FlexShares ETFs. Agenda. II. Understanding ETF Liquidity. III. ETF Capital Markets. I. ETF Trading. IV. Appendix

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1 FlexShares ETFs Understanding ETF Trading Edward Rosenberg: Director, ETF Capital Markets & Analytics For Use With Financial Intermediaries Not For Public Distribution 2012 Northern Trust Corporation Agenda I. ETF Trading II. Understanding ETF Liquidity III. ETF Capital Markets IV. Appendix 2

2 I. ETF Trading ETF Trading ETF Basket Basket Ask IOPV Generally not the midpoint Basket Bid Basket spread The combined weighted average spread of the securities contained within the basket. ETF Market Price Spread 4

3 ETF Trading ETF Market Price ETF Ask Market Maker Hedge Basket Ask IOPV Basket Bid Market Maker Hedge ETF Bid Market Maker Hedge The cost incurred by the market maker hedging the basket securities. The market maker wants its exposure to be market neutral and to make its money on trading of the ETF shares. ETF Market Price Spread ETF Trading ETF Ask Market Maker Hedge Basket Ask Market conditions can impact the basket spread ETF Market Price Spread Basket Bid Market Maker Hedge ETF Bid Investor behavior Implications Basket Ask Basket Bid ETF Ask ETF Bid 6 Strong buying volume 5 Heavy Selling Heavy Buying ETF Market Price What can impact a spread? IOPV ETF Ask ETF Bid ETF Ask ETF Bid Equal two way volume

4 NAV ETF Trading Premium/Discount Any time the ETF is trading in the secondary market above or below NAV at the end of the day. Premium What can cause a premium? Generally, this occurs with ETFs that have more illiquid portfolio securities or are non US equity based Fees to create and hedge ETF Cost of buying underlying securities Buying / Selling pressure from market Discount What can cause a discount? Creation / redemption fees Large market order to buy / sell ETF shares ETF Trading Our Trading Relationships Authorized Participants (APs) ConvergEx Merrill Lynch Merrill Lynch Professional Clearing Goldman Sachs & Co. Deutsche Bank Jefferies National Financial Services Knight Nomura Citigroup Credit Suisse Morgan Stanley RBC Capital Markets SG Americas JP Morgan Market Makers Susquehanna International Group Jane Street DRW Ronin Capital Wolverine Exchange Listings New York Stock Exchange 8 7

5 II. Understanding ETF Liquidity Understanding ETF Liquidity ETFs always have more than one level of liquidity Secondary Market ADV Compare volume and on-screen bid/offer data to total potential liquidity ETF Market Depth Market Maker Indications of Liquidity Help source liquidity through relationships with specialists/market makers Ensure all market makers have three levels of quotes Primary Market Creation / Redemption Liquidity (Underlying Basket) Identify available liquidity through 14 APs via the creation/redemption process For illustrative purposes only. There can be no assurance that an active trading market for shares of an ETF will develop or be maintained. 10

6 Five levels deep on bid side Source: Bloomberg Understanding ETF Liquidity Market Depth of TDTT Shows at least five levels of quotes by market makers, all a few pennies away from the inside quote on both the bid and ask Eight levels deep on ask side Buyer ETF Capital Markets ETF Creation/Redemption Process Send cash ETF shares to buyer Brokerage Firm Place order ETF shares to broker AP Purchase securities (aka basket) Release ETF shares Custodian The ETF creation process occurs when an investor enters an order to purchase a large number of ETF shares and there are not enough available shares on the secondary market

7 III.ETF Capital Markets ETF Capital Markets How ETF Capital Markets can assist Helps keep spreads down by: Diligently watching spreads Ensuring Lead Market Makers (LMM) post three levels of quotes Work with market makers to review illiquid securities within the basket Can assist with trades by: Getting indications of interest from APs Working with market makers to increase size Working with trade desks to source shares 14

8 ETF Capital Markets Trading Tips Things to watch out for when trading and ETF ETFs trade differently than individual securities Avoid trading for the first 15 minutes of the market open and the last 5 minutes before the market close Try to trade ETFs with international exposure when the majority of the underlying security markets are open Use limit orders Leverage a block desk for large orders IV.Appendix 15

9 ETF Terminology Net Asset Value (NAV) A fund s price per share, which is calculated by dividing the total value of all the securities in the fund s portfolio plus cash, interest and receivables less any liabilities by the number of fund shares outstanding. Primary market trades occur at NAV for both ETFs and mutual fund. For ETFs, only APs can trade at NAV (i.e. creations and redemptions). Market Price The price which an investor can purchase or sell the ETF on the exchange. ETFs differ from mutual funds in that they can be traded at current market prices throughout the regular trading session. All transactions that occur using market price happen in the secondary market. Intraday Optimized Portfolio Value (IOPV) The value of the ETF basket calculated by a third party every 15 seconds throughout market hours. IOPV is generally used as measure by individual investors only to compare estimated value of the ETF to the current market price. It is not used by institutional investors because it is not a real-time calculation. Also referred to as Intraday Optimized Value (IOV) or Indicative Net Asset Value (INAV) or Intraday Indicative Value (IIV). ETF Terminology National Best Bid Offer (NBBO) This is the highest bid price and the lowest offer price on a listed exchange. Bid Price The price someone can sell a security. Ask Price The price someone can buy a security. Size The amount of shares that can be bought or sold at the bid/ask price. Generally, this ranges from 100 shares to 50,000 shares. Market Depth The amount of quotes and shares posted behind the NBBO

10 Disclosure Before investing carefully consider the FlexShares investment objectives, risks, charges and expenses. This and other information is in the prospectus, a copy of which may be obtained by visiting Read the prospectus carefully before you invest. FlexShares ETFs are distributed by Foreside Fund Services, LLC, not affiliated with Northern Trust. An investment in FlexShares is subject to investment risk, including the possible loss of principal amount invested. Funds returns may not match the returns of their respective Indexes. The Funds may invest in emerging and foreign markets, derivatives and concentrated sectors. In addition, the Funds may be subject to asset class risk, small cap stock risk, value investing risk, non-diversification risk, fluctuation of yield, income risk, interest rate/maturity risk, currency risk, passive investment risk, inflation protected security risk, market risk and manager risk. For a complete description of risks associated with each Fund please refer to the prospectus. Disclosure The preceding information is confidential and may not be duplicated in any form or disseminated without the prior consent of Northern Trust. The information does not constitute investment advice or a recommendation to buy or sell any security and is subject to change without notice. Northern Trust and its affiliates may have positions in, and may effect transactions in, the markets, contracts and related investments described herein, which positions and transactions may be in addition to, or different from, those taken in connection with the investments described herein. All material has been obtained from sources believed to be reliable, but the accuracy, completeness and interpretation cannot be guaranteed. Information contained herein is current as of the date appearing in this material only and is subject to change without notice. Past performance is not a guide to the future. There are risks involved with investing, including possible loss of principal. There is no guarantee that the investment objectives of any fund or strategy will be met. Risk controls and asset allocation models do not promise any level of performance or guarantee against loss of principal. Index returns do not assume the deduction of any management fees, trading costs or expenses. Direct investment in an index is not possible. Indices and trademarks are the property of their respective owners. All rights reserved