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BlackRock’s New Breed of Exchange-Traded Bond Fund Prizes Stability Over Swagger

Scott Radell manages more than 80 exchange-traded bond funds, including the new INC fund, for BlackRock.Credit...Jim Wilson/The New York Times

SAN FRANCISCO — You will not see Scott Radell on CNBC. Nor does he inhabit a jaw-dropping mansion.

While he may not live the life of a swaggering bond market pro, Mr. Radell, a bond manager at the fund giant BlackRock, is challenging a strategy that has rewarded some of his flashier peers: the pursuit of high-risk, high-return investments.

The weapon that Mr. Radell will be using is a new variety of exchange-traded fund, or E.T.F., which tracks an index of stocks or bonds but trades like a common stock, allowing investors to jump in and out.

For years now, these funds have been a hit with passive investors. Now, BlackRock is introducing a new breed of bond E.T.F. that aims to blend the best of active investing (security selection) with index investing (cost and consistency).

“We don’t have any ‘key man’ risk — no one is trying to shoot the lights out here,” Mr. Radell said, referring to the muscular investment style that has turned the likes of William H. Gross, the Pimco co-founder who is now at the Janus Capital Group, and the equally outspoken Jeffrey Gundlach of DoubleLine Capital, into bond market celebrities. “We are just trying to build a nice portfolio over time.”

The history of Wall Street is littered with fads and inventions that have aimed to strike a balance between making money for the product innovator and for the investor. Of late, though, few if any of these confections have been as successful as E.T.F.s, which hardly existed 15 years ago and now, at $2 trillion, make up close to 15 percent of the mutual fund industry.

Be it a cautious retiree buying Treasury securities or a hedge fund looking to scoop up hard-to-trade high-yield bonds, investors have flocked to E.T.F.s. As a consequence, the iShares division has become a crucial profit driver for BlackRock, the world’s largest fund company, accounting for close to a quarter of its $4.6 trillion assets under management.

The rush into E.T.F.s has come at a time when the performance records of mutual fund portfolio managers, especially on the equity side, have been poor. According to Morningstar, 74 percent of equity mutual funds trailed their benchmark index last year.

For that reason, the bulk of E.T.F. flows have been into large funds that track stock indexes like the Standard & Poor’s 500, the Russell 2000 and other major benchmarks around the globe. And while bond E.T.F.s have also grown in size in recent years (BlackRock’s main bond offering is now $23 billion), the numbers have been smaller because there are many who still embrace the view of the wise bond seer who can beat the market on a regular basis by loading up on securitized mortgages and exotic emerging-market bonds.

“Investors have realized that picking stocks just does not work, but there has always been this belief that some form of active bond management is required,” said Dave Nadig, an industry expert at ETF.com. “What BlackRock is now trying to do is thread the needle between the Bill Gross model and the standard index fund.”

Recently, the fastest-growing area of the E.T.F. market has been so-called smart beta funds, which track specialized and predominantly equity indexes that are not composed of the highest-valued securities, like the S.&P. 500. For example, a fund that follows an index made up of United States stocks with a history of paying dividends might be attractive to a yield-hungry investor.

Similarly, on the bond side, Mr. Radell’s new fund, called United States Fixed Income Balanced Risk, will invest in an equal split of corporate bonds, which will benefit if rates spike upward, and Treasury securities, which will protect the fund if rates fall.

Because these funds target a specific area of demand in the market but follow an index, they are seen by their champions as joining the best aspects of active and passive fund management.

Yet because the cult of the bond manager still holds sway, there have been few if any quasi-active bond funds that have thrived.

“There is nothing out there that approximates what we are trying to do,” said Mark Wiedman, the BlackRock executive who oversees iShares. He admitted, though, that there was no guarantee that bond investors would flock to such a fund as equity investors have done.

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Mark Wiedman oversees iShares, BlackRock’s profitable E.T.F. division.Credit...Jim Wilson/The New York Times

“There is a void in the market,” he said. “But sometimes there are voids for a reason.”

BlackRock faces pressure to keep up with a fast-innovating marketplace not just because it is the industry leader. With its $787 billion in E.T.F.s in the United States, it is far ahead of Vanguard, with $462 billion.

It is also because iShares, BlackRock’s San Francisco-based E.T.F. unit, was formerly Barclays Global Investors, which first popularized these types of funds in the late 1990s. BlackRock bought the company for $13 billion from a retrenching Barclays in 2009.

About a third of BlackRock’s revenue now comes from iShares, and analysts expect that the firm will someday earn a majority of its fees from E.T.F.s.

For a company that has evolved as a bond manager focused on institutions under its current chief executive, Laurence D. Fink, this tilt toward a market segment that is very much driven by retail investors represents a significant shift in strategy.

That is why the early predictions of a successor to Mr. Fink, who has no plans to step down anytime soon, favor Mr. Wiedman, an ambitious 44-year-old executive and onetime top official at the United States Treasury, who has overseen the business since 2011.

With such growth has come criticism. In particular, there have been two academic studies — and a lawsuit (which was later dismissed) — that claim E.T.F. providers like BlackRock have taken advantage of investors by retaining too large a share of some of the side benefits of the business.

For example, BlackRock made $477 million in revenue last year by lending the stocks and bonds in its various funds to banks, which passed them on to hedge funds that needed to borrow the securities to bet against them through short sales. Most of the fees were returned to the E.T.F.s, and BlackRock said that the money it kept allowed for low fees.

Still, some experts have questions.

“I am just not convinced that the E.T.F. is a great tool for mom-and-pop investors,” said Jesse A. Blocher, a finance professor at Vanderbilt University and the author of a paper that examines the economics of securities lending. “They are so heavily used now by short-term players that you worry that something will go askew.”

Last month, the Institute of International Finance, a trade group for global banks, warned of the extraordinary flows into corporate bond E.T.F.s, pointing out that many of the investors were sophisticated institutions reaching for yield. Given how illiquid the market has become for these types of bonds, any sustained selling frenzy could have wider consequences, the institute cautioned.

All told, Mr. Radell oversees 81 bond E.T.F.s for BlackRock, representing $153 billion in assets. When he sits down in front of his bank of trading screens at 5:15 a.m., just before the market gets going in New York, one of the first things he checks is liquidity.

He looks at how the E.T.F.s are trading, and if there are more buyers (or sellers) of a certain E.T.F., he keeps a close eye on how the underlying market for, say, high-yield or investment-grade bonds is handling the increased activity.

These days, however, his eyes are drawn to his new bond fund, which everyone on the company’s sun-bright trading floor refers to by its symbol, INC. The bigger bond E.T.F.s under Mr. Radell’s watch may rake in the fees, but it is INC, he believes, that represents the future.

His voice catches as he explains why.

“This is what makes me so excited,” he said, pointing to a screen that showed INC doing almost as well as the E.T.F.s of BlackRock’s main competitors, Pimco and DoubleLine, and ahead of most diversified bond funds.

The returns are similar, he said, but because INC follows a clear set of rules, there is less risk that a manager will make a bad call that sends the fund reeling.

Investors have been slow to share in Mr. Radell’s enthusiasm so far, and the E.T.F., which started trading late last month at $75 million, has barely budged.

“It’s been slow,” Mr. Radell acknowledged. “But I really think we have created something that will last for ages.”

A version of this article appears in print on  , Section B, Page 1 of the New York edition with the headline: A New Breed of Bond Fund Prizes Stability Over Swagger. Order Reprints | Today’s Paper | Subscribe

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