginning Account Value (07/01/17) Actual Ending Account Value (12/31/17) Beginning Account Value (07/01/17) Hypothetical (b) Ending Account Value (12/31/17) Annualized Expense Ratio (c) Expenses Paid Expenses Paid During the Period (a) During the Period (a) BlackRock Shares... $1, $1, $4.95 $1, $1, $ % (a) For BlackRock Shares of the Fund, expenses are equal to the annualized expense ratio multiplied by the average account value over the period, multiplied by 184/365 (to reflect the onehalf year period shown). (b) Hypothetical 5% annual return before expenses is calculated by prorating the number of days in the most recent fiscal half year divided by 365. (c) Includes federal income taxes. Excluding such tax expense, the annualized expense ratio would have been 0.62%. See Disclosure of Expenses on page 7 for further information on how expenses were calculated. F UND S UMMARY 5

6 About Fund Performance BlackRock Exchange Portfolio BlackRock Shares are not subject to any sales charge. These shares bear no ongoing distribution or service fees and are not currently available for purchase. These shares are only available through distribution reinvestments by current holders. Performance information reflects past performance and does not guarantee future results. Current performance may be lower or higher than the performance data quoted. Refer to to obtain performance data current to the most recent month end. Performance results do not reflect the deduction of taxes that a shareholder would pay on fund distributions or the redemption of fund shares. Figures shown in the performance table on the previous page assume reinvestment of all distributions, if any, at net asset value ( NAV ) on the ex-dividend date. Investment return and principal value of shares will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. BlackRock Advisors, LLC (the Manager ), the Fund's investment adviser, has contractually agreed to waive and/or reimburse a portion of the Fund s expenses. Without such waiver and/or reimbursement, the Fund's performance would have been lower. The Manager is under no obligation to continue waiving and/or reimbursing its fees after the applicable termination date of such agreement. See Note 5 of the Notes to Financial Statements for additional information on waivers and/or reimbursements. Disclosure of Expenses Shareholders of the Fund may incur the following charges: (a) transactional expenses, such as sales charges; and (b) operating expenses, including investment advisory fees, administration fees and other fund expenses. The expense example on the previous page (which is based on a hypothetical investment of $1,000 invested on July 1, 2017 and held through December 31, 2017) is intended to assist shareholders both in calculating expenses based on an investment in the Fund and in comparing these expenses with similar costs of investing in other mutual funds. The expense example provides information about actual account values and actual expenses. In order to estimate the expenses a shareholder paid during the period covered by this report, shareholders can divide their account value by $1,000 and then multiply the result by the number under the heading entitled Expenses Paid During the Period. The expense example also provides information about hypothetical account values and hypothetical expenses based on the Fund s actual expense ratio and an assumed rate of return of 5% per year before expenses. In order to assist shareholders in comparing the ongoing expenses of investing in the Fund and other funds, compare the 5% hypothetical example with the 5% hypothetical examples that appear in shareholder reports of other funds. The expenses shown in the expense example are intended to highlight shareholders ongoing costs only and do not reflect transactional expenses, such as sales charges, if any. Therefore, the hypothetical example is useful in comparing ongoing expenses only, and will not help shareholders determine the relative total expenses of owning different funds. If these transactional expenses were included, shareholder expenses would have been higher BLACKR OCK A NNUAL R EPORT TO S HAREHOLDERS

7 Schedule of Investments December 31, 2017 BlackRock Exchange Portfolio Security Shares Value Common Stocks 99.5% Aerospace & Defense 9.8% General Dynamics Corp ,872 $ 17,063,759 Banks 7.7% JPMorgan Chase & Co ,728 13,338,412 Consumer Finance 6.1% American Express Co ,706 10,497,663 Diversified Financial Services 14.5% Berkshire Hathaway, Inc., Class B (a) ,112 25,196,141 Electronic Equipment, Instruments & Components 0.4% Keysight Technologies, Inc. (a)... 14, ,758 Energy Equipment & Services 4.4% Schlumberger Ltd ,961 7,612,442 Food & Staples Retailing 1.6% Wal-Mart Stores, Inc ,424 2,708,120 Food Products 2.1% Kraft Heinz Co ,761 1,381,095 Mondelez International, Inc., Class A... 53,285 2,280,598 3,661,693 Household Products 3.3% Procter & Gamble Co ,908 5,688,107 Industrial Conglomerates 2.0% General Electric Co ,970 3,402,227 IT Services 2.6% Visa, Inc., Class A... 39,748 4,532,067 Oil, Gas & Consumable Fuels 4.8% BPPLC-ADR... 31,546 1,325,878 Exxon Mobil Corp ,691 6,999,915 8,325,793 Security Shares Value Pharmaceuticals 18.8% AstraZeneca PLC - ADR ,000 $ 4,441,600 Johnson & Johnson... 80,592 11,260,314 Merck & Co., Inc ,117 3,832,944 Novartis AG - ADR ,681 5,766,457 Pfizer, Inc ,166 7,394,893 32,696,208 Software 15.2% Microsoft Corp ,263 26,368,817 Tobacco 6.2% Altria Group, Inc ,000 5,498,570 Philip Morris International, Inc ,136 5,296,868 10,795,438 Total Common Stocks 99.5% (Cost: $20,153,137) ,505,645 Total Long-Term Investments 99.5% (Cost: $20,153,137) ,505,645 Short-Term Securities 0.6% BlackRock Liquidity Funds, T-Fund, Institutional Class, 1.17% (b)(c)... 1,034,358 1,034,358 Total Short-Term Investments 0.6% (Cost: $1,034,358).... 1,034,358 Total Investments 100.1% (Cost: $21,187,495) ,540,003 Liabilities in Excess of Other Assets (0.1)%... (104,584) Net Assets 100.0%.... $ 173,435,419 Notes to Schedule of Investments (a) Non-income producing security. (b) Annualized 7-day yield as of period end. (c) During the period ended December 31, 2017, investments in issuers considered to be an affiliate of the Fund for purposes of Section 2(a)(3) of the Investment Company Act of 1940, as amended, were as follows: Net Realized Gain Change in Unrealized Appreciation (Depreciation) Affiliate Shares Held at 12/31/16 Net Activity Shares Held at 12/31/17 Value at 12/31/17 Income (Loss) BlackRock Liquidity Funds, T-Fund, Institutional Class , ,455 1,034,358 $1,034,358 $6,121 $ $ Portfolio Abbreviation ADR American Depositary Receipts For Fund compliance purposes, the Fund's industry classifications refer to one or more of the industry sub-classifications used by one or more widely recognized market indexes or ratings group indexes, and/or as defined by the investment adviser. These definitions may not apply for purposes of this report, which may combine such industry sub-classifications for reporting ease. Fair Value Hierarchy as of Period End Various inputs are used in determining the fair value of investments. For information about the Fund's policy regarding valuation of investments, refer to the Notes to Financial Statements. The following table summarizes the Fund s investments categorized in the disclosure hierarchy: Level 1 Level 2 Level 3 Total Assets Investments Long-Term Investments (a)... $ 172,505,645 $ $ $ 172,505,645 Short-Term Securities.... 1,034,358 1,034,358 $ 173,540,003 $ $ $ 173,540,003 (a) See above Schedule of Investments for values in each industry. During the year ended December 31, 2017, there were no transfers between levels. See notes to financial statements. S CHEDULE OF I NVESTMENTS 7

8 Statement of Assets and Liabilities December 31, 2017 BlackRock Exchange Portfolio ASSETS Investments at value unaffiliated (cost $20,153,137)... $ 172,505,645 Investments at value affiliated (cost $1,034,358) ,034,358 Receivables: Dividends affiliated.... 1,023 Dividends unaffiliated ,076 From the Manager Prepaid expenses Total assets ,902,714 LIABILITIES Bank overdraft... 11,791 Payables: Federal income tax ,722 Capital shares redeemed ,181 Investment advisory fees... 58,964 Officer's and Trustees' fees.... 2,468 Other accrued expenses... 18,529 Other affiliates... 6,583 Printing fees... 6,518 Professional fees... 35,539 Total liabilities ,295 NET ASSETS... $ 173,435,419 NET ASSETS CONSIST OF Paid-in capital... $ 21,045,687 Undistributed net investment income... 37,224 Net unrealized appreciation (depreciation) ,352,508 NET ASSETS... $ 173,435,419 NET ASSET VALUE BlackRock Shares Based on net assets of $173,435,419 and 165,112 shares outstanding, unlimited shares authorized, $0.001 par value $ 1, See notes to financial statements BLACKR OCK A NNUAL R EPORT TO S HAREHOLDERS

9 Statement of Operations Year Ended December 31, 2017 BlackRock Exchange Portfolio INVESTMENT INCOME Dividends unaffiliated... $ 4,081,852 Dividends affiliated.... 6,121 Foreign taxes withheld... (85,306) Total investment income... 4,002,667 EXPENSES Investment advisory ,535 Administration ,692 Professional... 68,899 Accounting services ,291 Printing... 29,516 Trustees and Officer ,674 Custodian... 11,073 Transfer agent... 8,026 Miscellaneous... 9,600 Total expenses excluding federal income tax.... 1,157,306 Federal income tax ,722 Total expenses... 1,435,028 Less: Fees waived by the Manager... (36,218) Administration fees waived... (34,782) Transfer agent fees waived and/or reimbursed... (8,020) Total expenses after fees waived and/or reimbursed... 1,356,008 Net investment income.... 2,646,659 NET REALIZED AND UNREALIZED GAIN Net realized gain from: Investments ,447 In-kind redemptions (a)... 16,923,178 Net change in unrealized appreciation (depreciation) on investments.... 4,336,897 Net realized and unrealized gain... 22,207,522 NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS..... $ 24,854,181 (a) See Note 2 of the Notes to Financial Statements. F INANCIAL S TATEMENTS 9

10 Statements of Changes in Net Assets BlackRock Exchange Portfolio Year Ended December 31, INCREASE (DECREASE) IN NET ASSETS: OPERATIONS Net investment income... $ 2,646,659 $ 3,399,659 Net realized gain from investment transactions , Net realized gain from in-kind redemption transactions... 16,923,178 18,298,659 Net change in unrealized appreciation... 4,336, ,043 Net increase in net assets resulting from operations... 24,854,181 22,240,372 DISTRIBUTIONS TO SHAREHOLDERS (a) From net investment income... (2,927,301) (3,403,208) CAPITAL SHARE TRANSACTIONS Shares issued in reinvestment of distributions , ,925 Shares redeemed... (20,982,596) (21,666,697) Net decrease in net assets derived from capital share transactions.... (20,344,833) (20,748,772) NET ASSETS Total increase (decrease) in net assets ,582,047 (1,911,608) Beginning of year ,853, ,764,980 End of year... $ 173,435,419 $ 171,853,372 Undistributed net investment income... $ 37,224 $ 40,144 (a) Distributions for annual periods determined in accordance with U.S. federal income tax regulations. See notes to financial statements BLACKR OCK A NNUAL R EPORT TO S HAREHOLDERS

11 Financial Highlights (For a share outstanding throughout each period) BlackRock Exchange Portfolio Year Ended December 31, Net asset value, beginning of year... $ $ $ $ $ Net investment income (a) Net realized and unrealized gain (loss) (35.82) Net increase (decrease) from investment operations (23.00) Distributions: (b) From net investment income... (17.50) (18.09) (16.10) (21.15) (13.33) From net realized gain.... (0.09) (0.02) Total distributions... (17.50) (18.09) (16.10) (21.24) (13.35) Net asset value, end of year... $ 1, $ $ $ $ Total Return: (c) Based on net asset value (d) % 13.82% (2.65)% 10.27% 28.07% Ratios to Average Net Assets: Total expenses % 0.65% 1.04% 1.12% 1.12% Total expenses after fees waived and/or reimbursed (e) % 0.62% 1.00% 1.08% 1.07% Net investment income % 1.97% 1.50% 1.86% 1.40% Supplemental Data: Net assets, end of year (000)... $ 173,435 $ 171,853 $ 173,765 $ 185,338 $ 183,769 Portfolio turnover rate... 2% (a) Based on average shares outstanding. (b) Distributions for annual periods determined in accordance with U.S. federal income tax regulations. (c) Where applicable, assumes the reinvestment of distributions. (d) Includes payment received from a settlement of litigation which impacted the Fund s total return. Excluding the payment from a settlement of litigation, the Fund s total return is as follows: Year Ended December 31, Total return % 28.06% (e) Includes excise tax and/or U.S. federal income taxes. Excluding such tax expense, total expenses after fees waived and/or reimbursed and paid indirectly would have been as follows: Year Ended December 31, % 0.62% 0.62% 0.62% See notes to financial statements. F INANCIAL H IGHLIGHTS 11

12 Notes to Financial Statements 1. ORGANIZATION BlackRock Funds SM (the Trust ) is registered under the Investment Company Act of 1940, as amended (the 1940 Act ), as an open-end management investment company. The Trust is organized as a Massachusetts business trust. These financial statements relate to one series of the Trust, BlackRock Exchange Portfolio (the Fund ). The Fund is classified as diversified. The Fund, together with certain other registered investment companies advised by BlackRock Advisors, LLC (the Manager ) or its affiliates, is included in a complex of open-end funds referred to as the Equity-Liquidity Complex. 2. SIGNIFICANT ACCOUNTING POLICIES The financial statements are prepared in conformity with accounting principles generally accepted in the United States of America ( U.S. GAAP ), which may require management to make estimates and assumptions that affect the reported amounts of assets and liabilities in the financial statements, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of increases and decreases in net assets from operations during the reporting period. Actual results could differ from those estimates. The Fund is considered an investment company under U.S. GAAP and follows the accounting and reporting guidance applicable to investment companies. Below is a summary of significant accounting policies: Investment Transactions and Income Recognition: For financial reporting purposes, investment transactions are recorded on the dates the transactions are entered into (the trade dates ). Realized gains and losses on investment transactions are determined on the identified cost basis. Dividend income is recorded on the ex-dividend date. Dividends from foreign securities where the ex-dividend date may have passed are subsequently recorded when the Fund is informed of the ex-dividend date. Under the applicable foreign tax laws, a withholding tax at various rates may be imposed on capital gains, dividends and interest. Upon notification from issuers, some of the dividend income received from a real estate investment trust may be redesignated as a reduction of cost of the related investment and/or realized gain. In-Kind Redemptions: The Fund transferred securities and cash to shareholders in connection with an in-kind redemption transaction. For financial reporting purposes, these transactions were treated as sales of securities and the resulting gains and losses were recognized based on the market value of the securities on the date of the redemption. For the year ended December 31, 2017, the Fund had in-kind redemptions of $19,272,453. For tax purposes, no gains or losses were recognized. Net gains and losses resulting from such in-kind redemptions are shown in the Statement of Operations. Distributions: Distributions paid by the Fund are recorded on the ex-dividend date. The character and timing of distributions are determined in accordance with U.S. federal income tax regulations, which may differ from U.S. GAAP. The Fund s current practice is to retain long-term capital gains, if any, and to pay U.S. federal taxes thereon at corporate tax rates on behalf of the shareholders. For U.S. federal income tax purposes, shareholders will be required to include their proportionate share of the retained capital gains in income and are entitled to report a credit for their share of the tax paid by the Fund. Indemnifications: In the normal course of business, the Fund enters into contracts that contain a variety of representations that provide general indemnification. The Fund s maximum exposure under these arrangements is unknown because it involves future potential claims against the Fund, which cannot be predicted with any certainty. Other: Expenses directly related to the Fund are charged to the Fund. Other operating expenses shared by several funds, including other funds managed by the Manager, are prorated among those funds on the basis of relative net assets or other appropriate methods. The Fund has an arrangement with its custodian whereby credits are earned on uninvested cash balances, which could be used to reduce custody fees and/or overdraft charges. The Fund may incur charges on certain uninvested cash balances and overdrafts, subject to certain conditions. 3. INVESTMENT VALUATION AND FAIR VALUE MEASUREMENTS Investment Valuation Policies: The Fund's investments are valued at fair value (also referred to as market value within the financial statements) as of the close of trading on the New York Stock Exchange ( NYSE ) (generally 4:00 p.m., Eastern time) (or if the reporting date falls on a day the NYSE is closed, investments are valued at fair value as of the period end). U.S. GAAP defines fair value as the price the Fund would receive to sell an asset or pay to transfer a liability in an orderly transaction between market participants at the measurement date. The Fund determines the fair values of its financial instruments using various independent dealers or pricing services under policies approved by the Board of Trustees of the Trust (the Board ). The BlackRock Global Valuation Methodologies Committee (the Global Valuation Committee ) is the committee formed by management to develop global pricing policies and procedures and to oversee the pricing function for all financial instruments. Fair Value Inputs and Methodologies: The following methods and inputs are used to establish the fair value of the Fund s assets and liabilities: Equity investments traded on a recognized securities exchange are valued at the official closing price each day, if available. For equity investments traded on more than one exchange, the official closing price on the exchange where the stock is primarily traded is used. Equity investments traded on a recognized exchange for which there were no sales on that day may be valued at the last available bid (long positions) or ask (short positions) price. Investments in open-end U.S. mutual funds are valued at net asset value ( NAV ) each business day. If events (e.g., a company announcement, market volatility or a natural disaster) occur that are expected to materially affect the value of such investments, or in the event that the application of these methods of valuation results in a price for an investment that is deemed not to be representative of the market value of such investment, or if a price is not available, the investment will be valued by the Global Valuation Committee, or its delegate, in accordance with a policy approved by the Board as reflecting fair value ( Fair Valued Investments ). The fair valuation approaches that may be used by the Global Valuation Committee will include market approach, income approach and cost approach. Valuation techniques such as discounted cash flow, use of market comparables and matrix pricing are types of valuation approaches and are typically used in determining fair value. When determining the price for Fair Valued Investments, the Global Valuation Committee, or its delegate, seeks to determine the price that the BLACKR OCK A NNUAL R EPORT TO S HAREHOLDERS

13 Notes to Financial Statements (continued) Fund might reasonably expect to receive or pay from the current sale or purchase of that asset or liability in an arm s-length transaction. Fair value determinations shall be based upon all available factors that the Global Valuation Committee, or its delegate, deems relevant and consistent with the principles of fair value measurement. The pricing of all Fair Valued Investments is subsequently reported to the Board or a committee thereof on a quarterly basis. Fair Value Hierarchy: Various inputs are used in determining the fair value of investments. These inputs to valuation techniques are categorized into a fair value hierarchy consisting of three broad levels for financial statement purposes as follows: Level 1 - Unadjusted price quotations in active markets/exchanges for identical assets or liabilities that the Fund has the ability to access Level 2 - Other observable inputs (including, but not limited to, quoted prices for similar assets or liabilities in markets that are active, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the assets or liabilities (such as interest rates, yield curves, volatilities, prepayment speeds, loss severities, credit risks and default rates) or other market corroborated inputs) Level 3 - Unobservable inputs based on the best information available in the circumstances, to the extent observable inputs are not available (including the Fund s own assumptions used in determining the fair value of investments) The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Accordingly, the degree of judgment exercised in determining fair value is greatest for instruments categorized in Level 3. The inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the fair value hierarchy classification is determined based on the lowest level input that is significant to the fair value measurement in its entirety. Investments classified within Level 3 have significant unobservable inputs used by the Global Valuation Committee in determining the price for Fair Valued Investments. Level 3 investments include equity or debt issued by privately held companies. There may not be a secondary market, and/or there are a limited number of investors. Level 3 investments may also be adjusted to reflect illiquidity and/or nontransferability, with the amount of such discount estimated by the Global Valuation Committee in the absence of market information. Changes in valuation techniques may result in transfers into or out of an assigned level within the hierarchy. In accordance with the Fund s policy, transfers between different levels of the fair value hierarchy are deemed to have occurred as of the beginning of the reporting period. The categorization of a value determined for investments is based on the pricing transparency of the investments and is not necessarily an indication of the risks associated with investing in those securities. 4. SECURITIES AND OTHER INVESTMENTS Securities Lending: The Fund may lend its securities to approved borrowers, such as brokers, dealers and other financial institutions. The borrower pledges and maintains with the Fund collateral consisting of cash, an irrevocable letter of credit issued by a bank, or securities issued or guaranteed by the U.S. Government. The initial collateral received by the Fund is required to have a value of at least 102% of the current value of the loaned securities for securities traded on U.S. exchanges and a value of at least 105% for all other securities. The collateral is maintained thereafter at a value equal to at least 100% of the current market value of the securities on loan. The market value of the loaned securities is determined at the close of each business day of the Fund and any additional required collateral is delivered to the Fund, or excess collateral returned by the Fund, on the next business day. During the term of the loan, the Fund is entitled to all distributions made on or in respect of the loaned securities but does not receive interest income on securities received as collateral. Loans of securities are terminable at any time and the borrower, after notice, is required to return borrowed securities within the standard time period for settlement of securities transactions. The market value of any securities on loan, all of which were classified as common stocks in the Fund s Schedule of Investments, and the value of any related collateral are shown separately in the Statement of Assets and Liabilities as a component of investments at value-unaffiliated, and collateral on securities loaned at value, respectively. As of period end, any securities on loan were collateralized by cash and/or U.S. Government obligations. Cash collateral invested by the securities lending agent, BlackRock Investment Management, LLC ( BIM ), if any, is disclosed in the Schedule of Investments. Securities lending transactions are entered into by the Fund under Master Securities Lending Agreements (each, an MSLA ), which provide the right, in the event of default (including bankruptcy or insolvency), for the non-defaulting party to liquidate the collateral and calculate a net exposure to the defaulting party or request additional collateral. In the event that a borrower defaults, the Fund, as lender, would offset the market value of the collateral received against the market value of the securities loaned. When the value of the collateral is greater than that of the market value of the securities loaned, the lender is left with a net amount payable to the defaulting party. However, bankruptcy or insolvency laws of a particular jurisdiction may impose restrictions on or prohibitions against such a right of offset in the event of an MSLA counterparty s bankruptcy or insolvency. Under the MSLA, absent an event of default, the borrower can resell or re-pledge the loaned securities, and the Fund can reinvest cash collateral received in connection with loaned securities. Upon an event of default, the parties obligations to return the securities or collateral to the other party are extinguished, and the parties can resell or re-pledge the loaned securities or the collateral received in connection with the loaned securities in order to satisfy the defaulting party s net payment obligation for all transactions under the MSLA. The defaulting party remains liable for any deficiency. The risks of securities lending include the risk that the borrower may not provide additional collateral when required or may not return the securities when due. To mitigate these risks, the Fund benefits from a borrower default indemnity provided by BIM. BIM s indemnity allows for full replacement of the securities loaned if the collateral received does not cover the value on the securities loaned in the event of borrower default. The Fund could incur a loss if the value of an investment purchased with cash collateral falls below the market value of loaned securities or if the value of an investment purchased with cash collateral falls below the value of the original cash collateral received. N OTES TO F INANCIAL S TATEMENTS 13

14 Notes to Financial Statements (continued) 5. INVESTMENT ADVISORY AGREEMENT AND OTHER TRANSACTIONS WITH AFFILIATES The PNC Financial Services Group, Inc. is the largest stockholder and an affiliate of BlackRock, Inc. ( BlackRock ) for 1940 Act purposes. Investment Advisory: The Trust, on behalf of the Fund, entered into an Investment Advisory Agreement with the Manager, the Fund's investment adviser, an indirect, whollyowned subsidiary of BlackRock, to provide investment advisory services. The Manager is responsible for the management of the Fund s portfolio and provides the personnel, facilities, equipment and certain other services necessary to the operations of the Fund. For such services, the Fund pays the Manager a monthly fee at an annual rate equal to the following percentages of the average daily value of the Fund's net assets. Average Daily Net Assets Investment Advisory Fee First $1 Billion % $1 Billion - $3 Billion $3 Billion - $5 Billion $5 Billion - $10 Billion Greater than $10 Billion Administration: The Trust, on behalf of the Fund, entered into an Administration Agreement with the Manager, to provide administrative services. For these services, the Manager receives an administration fee computed daily and payable monthly, based on a percentage of the average daily net assets of the Fund. The administration fee, which is shown as administration in the Statement of Operations, is paid at the annual rates below. Average Daily Net Assets Administration Fee First $500 Million % $500 Million - $1 Billion $1 Billion - $2 Billion $2 Billion - $4 Billion $4 Billion - $13 Billion Greater than $13 Billion In addition, the Manager charges the BlackRock share class an administration fee, which is shown as administration in the Statement of Operations, at an annual rate of 0.02% of the average daily net assets of the BlackRock share class. Transfer Agent: Pursuant to written agreements, certain financial intermediaries, some of which may be affiliates, provide the Fund with sub-accounting, recordkeeping, sub-transfer agency and other administrative services with respect to sub-accounts they service. For these services, these entities receive an asset-based fee or an annual fee per shareholder account, which will vary depending on share class and/or net assets. The Manager maintains a call center that is responsible for providing certain shareholder services to the Fund. Shareholder services include responding to inquiries and processing subscriptions and redemptions based upon instructions from shareholders. For the year ended December 31, 2017, the Fund reimbursed the Manager $1,668 for costs incurred in running the call center, which are included in transfer agent in the Statement of Operations. Expense Limitations, Waivers, Reimbursements and Recoupments: With respect to the Fund, the Manager voluntarily agreed to waive its investment advisory fees by the amount of investment advisory fees the Fund pays to the Manager indirectly through its investment in affiliated money market funds (the affiliated money market fund waiver ). This amount is included in fees waived by the Manager in the Statement of Operations. The amount of waivers and/or reimbursements of fees and expenses made pursuant to the expense limitation caps, as applicable, will be reduced by the amount of the affiliated money market fund waiver. For the year ended December 31, 2017, the amount waived was $543. The Manager has contractually agreed to waive its investment advisory fee with respect to any portion of the Fund s assets invested in affiliated equity and fixed-income mutual funds and affiliated exchange-traded funds that have a contractual management fee through April 30, The contractual agreement may be terminated upon 90 days notice by a majority of the trustees who are not interested persons of the Trust, as defined in the 1940 Act ( Independent Trustees ), or by a vote of a majority of the outstanding voting securities of the Fund. For the year ended December 31, 2017, there were no fees waived by the Manager. With respect to the Fund, the Manager contractually agreed to waive and/or reimburse fees or expenses in order to limit expenses, excluding interest expense, dividend expense, tax expense, acquired fund fees and expenses, and certain other fund expenses, which constitute extraordinary expenses not incurred in the ordinary course of the Fund's business ( expense limitation ). The expense limitation as a percentage of average daily net assets is 0.62%. The Manager has agreed not to reduce or discontinue this contractual expense limitation through April 30, 2018, unless approved by the Board, including a majority of the Independent Trustees or by a vote of a majority of the outstanding voting securities of the Fund. These amounts waived and/or reimbursed are included in fees waived by the Manager, and shown as administration fees waived and transfer agent fees waived and/or reimbursed, respectively, in the Statement of Operations. For the year ended December 31, 2017, the amount waived and/or reimbursed was $78,477. With respect to the contractual expense limitation, if during the Fund's fiscal year the operating expenses of a share class, that at any time during the prior two fiscal years received a waiver and/or reimbursement from the Manager, are less than the current expense limitation for that share class, the Manager is entitled to be reimbursed by such share class up to the lesser of: (a) the amount of fees waived and/or expenses reimbursed during those prior two fiscal years under the agreement and (b) an amount not to exceed either the current expense limitation of that share class or the expense limitation of the share class in effect at the time that the share class received the applicable waiver and/or reimbursement, provided that: BLACKR OCK A NNUAL R EPORT TO S HAREHOLDERS

15 Notes to Financial Statements (continued) (1) the Fund, of which the share class is a part, has more than $50 million in assets for the fiscal year, and (2) the Manager or an affiliate continues to serve as the Fund s investment adviser or administrator. This repayment applies only to the contractual expense limitation on net expenses and does not apply to the contractual investment advisory fee waiver described above or any voluntary waivers that may be in effect from time to time. On December 31, 2017, the fund level and class specific waivers and/or reimbursements subject to possible future recoupment under the expense limitation agreement are as follows: Expires December 31, Fund Level... $13,197 $35,675 BlackRock... $39,103 $42,802 The following fund level and class specific waivers and/or reimbursements previously recorded by the Fund, which were subject to recoupment by the Manager, expired on December 31, 2017: Fund Level... $33,296 BlackRock.... $45,531 Securities Lending: The U.S. Securities and Exchange Commission ( SEC ) has issued an exemptive order which permits BIM, an affiliate of the Manager, to serve as securities lending agent for the Fund, subject to applicable conditions. As securities lending agent, BIM bears all operational costs directly related to securities lending. The Fund is responsible for expenses in connection with the investment of cash collateral received for securities on loan (the collateral investment expenses ). The cash collateral is invested in a private investment company managed by the Manager or its affiliates. However, BIM has agreed to cap the collateral investment expenses of the private investment company to an annual rate of 0.04%. The investment adviser to the private investment company will not charge any advisory fees with respect to shares purchased by the Fund. The private investment company in which the cash collateral has been invested may, under certain circumstances, impose a liquidity fee of up to 2% of the value withdrawn or temporarily restrict withdrawals for up to 10 business days during a 90 day period, in the event that the private investment company s weekly liquid assets fall below certain thresholds. Securities lending income is equal to the total of income earned from the reinvestment of cash collateral, net of fees and other payments to and from borrowers of securities, and less the collateral investment expenses. The Fund retains a portion of securities lending income and remits a remaining portion to BIM as compensation for its services as securities lending agent. Pursuant to a securities lending agreement, BIM may lend securities only when the difference between the borrower rebate rate and the risk free rate exceeds a certain level (such securities, the specials only securities ). Pursuant to such agreement, the Fund retains 80% of securities lending income. In addition, commencing the business day following the date that the aggregate securities lending income earned across certain funds in the Equity-Liquidity Complex in a calendar year exceeds a specified threshold, the Fund, pursuant to the securities lending agreement, will retain for the remainder of the calendar year securities lending income in an amount equal to 85% of securities lending income. Officers and Trustees: Certain trustees and/or officers of the Trust are directors and/or officers of BlackRock or its affiliates. The Fund reimburses the Manager for a portion of the compensation paid to the Trust's Chief Compliance Officer, which is included in Trustees and Officer in the Statement of Operations. 6. PURCHASES AND SALES For the year ended December 31, 2017, sales of investments, excluding short-term securities were $21,022,533, including in-kind redemptions of $19,272,453. For the year ended December 31, 2017, there were no purchases. 7. INCOME TAX INFORMATION It is the Fund s policy to comply with the requirements of the Internal Revenue Code of 1986, as amended, applicable to regulated investment companies, and to distribute substantially all of its taxable income to its shareholders. The Fund s current practice is to retain long-term capital gains, if any, and to pay U.S. federal taxes thereon at corporate tax rates on behalf of the shareholders. For U.S. federal income tax purposes, shareholders will be required to include their proportionate share of the retained capital gains in income and are entitled to report a credit for their share of the tax paid by the Fund. The Fund files U.S. federal and various state and local tax returns. No income tax returns are currently under examination. The statute of limitations on the Fund's U.S. federal tax returns generally remains open for each of the four years ended December 31, The statutes of limitations on the Fund s state and local tax returns may remain open for an additional year depending upon the jurisdiction. Management has analyzed tax laws and regulations and their application to the Fund as of December 31, 2017, inclusive of the open tax return years, and does not believe that there are any uncertain tax positions that require recognition of a tax liability in the Fund's financial statements. U.S. GAAP requires that certain components of net assets be adjusted to reflect permanent differences between financial and tax reporting. These reclassifications have no effect on net assets or net asset values per share. As of period end, the following permanent differences attributable to redemption in-kind transactions, non-deductible expenses and long-term capital gains deemed distributed to shareholders were reclassified to the following accounts: N OTES TO F INANCIAL S TATEMENTS 15