N-CSR 1 d402077dncsr.htm FLEXSHARES TRUST FlexShares Trust
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM N-CSR

 

 

CERTIFIED SHAREHOLDER REPORT OF REGISTERED

MANAGEMENT INVESTMENT COMPANIES

Investment Company Act file number: 811-22555

 

 

FlexShares Trust

(Exact name of registrant as specified in charter)

 

 

50 South LaSalle Street

Chicago, Illinois 60603

(Address of principal executive offices) (Zip code)

 

 

Michael Mabry, Esq.

Stradley Ronon Stevens & Young, LLP

2005 Market Street, Suite 2600

Philadelphia, Pennsylvania 19103-6996

(Name and Address of Agent for Service)

 

 

with a copy to:

Himanshu Surti

Jose Del Real, Esq.

Northern Trust Investments, Inc.

50 South LaSalle Street

Chicago, Illinois 60603

(Name and Address of Agent for Service)

 

 

Registrant’s telephone number, including area code: 855-353-9383

Date of fiscal year end: October 31

Date of reporting period: October 31, 2022

 

 

 


Table of Contents

Item 1. Reports to Stockholders.

 

a.)

The following is a copy of the report transmitted to shareholders pursuant to Rule 30e-1 under the Investment Company Act of 1940 (17 CFR 270.30e-1).


Table of Contents

LOGO

 

FlexShares® Trust

 

Annual Report

October 31, 2022

 

LOGO


Table of Contents

 

 

 
LOGO    LOGO

 

 

Table of Contents

 

Letter to Shareholders

     2  

Management’s Discussion of Fund Performance

     3  

FlexShares® US Quality Low Volatility Index Fund

     3  

FlexShares® Developed Markets ex-US Quality Low Volatility Index Fund

     5  

FlexShares® Emerging Markets Quality Low Volatility Index Fund

     7  

FlexShares® Morningstar US Market Factor Tilt Index Fund

     9  

FlexShares® Morningstar Developed Markets ex-US Factor Tilt Index Fund

     11  

FlexShares® Morningstar Emerging Markets Factor Tilt Index Fund

     13  

FlexShares® US Quality Large Cap Index Fund

     15  

FlexShares® STOXX® US ESG Select Index Fund

     17  

FlexShares® STOXX® Global ESG Select Index Fund

     19  

FlexShares® ESG  & Climate US Large Cap Core Index Fund

     21  

FlexShares® ESG  & Climate Developed Markets ex-US Core Index Fund

     23  

FlexShares® ESG  & Climate Emerging Markets Core Index Fund

     25  

FlexShares® Morningstar Global Upstream Natural Resources Index Fund

     27  

FlexShares® STOXX® Global Broad Infrastructure Index Fund

     29  

FlexShares® Global Quality Real Estate Index Fund

     31  

FlexShares® Real Assets Allocation Index Fund

     33  

FlexShares® Quality Dividend Index Fund

     35  

FlexShares® Quality Dividend Defensive Index Fund

     37  

FlexShares® Quality Dividend Dynamic Index Fund

     39  

FlexShares® International Quality Dividend Index Fund

     41  

FlexShares® International Quality Dividend Defensive Index Fund

     43  

FlexShares® International Quality Dividend Dynamic Index Fund

     45  

FlexShares® iBoxx 3-Year Target Duration TIPS Index Fund

     47  

FlexShares® iBoxx 5-Year Target Duration TIPS Index Fund

     49  

FlexShares® Disciplined Duration MBS Index Fund

     51  

FlexShares® Credit-Scored US Corporate Bond Index Fund

     53  

FlexShares® Credit-Scored US Long Corporate Bond Index Fund

     55  

FlexShares® High Yield Value-Scored Bond Index Fund

     57  

FlexShares® ESG  & Climate High Yield Corporate Core Index Fund

     60  

FlexShares® ESG  & Climate Investment Grade Corporate Core Index Fund

     63  

FlexShares® Ready Access Variable Income Fund

     65  

FlexShares® Core Select Bond Fund

     67  

Statements of Assets and Liabilities

     69  

Statements of Operations

     77  

Statements of Changes in Net Assets

     85  

Financial Highlights

     101  

Schedules of Investments

     134  

FlexShares® US Quality Low Volatility Index Fund

     134  

FlexShares® Developed Markets ex-US Quality Low Volatility Index Fund

     138  

FlexShares® Emerging Markets Quality Low Volatility Index Fund

     144  

FlexShares® Morningstar US Market Factor Tilt Index Fund

     149  

FlexShares® Morningstar Developed Markets ex-US Factor Tilt Index Fund

     188  

FlexShares® Morningstar Emerging Markets Factor Tilt Index Fund

     233  

FlexShares® US Quality Large Cap Index Fund

     284  

FlexShares® STOXX® US ESG Select Index Fund

     289  

FlexShares® STOXX® Global ESG Select Index Fund

     296  

FlexShares® ESG  & Climate US Large Cap Core Index Fund

     311  

FlexShares® ESG  & Climate Developed Markets ex-US Core Index Fund

     316  

FlexShares® ESG  & Climate Emerging Markets Core Index Fund

     324  

FlexShares® Morningstar Global Upstream Natural Resources Index Fund

     331  

FlexShares® STOXX® Global Broad Infrastructure Index Fund

     338  

FlexShares® Global Quality Real Estate Index Fund

     344  

FlexShares® Real Assets Allocation Index Fund

     349  

FlexShares® Quality Dividend Index Fund

     350  

FlexShares® Quality Dividend Defensive Index Fund

     356  

FlexShares® Quality Dividend Dynamic Index Fund

     360  

FlexShares® International Quality Dividend Index Fund

     364  

FlexShares® International Quality Dividend Defensive Index Fund

     371  

FlexShares® International Quality Dividend Dynamic Index Fund

     378  

FlexShares® iBoxx 3-Year Target Duration TIPS Index Fund

     385  

FlexShares® iBoxx 5-Year Target Duration TIPS Index Fund

     386  

FlexShares® Disciplined Duration MBS Index Fund

     387  

FlexShares® Credit-Scored US Corporate Bond Index Fund

     392  

FlexShares® Credit-Scored US Long Corporate Bond Index Fund

     408  

FlexShares® High Yield Value-Scored Bond Index Fund

     417  

FlexShares® ESG  & Climate High Yield Corporate Core Index Fund

     438  

FlexShares® ESG  & Climate Investment Grade Corporate Core Index Fund

     455  

FlexShares® Ready Access Variable Income Fund

     464  

FlexShares® Core Select Bond Fund

     476  

Notes to the Financial Statements

     478  

Report of Independent Registered Public Accounting Firm

     533  

Tax Information

     536  

Fund Expenses

     538  

Trustees and Officers

     542  

Approval of Advisory Agreement

     546  

Supplemental Information

     557  

For More Information

     575  

 

LOGO


Table of Contents

 

 

Letter to Shareholders

 

 

Dear Shareholder,

 

In retrospect, there was no contest. The optimism with which many investors approached 2022, though by no means unfounded, could not prevail against the markets’ most formidable adversary: Uncertainty.

 

A startling spike in inflation, an aggressive response by the Federal Reserve (“the Fed”), Russia’s invasion of Ukraine, and the relative de-globalization of relations with China easily overshadowed the positive effects of recovering supply chains, solid employment numbers, rising wages and an active consumer.

 

While macroeconomic and geopolitical challenges are hardly unprecedented, encountering them simultaneously and at this magnitude is a distant memory for many investors and, for some, an entirely new phenomenon. It’s no wonder, then, that we saw such a flight to perceived “safety” or to the sidelines, even though we believe that past experience argues for staying the course and maintaining a long-term perspective.

 

We enter 2023 with optimism, tempered with a healthy degree of caution. We believe stock valuations reflect potential risks, with many asset classes presenting compelling opportunities for investors. The slowing global economy has aided recent inflation trends, and we believe that if inflationary pressures continue to subside, it could allow the Fed to pause its rate hikes. Nevertheless, our opinion is that the possibility of a global recession is at its highest levels since the reopening of the global economy and even if we manage to avoid it, we believe below-trend growth appears likely.

 

Against this backdrop, we bring you our update for the FlexShares exchange-traded funds, sponsored and managed by Northern Trust Asset Management, for the year ended October 31, 2022. In addition to financial results for each fund, our portfolio managers explain the specific factors that influenced fund performance. As always, we encourage you to make the Insights Section on our website a destination for up to date analysis and perspective.

 

On behalf of all of us at Northern Trust and FlexShares, I want to thank you for your ongoing confidence and support.

We are proud to share our insights and acumen to help you navigate potential risks and identify opportunities within the marketplace.

 

Best wishes to you and yours for a joyous, productive, and rewarding new year.

 

Sincerely,

 

Darek Wojnar, CFA

Head, Funds & Managed Account Solutions, Northern Trust Asset Management

 

The views in this letter were as of October 31, 2022 and may not necessarily reflect the same views on the date this letter is first published or any time thereafter. These views are intended to help shareholders in understanding the Funds’ investment methodology and do not constitute investment advice.

 

This report is submitted for the general information of the shareholders of the Funds. It is not authorized for distribution to prospective investors unless preceded or accompanied by an effective prospectus, which includes information regarding the Funds’ risks, objectives, fees and expenses, experience of its management, and other information.

 

An investment in the Funds’ is subject to numerous risks, including possible loss of principal. Fund returns may not match the return of the respective indexes.

 

Some of the risks include, but are not limited to, the following: asset class; commodity; concentration; counterparty; currency; derivatives; dividend; emerging markets; equity securities; fluctuation of yield; foreign securities; geographic; income; industry concentration; inflation protected securities; infrastructure-related companies; interest rate/ maturity risk; issuer; large cap; management; market; market trading; mid cap stock; MLP; momentum; natural resources; new funds; non-diversification; passive investment; privatization; small cap stock; tracking error; value investing; and volatility risk. A full description of risks is in each Fund’s prospectus.

 

Foreside Fund Services, LLC, distributor.

 

 

2    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

US Quality Low Volatility Index Fund Ticker:  QLV

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     Fund
Inception
7/15/2019
 
 

 

 

 

FlexShares US Quality Low Volatility Index Fund (Based on Net Asset Value)

    -7.12     8.78     8.39

FlexShares US Quality Low Volatility Index Fund (Based on Market Price)

    -7.15     8.74     8.39

Russell 1000® Index

    -16.38     9.98     9.38

Northern Trust Quality Low Volatility Index

    -6.86     9.02     8.69

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.23% and the net expense ratio is 0.22%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the Northern Trust Quality Low Volatility IndexSM (the “Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that, in the aggregate, possess lower absolute volatility characteristics relative to the Northern Trust 1250 Index (the “Parent Index”), a float-adjusted market capitalization weighted index of U.S. domiciled large- and mid-capitalization companies. In addition, the Underlying Index is designed to select companies from the Parent Index that exhibit financial strength, stability and enhanced risk-return characteristics, which Northern Trust Investments, Inc. (“NTI”) believes can provide equity-market participation while seeking to protect against downside risks during certain market environments. As of October 31, 2022, there were 121 issues in the Underlying Index. NTI uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on domestic equities generally traded lower. Through Q4 of 2021, U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. U.S. equities declined in Q1 of 2022 as concern over rising inflation was intensified by Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. In an attempt to

 

 

   FLEXSHARES ANNUAL REPORT     3  


Table of Contents

 

FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

US Quality Low Volatility Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

combat inflation, the U.S. Federal Reserve (the “Fed”) raised the key interest rate1 by 0.25% in March 2022 and signaled more aggressive key interest rate hikes may be necessary. Q1 of 2022 also saw a wide variance in sector performance as energy companies had outsized positive performance while the technology and communication services sectors were the worst performers. The selloff of U.S. equities accelerated in Q2 of 2022 as the Fed moved forward with aggressive key interest rate hikes to seek to combat rising inflation. The Fed increased the key interest rate by 0.50% in May and by 0.75% in June, while signaling additional aggressive key interest rate hikes at future meetings were likely. Economic data was better than expected, but there were some signals that a slowdown may be coming. U.S. equity markets continued lower in Q3 of 2022 as the Fed continued raising the key interest rate with two 0.75% increases in July and September. Gross Domestic Product data showed year-over-year growth to be negative for Q2 of 2022, marking the second consecutive quarter of negative growth. Domestic equities rebounded in October of 2022 as corporate earnings reported over the month were generally better than expected. Sector performance dispersion was again large as the energy sector continued to outpace the rest of the U.S. equity market.

 

Because U.S. domestic investments trended down and were highly volatile during the 12 months ended October 31, 2022, we believe the low volatility2 approach of the Underlying Index was a positive driver of Fund performance for the twelve-month period. In addition, we believe that the changes experienced in the macroeconomic environment as well as the increase in key interest rates were conducive to high quality factor3 companies, resulting in the high-quality factor exposure augmenting Fund performance over the 12 months. Overall, the positive performance derived from the low volatility and quality factor exposures of the Underlying Index were the primary sources of the Underlying

Index’s outperformance against the Russell 1000® Index4 by 9.52%. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was -26 basis points (“bps”)5, which is reflective of the management fee (-22 bps), stock selection/futures (-6 bps), and the compounding effect of tracking error over time (+2 bps).

 
1 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

2 

Volatility is the measurement of the price movements of a group of stocks over a defined time frame.

 

3 

The quality factor is a factor that seeks to identify companies that exhibit financial strength and stability relative to the Parent Index.

 

4 

The Russell 1000® Index refers to a stock market index that represents the 1000 top companies in the United States.

 

5 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

4    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® Developed   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Markets Ex-US Quality Low Volatility Index Fund Ticker:  QLVD

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     Fund
Inception
7/15/2019
 
 

 

 

 

FlexShares Developed Markets ex-US Quality Low Volatility Index Fund (Based on Net Asset Value)

    -18.36     -2.24     -1.23

FlexShares Developed Markets ex-US Quality Low Volatility Index Fund (Based on Market Price)

    -18.33     -2.21     -1.12

MSCI World ex-US Index

    -22.04     -0.49     0.17

Northern Trust Developed Markets ex-US Quality Low Volatility Index

    -18.14     -2.04     -1.00

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.33% and the net expense ratio is 0.32%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the Northern Trust Developed Markets ex-US Quality Low Volatility IndexSM (the “Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that, in the aggregate, possess lower overall absolute volatility characteristics relative to a broad universe of securities domiciled in developed market countries, excluding the U.S. (the “Parent Index”). The Parent Index is a subset of the Northern Trust Global Index, where eligible securities are limited to those securities domiciled in non-U.S. developed market countries and designated as large- and mid-capitalization companies by Northern Trust Investments, Inc. (“NTI”), acting in its capacity as the index provider. In addition, the Underlying Index is designed to select companies from the Parent Index that exhibit financial strength, stability and enhanced risk-return characteristics, which NTI believes can provide equity-market participation while seeking to protect against downside risks during certain market environments. As of October 31, 2022, there were 172 issues in the Underlying Index. NTI uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on Developed international equities generally traded lower. Over the course of the 12-month period the U.S. dollar (USD) rose significantly and negatively impacted U.S. investors as returns in international currencies generally were hurt by the rising dollar. Through Q4 of 2021 Developed international equities were relatively flat as strength in European and U.K. investments due to resilient economic data from that region was offset by weakness in Asia Pacific equities. The emergence of the Omicron variant of Covid-19 weighed on investments in Hong Kong and Singapore as investors feared

 

   FLEXSHARES ANNUAL REPORT     5  


Table of Contents

 

FlexShares® Developed   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Markets Ex-US Quality Low Volatility Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

additional lockdowns in China would impact their overall markets. Developed international investments declined in Q1 of 2022 as we believe Russia’s invasion of Ukraine contributed to rising inflation and fears that energy supply shortages could impact economic growth. Investments in Hong Kong and Taiwan were also negatively impacted by a sharp rise in the number of Covid cases reported in China, leading to an increased number of cities being placed under lockdown. The selloff in developed international investments accelerated in Q2 and Q3 of 2022 as the continued war in Ukraine, rising inflation, energy shortages and tightening monetary policy increased the risk of a global recession. As global central banks struggled to keep pace with the aggressive key interest rate1 hikes by the U.S. Federal Reserve, the increasing interest rate differential caused the U.S. dollar to strengthen in comparison to other developed market currencies. Developed international investments were generally higher in October of 2022 as corporate earnings showed resilience and investors interpreted statements by the European Central Bank regarding the likelihood of a recession as a potential reprieve to further key interest rate hikes.

 

Because Developed international investments trended down and were highly volatile during the 12 months ended October 31, 2022, we believe the low volatility2 approach of the Underlying Index was a positive driver of Fund performance for the twelve-month period. Additionally, we believe that the changes experienced in the macroeconomic environment and the higher overall interest rate environment were conducive to high quality companies within the Developed international universe. Consequently, the quality factor3 focus of the Fund’s Underlying Index was a positive driver of Fund performance for the 12-month period. Overall, the positive performance derived from both the low volatility and quality factor exposures were the primary sources of the Underlying Index’s outperformance against the MSCI World ex-US Index4 by 3.90%. The

tracking difference between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was -22 basis points (“bps”)5, which is reflective of the Fund’s management fee (-32 bps), stock selection/futures (+2 bps), securities lending (+1 bps), dividend tax differential (+2 bps), and the compounding effect of tracking error over time (+5 bps).

 
1 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

2 

Volatility is the measurement of the price movements of a group of stocks over a defined time frame.

 

3 

The quality factor is a factor that seeks to identify companies that exhibit financial strength and stability relative to the Parent Index.

4 

The Morgan Stanley Capital International All Country World Index Ex-U.S. is a market-capitalization-weighted index maintained by Morgan Stanley Capital International (MSCI) and is designed to provide a broad measure of stock performance throughout the world, with the exception of U.S.-based companies.

 

5 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

 

6    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® Emerging   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Markets Quality Low Volatility Index Fund Ticker:  QLVE

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     Fund
Inception
7/15/2019
 
 

 

 

 

FlexShares Emerging Markets Quality Low Volatility Index Fund (Based on Net Asset Value)

    -19.77     -3.93     -3.53

FlexShares Emerging Markets Quality Low Volatility Index Fund (Based on Market Price)

    -20.74     -4.19     -3.73

MSCI Emerging Markets Index

    -31.03     -4.42     -4.25

Northern Trust Emerging Markets Quality Low Volatility Index

    -19.14     -3.16     -2.76

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.41% and the net expense ratio is 0.40%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the Northern Trust Emerging Markets Quality Low Volatility IndexSM (the “Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that, in the aggregate, possess lower overall absolute volatility characteristics relative to a broad universe of securities domiciled in emerging market countries (the “Parent Index”). The Parent Index is a subset of the Northern Trust Global Index, limited to those securities domiciled in emerging markets and designated as large- and mid- capitalization companies by Northern Trust Investments, Inc. (“NTI”), acting in its capacity as the index provider. In addition, the Underlying Index is designed to select companies from the Parent Index that exhibit financial strength, stability and enhanced risk-return characteristics, which NTI believes can provide equity-market participation while seeking to protect against downside risks during certain market environments. As of October 31, 2022, there were 148 issues in the Underlying Index. NTI uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on emerging market equities generally traded lower. Over the course of the 12-month period, the U.S. dollar (USD) rose significantly and negatively impacted U.S. investors as returns in international currencies generally were hurt by the rising USD. Through Q4 of 2021, emerging equities traded lower as the rapid spread of the Omicron variant of Covid-19 stoked fears that a new round of lockdowns in China would hinder growth in the region. Russian equities were the worst performing market as geopolitical tensions with the West worsened due to the buildup of Russian troops on its

 

   FLEXSHARES ANNUAL REPORT     7  


Table of Contents

 

FlexShares® Emerging   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Markets Quality Low Volatility Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

border with Ukraine. Emerging markets continued to decline in Q1 of 2022 as Russia launched a full scale invasion into Ukraine and the U.S. and its European allies responded with sanctions. As part of these sanctions, Russian equity securities were removed from major emerging market indices in March. Increased Covid cases in China and the lockdown of several cities also weighed on markets. Due to rising commodity prices, equity markets in countries that export natural resources in Latin America and the Middle East were up for Q1 of 2022, but not enough to overcome the weakness in emerging markets in Europe and Asia Pacific. The selloff in emerging equities accelerated in Q2 and Q3 of 2022 as the continued war in Ukraine, rising inflation, energy shortages and USD strength increased the risk of a global recession. Emerging markets continued lower in October of 2022, driven primarily by declining China equity markets as Premier Xi was elected to a third five-year term, leading to speculation that nationalistic policies would be put in place that would limit China’s growth.

 

Because emerging investments trended down and were highly volatile during the 12 months ended October 31, 2022, we believe the low volatility1 approach of the Underlying Index was a positive driver of Fund performance for the twelve-month period. In addition, we believe that the changes experienced in the macroeconomic environment as well as the increase in key interest rates were conducive to high quality factor2 companies, resulting in the high-quality factor exposure augmenting Fund performance over the 12 months. Overall, the positive performance derived from both the low volatility and quality factor exposures of the Underlying Index were the primary sources of the Underlying Index’s outperformance against the MSCI Emerging Markets Index3 by 11.89%. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was -63 basis points (“bps”)4, which

is reflective of the Fund’s management fee (-40 bps), stock selection/futures (-21 bps), and the compounding effect of tracking error over time (-2 bps).

 
1 

Volatility is the measurement of the price movements of a group of stocks over a defined time frame.

 

2 

The quality factor is a factor that seeks to identify companies that exhibit financial strength and stability relative to the Parent Index.

 

3 

The Morgan Stanley Capital International Emerging Markets Index is a selection of stocks that are designed to track the financial performance of key companies in fast-growing nations.

 

4 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

 

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Table of Contents

 

FlexShares® Morningstar®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

US Market Factor Tilt Index Fund Ticker:  TILT

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     5 Year     10 Year     Fund
Inception
9/16/2011
 
 

 

 

 

FlexShares Morningstar US Market Factor Tilt Index Fund (Based on Net Asset Value)

    -14.33     8.79     11.72     12.10

FlexShares Morningstar US Market Factor Tilt Index Fund (Based on Market Price)

    -14.29     8.79     11.41     12.11

Morningstar® U.S. Market Factor Tilt IndexSM

    -14.26     8.91     11.88     12.27

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.26% and the net expense ratio is 0.25%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the Morningstar® US Market Factor Tilt Index (the “Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that, in the aggregate, possess greater exposure to size and value factors relative to the Morningstar US Market Index (the “Parent Index”), a float-adjusted market-capitalization weighted index of U.S.-incorporated large-, mid-, small- and micro- capitalization companies. The Underlying Index seeks to achieve increased exposures to size and value factors, or a “factor tilt,” by adjusting the Parent Index’s constituent weights to achieve a slightly greater weight on companies with smaller market capitalizations or lower valuations, as determined by Morningstar, Inc. pursuant to its index methodology. The Underlying Index is designed to include companies with enhanced risk-return characteristics relative to the broader U.S. equity market by featuring size and value risk premiums, which Northern Trust Investments, Inc. (“NTI”) believes have been historically demonstrated over a full market cycle. As of October 31, 2022, there were 2,558 issues in the Underlying Index. NTI uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on U.S. domestic investments generally traded lower. During Q4 of 2021, U.S. domestic investments rose as economic data and strong corporate earnings suggested continued growth which allayed concerns over a potential spike in Covid cases. U.S. domestic investments declined in Q1 of 2022, however, as we believe investor concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the potential impact of sanctions from the U.S. and European countries on overall global commodity prices. To combat inflation, the Federal Reserve (Fed) raised the

 

   FLEXSHARES ANNUAL REPORT     9  


Table of Contents

 

FlexShares® Morningstar®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

US Market Factor Tilt Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

benchmark key interest rate1 0.25% in March 2022 and signaled more aggressive key interest hikes may be necessary. Q1 of 2022 also saw a wide variance in sector performance as energy companies had positive performance in comparison to the technology and communication services sectors which were the worst performers. The downturn of U.S. domestic investments accelerated in Q2 of 2022 as the Fed moved forward with two more rounds of hikes of the key interest rate—0.50% in May and 0.75% in June—in an effort to combat rising inflation as seen in the Consumer Price Index.2 Overall U.S. domestic investment fell as the Fed continued raising the key interest rate again with two 0.75% increases in July and September, respectively. In Q2 of 2022, Gross Domestic Product (GDP)3 showed negative data year-over-year, marking the second consecutive quarter of negative growth. U.S. domestic investments overall rebounded in October of 2022, however, as corporate earnings reported over the month were generally better than expected. Sector performance dispersion was again large as the energy sector continued to outpace the rest of U.S. domestic investments.

 

Because of the changes in growth expectations and the rising rate environment, U.S. domestic investments trended downward during the 12 months ended October 31, 2022. We believe the Morningstar value factor4 was a positive driver of Fund performance during the fiscal year ended October 31, 2022, as value stocks outperformed growth stocks5. The Morningstar size factor6 was also impacted by the changes in growth and interest rates and was a negative driver of Fund performance over the twelve months as small cap stocks underperformed large cap stocks. Overall, the positive performance derived from the Morningstar value factor was enough to offset the negative performance of the Morningstar size factor leading to the Underlying Index’s outperformance against the Russell 3000 Index®7 by 2.26%. Tracking difference

between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was -7 basis points (“bps”)8, which is reflective of the management fee (-25 bps), stock selection/futures (+14 bps) and securities lending (+4 bps).

 

The Morningstar U.S. Market Factor Tilt Index is the intellectual property (including registered trademarks) of Morningstar and/or its licensors (“Licensors”), which is used under license. The securities based on the Index are in no way sponsored, endorsed, sold or promoted by Morningstar and its Licensors and neither of the Licensors shall have any liability with respect thereto.

 
1 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

2 

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

 

3 

Gross Domestic Product (GDP) is seen as a comprehensive measure of U.S. economic activity which measures the value of the final goods and services produced in the United States.

 

4 

The Morningstar value factor seeks to identify stocks that are inexpensive relative to some measure of fundamental value (e.g., low price/book, low price/earnings, high dividend yields, etc.), which could result in outperformance relative to those that are pricier.

 

5 

Growth stocks are defined as those issued by companies that are anticipated to grow at a rate significantly above the average for the market.

 

6 

The Morningstar size factor measures a stock’s total capitalization which can be found by multiplying the current share price by all the outstanding shares of the stock, and seeks to overweight smaller capitalization stocks.

 

7 

The Russell 3000 Index is a market-capitalization-weighted equity index that seeks to track 3000 of the largest U.S.-traded stocks.

 

8 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

10    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® Morningstar®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Developed Markets ex-US Factor Tilt Index Fund Ticker:  TLTD

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     5 Year     10 Year     Fund
Inception
9/25/2012
 
 

 

 

 

FlexShares Morningstar Developed Markets ex-US Factor Tilt Index Fund (Based on Net Asset Value)

    -22.83     -1.09     3.84     3.65

FlexShares Morningstar Developed Markets ex-US Factor Tilt Index Fund (Based on Market Price)

    -23.18     -1.27     1.46     3.63

Morningstar® Developed Markets ex-US Factor Tilt IndexSM

    -22.89     -1.10     3.92     3.73

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.40% and the net expense ratio is 0.39%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the Morningstar® Developed Markets ex-US Factor Tilt IndexSM (the “Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that, in the aggregate, possess greater exposure to size and value factors relative to the Morningstar Developed Markets ex-US Index (the “Parent Index”), a float adjusted market-capitalization weighted index of companies incorporated in developed-market countries, excluding the U.S. The Underlying Index seeks to achieve increased exposures to size and value factors, or a “factor tilt”, by adjusting the Parent Index’s constituent weights to achieve a slightly greater weight on companies with smaller market capitalizations or lower valuations, as determined by Morningstar, Inc. pursuant to its index methodology. The Underlying Index is designed to include companies with enhanced risk-return characteristics relative to the broader developed international equity market by featuring size and value risk premiums, which Northern Trust Investments, Inc. (“NTI”) believes have been historically demonstrated over a full market cycle. As of October 31, 2022, there were 3,187 issues in the Underlying Index. NTI uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on developed international equities generally traded lower. Over the course of the 12-month period, the U.S. dollar (USD) rose significantly and negatively impacted U.S. investors as returns in international currencies generally were hurt by the rising dollar. Through Q4 of 2021, developed international markets were relatively flat as strength in the European and U.K. equity markets was offset by weakness is the Asia Pacific equity markets. The emergence of the Omicron variant of Covid-19 weighed on equities in Hong Kong and Singapore as investors feared additional lockdowns in China would impact these equity markets. Developed international equities declined in Q1 of 2022 as Russia’s invasion of Ukraine contributed to rising inflation and

 

   FLEXSHARES ANNUAL REPORT     11  


Table of Contents

 

FlexShares® Morningstar®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Developed Markets ex-US Factor Tilt Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

fears that energy supply shortages would impact economic growth. Equity markets in Hong Kong and Taiwan were also negatively impacted by a sharp rise in the number of Covid cases in China, leading to an increased number of cities being placed under lockdown. The selloff in developed international equities accelerated in Q2 and Q3 of 2022 as the continued war in Ukraine, rising inflation, energy shortages and tightening monetary policy increased the risk of a global recession. As global central banks struggled to keep pace with the aggressive key interest rate1 hikes by the U.S. Federal Reserve, the increasing interest rate differential caused the USD to strengthen versus many developed market currencies. Developed international equities generally traded higher in October of 2022 as corporate earnings showed resilience and investors interpreted statements by the European Central Bank regarding the likelihood of a recession as a potential reprieve to further key interest rate hikes in the near future.

 

Because of the changes in growth expectations and the rising rate environment, developed international investments trended downward during the 12 months ended October 31, 2022 and we believe the Morningstar value factor2 was a positive driver of Fund performance during the fiscal year ended October 31, 2022 as value stocks outperformed growth stocks3. The Morningstar size factor4, however, was a negative driver of Fund performance over the twelve months as small cap stocks underperformed large cap stocks. Overall, the positive performance derived from the Morningstar value factor exposures of the Underlying Index offset the negative performance of the Morningstar size factor, leading to the Underlying Index’s outperformance against the MSCI World ex-USA IMI Index5 by 0.25%. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was +6 basis points (“bps”)6, which is reflective of the Fund’s management fee (-39 bps), stock selection/futures (+17 bps), securities lending (+8 bps) and dividend tax differential (+20 bps).

The Morningstar Developed Markets ex-US Factor Tilt Index is the intellectual property (including registered trademarks) of Morningstar and/or its licensors (“Licensors”), which is used under license. The securities based on the Index are in no way sponsored, endorsed, sold or promoted by Morningstar and its Licensors and neither of the Licensors shall have any liability with respect thereto.

 
1 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

2 

The Morningstar value factor seeks to identify stocks that are inexpensive relative to some measure of fundamental value (e.g., low price/book, low price/earnings, high dividend yields, etc.), which could result in outperformance relative to those that are pricier.

 

3 

Growth stocks are defined as those issued by companies that are anticipated to grow at a rate significantly above the average for the market.

4 

The Morningstar size factor measures a stock’s total capitalization, which can be found by multiplying the current share price by all the outstanding shares of the stock, and seeks to overweight smaller capitalization stocks.

 

5 

The Morgan Stanley Capital International World ex USA Investable Market Index captures large, mid and small cap representation across 22 of 23 Developed Markets (DM) countries – excluding the U.S.

 

6 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

12    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® Morningstar®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Emerging Markets Factor Tilt Index Fund Ticker:  TLTE

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     5 Year     10 Year     Fund
Inception
9/25/2012
 
 

 

 

 

FlexShares Morningstar Emerging Markets Factor Tilt Index Fund (Based on Net Asset Value)

    -27.32     -3.05     0.79     0.70

FlexShares Morningstar Emerging Markets Factor Tilt Index Fund (Based on Market Price)

    -27.75     -3.22     -1.43     0.67

Morningstar® Emerging Markets Factor Tilt IndexSM

    -26.66     -2.32     1.50     1.45

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.60% and the net expense ratio is 0.59%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the Morningstar® Emerging Markets Factor Tilt Index SM (the “Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that, in aggregate, possess greater exposure to size and value factors relative to the Morningstar Emerging Markets Index (the “Parent Index”), a float-adjusted market-capitalization weighted index of companies incorporated in emerging-market countries. The Underlying Index seeks to achieve increased exposures to size and value factors, or a “factor tilt,” by adjusting the Parent Index’s constituent weights to achieve a slightly greater weight on companies with smaller market capitalizations or lower valuations, as determined by Morningstar, Inc., pursuant to its index methodology. The Underlying Index is designed to include companies with enhanced risk-return characteristics relative to the broader emerging equity market by featuring size and value risk premiums, which Northern Trust Investments, Inc. believes have been historically demonstrated over a full market cycle. As of October 31, 2022, there were 3,293 issues in the Underlying Index. NTI uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on emerging market equities generally traded lower. Over the course of the 12-month period, the U.S. dollar (USD) rose significantly and negatively impacted U.S. investors as returns in international currencies generally were hurt by the rising USD. Through Q4 of 2021, emerging equities traded lower as the rapid spread of the Omicron variant of Covid-19 stoked fears that a new round of lockdowns in China would hinder growth in the region. Russian equities were the worst performing market as geopolitical tensions with the West worsened due to the buildup of Russian troops on its border with Ukraine. Emerging markets continued to decline in Q1 of 2022 as Russia launched a full scale invasion into Ukraine and the U.S. and its European allies responded with sanctions. As part of

 

   FLEXSHARES ANNUAL REPORT     13  


Table of Contents

 

FlexShares® Morningstar®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Emerging Markets Factor Tilt Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

these sanctions, Russian equity securities were removed from major emerging market indices in March. Increased Covid cases in China and the lockdown of several cities also weighed on markets. Due to rising commodity prices, equity markets in countries that export natural resources in Latin America and the Middle East were up for Q1 of 2022, but not enough to overcome the weakness in emerging markets in Europe and Asia Pacific. The selloff in emerging equities accelerated in Q2 and Q3 of 2022 as the continued war in Ukraine, rising inflation, energy shortages and USD strength increased the risk of a global recession. Emerging markets continued lower in October of 2022 driven primarily by declining China equity markets as Premier Xi was elected to a third five-year term, leading to speculation that nationalistic policies would be put in place that would limit China’s growth.

 

Investors showed a preference for value companies in emerging markets for the twelve months ending October 31, 2022, resulting in the high Morningstar value factor1 exposure being a positive driver of Fund performance as value stocks outperformed growth stocks.2 In addition, the Morningstar size factor3 was a positive driver of Fund performance over the twelve months as small cap stocks outperformed large cap stocks. Overall, the positive performance derived from the Morningstar value and size factor exposures of the Underlying Index was the primary source of the Underlying Index’s outperformance against the MSCI EM IMI Net Index4 by 3.43%. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was -66 basis points (“bps”)5, which is reflective of the Fund’s management fee (-59 bps), stock selection/futures (-12 bps), securities lending (+5 bps) and dividend tax differential (+1 bps), performance calculation differences between the Underlying Index and the Fund (-1 bp), India Capital Gains Taxes (-1 bps) and compounding of tracking error over time (+1 bps).

The Morningstar Emerging Markets Factor Tilt Index is the intellectual property (including registered trademarks) of Morningstar and/or its licensors (“Licensors”), which is used under license. The securities based on the Index are in no way sponsored, endorsed, sold or promoted by Morningstar and its Licensors and neither of the Licensors shall have any liability with respect thereto.

 
1 

The Morningstar value factor seeks to identify stocks that are inexpensive relative to some measure of fundamental value (e.g., low price/book, low price/earnings, high dividend yields, etc.), which could result in outperformance relative to those that are pricier.

 

2 

Growth stocks are defined as those issued by companies that are anticipated to grow at a rate significantly above the average for the market.

3 

The Morningstar size factor measures a stock’s total capitalization, which can be found by multiplying the current share price by all the outstanding shares of the stock, and seeks to overweight smaller capitalization stocks.

 

4 

The Morgan Stanley Capital International Emerging Markets Investable Market Index (IMI) captures large, mid and small cap representation across 27 Emerging Markets (EM) countries.

 

5 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

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Table of Contents

 

FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

US Quality Large Cap Index Fund Ticker:  QLC

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     5 Year     Fund
Inception
9/23/2015
 
 

 

 

 

FlexShares US Quality Large Cap Index Fund Index Fund (Based on Net Asset Value)

    -12.98     9.08     7.97     9.73

FlexShares US Quality Large Cap Index Fund Index Fund (Based on Market Price)

    -12.88     9.09     7.91     9.74

S&P 500 Index

    -14.61     10.21     10.44     12.31

Northern Trust Quality Large Cap IndexSM

    -12.71     9.40     8.25     10.06

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. Prior to July 11, 2022, the gross expense ratio of the Fund was 0.33% and the net expense ratio was 0.32%. Effective July 11, 2022, the gross expense ratio of the Fund is 0.26% and the net expense ratio is 0.26%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the Northern Trust Quality Large Cap IndexSM (the “Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that, in aggregate, possess greater exposure to quality, value and momentum factors relative to a universe of publicly traded U.S. large-capitalization equity securities. The universe is comprised of the 600 largest companies in the Northern Trust 1250 Index, a float- adjusted market-capitalization weighted index of U.S. domiciled companies. The Underlying Index is designed to include companies with enhanced risk-return characteristics relative to the broader U.S. large-cap equity market by featuring quality, value and momentum risk premiums, which Northern Trust Investments, Inc. (“NTI”) believes have been historically demonstrated over a full market cycle. As of October 31, 2022, there were 173 issues in the Underlying Index. NTI uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on domestic equities generally traded lower. Through Q4 of 2021 U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. U.S. equities declined in Q1 of 2022 as concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. In an attempt to combat inflation, the U.S. Federal Reserve (the “Fed”) raised the key interest rate1 by 0.25% in March 2022 and signaled more aggressive key interest rate hikes may be necessary. Q1 of 2022 also saw a wide variance in sector performance as

 

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Table of Contents

 

FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

US Quality Large Cap Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

energy companies had outsized positive performance while the technology and communication services sectors were the worst performers. The selloff of U.S. equities accelerated in Q2 of 2022 as the Fed moved forward with aggressive key interest rate hikes to seek to combat rising inflation. The Fed increased the key interest rate by 0.50% in May and by 0.75% in June while signaling additional aggressive key interest rate hikes at future meetings were likely. Economic data was better than expected, but there were some signals that a slowdown may be coming. U.S. equity markets continued lower in Q3 of 2022 as the Fed continued raising the key interest rate with two 0.75% increases in July and September. Gross Domestic Product data showed year-over-year growth to be negative for Q2 of 2022, marking the second consecutive quarter of negative growth. Domestic equities rebounded in October of 2022 as corporate earnings reported over the month were generally better than expected. Sector performance dispersion was again large as the energy sector continued to outpace the rest of the U.S. equity market.

 

Because of the changes in growth expectations and the rising rate environment, U.S. domestic investments trended downward during the 12 months ended October 31, 2022 and we believe the value factor2 was a positive driver of Fund performance during the fiscal year ended October 31, 2022 as value stocks outperformed growth stocks3. In addition, we believe that investors showed a preference for high quality factor4 companies within the large cap universe utilized by the Underlying Index, resulting in the high-quality factor exposure enhancing Fund performance over the 12 months. The momentum factor exposure5 of the Underlying Index was also a positive driver of Fund performance as positive momentum companies outperformed negative momentum companies over the twelve months. Overall, the positive performance from the value, quality and momentum exposures of the Underlying Index were the primary sources of the Underlying Index’s outperformance relative to the

S&P 500 Index6 by 1.90%. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was -27 basis points (“bps”)7, which is reflective of the management fee (-25 bps), stock selection/futures (-5 bps), securities lending (+1 bps), performance calculation differences between the Underlying Index and the Fund (+1 bps) and compounding of tracking error over time (+1 bps).

 
1 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

2 

The value factor is a factor reflecting the current worth of a company relative to its own historical value, book value, or valuation versus peers.

 

3 

Growth stocks are defined as those issued by companies that are anticipated to grow at a rate significantly above the average for the market.

4 

The quality factor is a factor that seeks to identify companies that exhibit financial strength and stability relative to the market.

 

5 

The momentum factor is a factor that reflects market sentiment and changes in security price over a given time period.

 

6 

The Standard & Poor’s 500 Index is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S.

 

7 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

16    FLEXSHARES ANNUAL REPORT  


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FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

STOXX® US ESG Select Index Fund Ticker:  ESG

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     5 Year     Fund
Inception
7/13/2016
 
 

 

 

 

FlexShares STOXX® US ESG Select Index Fund (Based on Net Asset Value)

    -16.51     10.27     10.61     12.02

FlexShares STOXX® US ESG Select Index Fund (Based on Market Price)

    -16.52     10.27     10.59     12.03

Russell 1000® Index

    -16.38     9.98     10.20     11.60

STOXX® USA ESG Select KPIs Index

    -16.61     10.07     10.13     11.53

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.33% and the net expense ratio is 0.32%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the STOXX USA ESG Select KPIs Index (“Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that, in aggregate, score better with respect to a set of environmental, social and governance (“ESG”) key performance indicators relative to the U.S. companies in the STOXX Global 1800 Index, a float adjusted market-capitalization weighted index of companies incorporated in the U.S. and in developed international markets. As of October 31, 2022, there were 271 issues in the Underlying Index. Northern Trust Investments, Inc. (“NTI”) uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on domestic equities generally traded lower. Through Q4 of 2021 U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. U.S. equities declined in Q1 of 2022 as concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. In an attempt to combat inflation, the U.S. Federal Reserve (the “Fed”) raised the key interest rate1 by 0.25% in March 2022 and signaled more aggressive key interest rate hikes may be necessary. Q1 of 2022 also saw a wide variance in sector performance as energy companies had outsized positive performance while the technology and communication services sectors were the

 

1 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

   FLEXSHARES ANNUAL REPORT     17  


Table of Contents

 

FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

STOXX® US ESG Select Index Fund (cont.)

 

 

 

 

 

 

PORTFOLIO ANALYSIS (cont.)

 

worst performers. The selloff of U.S. equities accelerated in Q2 of 2022 as the Fed moved forward with aggressive key interest rate hikes to seek to combat rising inflation. The Fed increased the key interest rate 0.50% in May and 0.75% in June while signaling additional aggressive key interest rate hikes at future meetings were likely. Economic data was better than expected, but there were some signals that a slowdown may be coming. U.S. equity markets continued lower in Q3 of 2022 as the Fed continued raising the key interest rate with two 0.75% increases in July and September. Gross Domestic Product data showed year-over-year growth to be negative for Q2 of 2022, marking the second consecutive quarter of negative growth. Domestic equities rebounded in October of 2022 as corporate earnings reported over the month were generally better than expected. Sector performance dispersion was again large as the energy sector continued to outpace the rest of the U.S. equity market.

 

The Underlying Index had a negative total return during the 12 months ended October 31, 2022, and underperformed domestic equity markets, as defined by the Russell 1000® Index2 by -0.23%. The Underlying Index’s ESG-tilted approach led to overweight Fund exposure to the communication services and consumer discretionary sectors that detracted from Fund performance. Likewise, the ESG tilt led to underweights to the industrials, consumer staples, materials and utilities sectors that were negative drivers of Fund performance. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was +10 basis points (“bps”)3, which is reflective of the management fee (-32 bps), stock selection/futures (-4 bps) and dividend tax differential (+46 bps).

 

The STOXX USA ESG Select KPIs Index is the intellectual property (including registered trademarks) of STOXX Limited, Zurich, Switzerland and/or its licensors (“Licensors”), which is used under license. The securities based on the Index are in no way sponsored, endorsed, sold or promoted by STOXX and its Licensors and neither of the Licensors shall have any liability with respect thereto.

 

2 

The Russell 1000® Index refers to a stock market index that represents the 1000 top companies in the United States.

 

3 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

18    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

STOXX® Global ESG Select Index Fund Ticker:  ESGG

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     5 Year     Fund
Inception
7/13/2016
 
 

 

 

 

FlexShares STOXX® Global ESG Select Index Fund (Based on Net Asset Value)

    -19.35     6.71     6.93     9.35

FlexShares STOXX® Global ESG Select Index Fund (Based on Market Price)

    -19.55     6.70     6.89     9.35

MSCI World Index

    -18.48     6.11     6.37     8.55

STOXX® Global ESG Select KPIs Index

    -19.30     6.79     6.99     9.37

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.43% and the net expense ratio is 0.42%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com

 

PORTFOLIO ANALYSIS

 

The Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the STOXX Global ESG Select KPIs Index (the “Underlying Index”) The Underlying Index is designed to reflect the performance of a selection of companies that, in aggregate, score better with respect to a set of environmental, social and governance (“ESG”) key performance indicators relative to the STOXX Global 1800 Index, the parent index, a float-adjusted market-capitalization weighted index of companies incorporated in the U.S. and in developed international markets. As of October 31, 2022, there were 887 issues in the Underlying Index. Northern Trust Investments, Inc. (“NTI”) uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on global equities generally traded lower. Through Q4 of 2021 global equity markets rose as economic data suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. Global equities declined in Q1 of 2022 as concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. The selloff in global equities accelerated in Q2 and Q3 of 2022 as the continued war in Ukraine, rising inflation, energy shortages and tightening monetary policy increased the risk of a global recession. Global equities traded higher in October of 2022 as corporate earnings reported over the month were generally better than expected.

 

The Underlying Index had a negative total return during the 12 months ended October 31, 2022 and underperformed global equity markets, as defined by the MSCI World Index1, by -0.82%. The Underlying

 

1 

The Morgan Stanley Capital International World Index captures large and mid-cap representation across 23 Developed Markets countries.

 

   FLEXSHARES ANNUAL REPORT     19  


Table of Contents

 

FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

STOXX® Global ESG Select Index Fund (cont.)

 

 

 

 

 

 

PORTFOLIO ANALYSIS (cont.)

 

Index’s ESG-tilted approach led to underweight Fund exposure to the industrials, utilities and financials sectors as well as an overweight to the consumer discretionary sector that detracted from Fund performance. The ESG tilt also led to overweights to the healthcare and technology sectors that were beneficial to Fund performance. Overall the overweights to healthcare and technology were not enough to overcome the negative performance in other sector overweights and underweights and the Underlying Index underperformed the MSCI World Index. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was -5 basis points (“bps”)2, which is reflective of the management fee (-42 bps), stock selection/futures (-2 bps), securities lending (+1 bps), dividend tax differential (+39 bps), and compounding of tracking error over time (-1 bps).

 

The STOXX Global ESG Select KPIs Index is the intellectual property (including registered trademarks) of STOXX Limited, Zurich, Switzerland and/or its licensors (“Licensors”), which is used under license. The securities based on the Index are in no way sponsored, endorsed, sold or promoted by STOXX and its Licensors and neither of the Licensors shall have any liability with respect thereto.

 

 

2 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

20    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® ESG & Climate   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

US Large Cap Core Index Fund Ticker:  FEUS

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

     1 Year     Fund
Inception
9/20/2021
 
  

 

 

 

FlexShares ESG & Climate US Large Cap Core Index Fund (Based on Net Asset Value)

     -16.09     -9.40

FlexShares ESG & Climate US Large Cap Core Index Fund (Based on Market Price)

     -16.07     -9.40

S&P 500 Index

     -14.61     -8.73

Northern Trust ESG & Climate US Large Cap Core Index

     -16.08     -9.35

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.10% and the net expense ratio is 0.09%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Northern Trust ESG & Climate US Large Cap Core IndexSM (the “Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that exhibit certain environmental, social and governance (“ESG”) characteristics, while also seeking to provide broad-market, core exposure to publicly-traded U.S. large capitalization equity securities, i.e., the 600 largest companies in the Northern Trust 1250 IndexSM (the “Starting Universe”), as measured by largest float adjusted market capitalization. The Underlying Index is designed to minimize tracking differences relative to the Starting Universe, while also seeking (a) an aggregate higher scoring of certain ESG characteristics, as measured by the Northern Trust ESG Vector Score, and (b) reduction of aggregate climate-related risk, as measured by certain carbon-related risk metrics, each relative to the Starting Universe. As of October 31, 2022, there were 185 issues in the Underlying Index. Northern Trust Investments, Inc. (“NTI”) uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on domestic equities generally traded lower. Through Q4 of 2021 U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. U.S. equities declined in Q1 of 2022 as concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. In an attempt to combat inflation, the U.S. Federal Reserve (the “Fed”) raised the key interest rate1 by 0.25% in March

 

1 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

   FLEXSHARES ANNUAL REPORT     21  


Table of Contents

 

FlexShares® ESG & Climate   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

US Large Cap Core Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

2022 and signaled more aggressive key interest rate hikes may be necessary. Q1 of 2022 also saw a wide variance in sector performance as energy companies had outsized positive performance while the technology and communication services sectors were the worst performers. The selloff of U.S. equities accelerated in Q2 of 2022 as the Fed moved forward with aggressive key interest rate hikes to seek to combat rising inflation. The Fed increased the key interest rate 0.50% in May and 0.75% in June while signaling additional aggressive key interest rate hikes at future meetings were likely. Economic data was better than expected, but there were some signals that a slowdown may be coming. U.S. equity markets continued lower in Q3 of 2022 as the Fed continued raising the key interest rate with two 0.75% increases in July and September. Gross Domestic Product data showed year-over-year growth to be negative for Q2 of 2022, marking the second consecutive quarter of negative growth. Domestic equities rebounded in October of 2022 as corporate earnings reported over the month were generally better than expected. Sector performance dispersion was again large as the energy sector continued to outpace the rest of the U.S. equity market.

 

Surging commodity prices and concerns over natural resource shortages had a negative impact on the climate-related tilt of the Fund as companies that scored poorer on carbon-related measures outperformed during the 12 months ended October 31, 2022. In addition, companies with higher ESG characteristics also were a negative driver of Fund performance over the 12 months. Overall, the negative performance from the climate-related risk reduction and the aggregate higher ESG characteristics of the Underlying Index were the primary sources of the Underlying Index’s underperformance relative to the S&P 500 Index2 by -1.47%. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was -1 basis point (“bps”)3, which is reflective of the management fee

(-9 bps), stock selection/futures (+6 bps), performance calculation differences between the Underlying Index and the Fund (+1 bps) and compounding of tracking error over time (+1 bps).

 

 

2 

The Standard & Poor’s 500 Index is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S.

 

3 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

 

22    FLEXSHARES ANNUAL REPORT  


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FlexShares® ESG & Climate   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Developed Markets ex-US Core Index Fund Ticker:  FEDM

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year    

Fund

Inception

9/20/2021

 
 

 

 

 

FlexShares ESG & Climate Developed Markets Ex-US Core Index Fund (Based on Net Asset Value)

    -23.36     -19.59

FlexShares ESG & Climate Developed Markets Ex-US Core Index Fund (Based on Market Price)

    -23.47     -19.39

MSCI World ex-US Index

    -22.04     -18.81

Northern Trust ESG & Climate Developed Markets ex-US Core Index

    -23.43     -19.73

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.13% and the net expense ratio is 0.12%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Northern Trust ESG & Climate Developed Markets ex-US Core IndexSM (the “Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that exhibit certain environmental, social and governance (“ESG”) characteristics, while also seeking to provide broad-market, core exposure to publicly traded equity securities issued by companies domiciled in developed market countries, excluding the U.S. The Underlying Index is designed to minimize tracking differences relative to the Northern Trust Developed Markets ex-US Large Cap IndexSM (the “Parent Index”), while also seeking (a) an aggregate higher scoring of certain ESG characteristics, as measured by the Northern Trust ESG Vector Score, and (b) reduction of aggregate climate-related risk, as measured by certain carbon-related risk metrics, each relative to the Parent Index. As of October 31, 2022, there were 309 issues in the Underlying Index. Northern Trust Investments, Inc. (“NTI”) uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on developed international equities generally traded lower. Over the course of the 12-month period the U.S. dollar (USD) rose significantly and negatively impacted U.S. investors as returns in international currencies generally were hurt by the rising USD. Through Q4 of 2021, developed international markets were relatively flat as strength in the European and U.K. equity markets was offset by weakness is the Asia Pacific equity markets. The emergence of the Omicron variant of Covid-19 weighed on equities in Hong Kong and Singapore as investors feared additional lockdowns in China would impact these equity markets.

 

   FLEXSHARES ANNUAL REPORT     23  


Table of Contents

 

FlexShares® ESG & Climate   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Developed Markets ex-US Core Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

Developed international equities declined in Q1 of 2022 as Russia’s invasion of Ukraine contributed to rising inflation and fears that energy supply shortages would impact economic growth. Equity markets in Hong Kong and Taiwan were also negatively impacted by a sharp rise in the number of Covid cases in China, leading to an increased number of cities being placed under lockdown. The selloff in developed international equities accelerated in Q2 and Q3 of 2022 as the continued war in Ukraine, rising inflation, energy shortages and tightening monetary policy increased the risk of a global recession. As global central banks struggled to keep pace with the aggressive key interest rate1 hikes by the U.S. Federal Reserve, the increasing interest rate differential caused the USD to strengthen versus many developed international market currencies. Developed international equities generally traded higher in October of 2022 as corporate earnings showed resilience and investors interpreted statements by the European Central Bank regarding the likelihood of a recession as a potential reprieve to further key interest rate hikes in the near future.

 

Surging commodity prices and concerns over natural resource shortages had a negative impact on the climate-related tilt of the Fund as companies that scored poorer on carbon-related measures outperformed during the 12 months ended October 31, 2022. In addition, companies with higher ESG characteristics also were a negative driver of Fund performance over the 12 months. Overall, the negative performance from the climate-related risk reduction and the aggregate higher ESG characteristics of the Underlying Index were the primary sources of the Underlying Index’s underperformance relative to the MSCI World ex-US Index2 by -1.39%. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was +7 basis points (“bps”)3, which is reflective of

the management fee (-12 bps), stock selection/futures (+19 bps), dividend tax differential (+2 bps), and compounding of tracking error over time (-2 bps).

 

 

1 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

2 

The MSCI World ex USA Index captures large and mid cap representation across 22 of 23 Developed Markets (DM) countries*— excluding the United States.

 

3 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

 

24    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® ESG & Climate   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Emerging Markets Core Index Fund Ticker:  FEEM

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

   

Fund

Inception
4/20/2022

 
 

 

 

 

FlexShares ESG & Climate Emerging Markets Core Index Fund (Based on Net Asset Value)

    -21.47

FlexShares ESG & Climate Emerging Markets Core Index Fund (Based on Market Price)

    -21.00

MSCI Emerging Markets Index

    -21.06

Northern Trust ESG & Climate Emerging Markets Core Index

    -21.66

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.19% and the net expense ratio is 0.18%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Northern Trust ESG & Climate Emerging Markets Core IndexSM (the “Underlying Index”) The Underlying Index is designed to reflect the performance of a selection of companies that exhibit certain environmental, social and governance (“ESG”) characteristics, while also seeking to provide broad-market, core exposure to publicly traded equity securities issued by companies domiciled in emerging market countries. The Underlying Index is designed to minimize tracking differences relative to the Northern Trust Emerging Markets Large Cap IndexSM (the “Parent Index”), while also seeking (a) an aggregate higher scoring of certain ESG characteristics, as measured by the Northern Trust ESG Vector Score, and (b) reduction of aggregate climate-related risk, as measured by certain carbon-related risk metrics, each relative to the Parent Index. As of October 31, 2022, there were 251 issues in the Underlying Index. Northern Trust Investments, Inc. (“NTI”) uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the period ending October 31, 20221, prices on emerging market equities generally traded lower. Over the course of the period ending October 31, 2022, the U.S. dollar (USD) rose significantly and negatively impacted U.S. investors as returns in international currencies generally were hurt by the rising of the dollar. Through Q2 and Q3 of 2022 emerging equities traded lower as Russia’s invasion of Ukraine continued and the U.S. and its European allies responded with sanctions. The selloff was also impacted by rising inflation, energy shortages and USD strength that increased the risk of a global

 

1 

The Fund commenced investment operations on April 20, 2022.

 

   FLEXSHARES ANNUAL REPORT     25  


Table of Contents

 

FlexShares® ESG & Climate   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Emerging Markets Core Index Fund (cont.)

 

 

 

 

 

 

PORTFOLIO ANALYSIS (cont.)

 

recession. Emerging markets continued lower in October of 2022 driven primarily by declining China equity markets as Premier Xi was elected to a third five-year term, leading to speculation that nationalistic policies would be put in place that would limit China’s growth.

 

From inception through October 31, 2022 the total return for the Fund was -21.47% compared to the MSCI Emerging Markets Index2 that returned -21.06%. Surging commodity prices and concerns over natural resource shortages had a negative impact on the climate-related tilt of the Fund as companies that scored poorer on carbon-related measures outperformed during the period from inception through October 31, 2022. In addition, companies with higher ESG characteristics also were a negative driver of Fund performance over the period ending October 31, 2022. Overall, the negative performance from the climate-related risk reduction and the aggregate higher ESG characteristics of the Underlying Index were the primary sources of the Underlying Index’s underperformance relative to the MSCI World ex-US Index by -36 basis points (“bps”)3. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the period from inception through October 31, 2022 was +19 bps, which is reflective of the management fee (-9 bps), stock selection/futures (+18 bps), performance calculation differences between the Underlying Index and the Fund (+1 bps) and compounding of tracking error over time (+9 bps).

 

26    FLEXSHARES ANNUAL REPORT  
2 

The MSCI Emerging Markets Index captures large and mid cap representation across 24 Emerging Markets (EM) countries.

 

3 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.


Table of Contents

 

FlexShares® Morningstar®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Global Upstream Natural Resources Index Fund Ticker:  GUNR

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     5 Year     10 Year     Fund
Inception
9/16/2011
 
 

 

 

 

FlexShares Morningstar Global Upstream Natural Resources Index Fund (Based on Net Asset Value)

    12.20     9.34     4.88     4.45

FlexShares Morningstar Global Upstream Natural Resources Index Fund (Based on Market Price)

    12.01     9.30     4.85     4.46

Morningstar® Global Upstream Natural Resources IndexSM

    12.96     9.93     5.36     4.88

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.47% and the net expense ratio is 0.46%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Morningstar Global Upstream Natural Resources IndexSM (the “Underlying Index”). The Underlying Index reflects the performance of a selection of equity securities that are traded in or are issued by companies classified as developed or emerging markets (including the U.S.), as determined by Morningstar, Inc., the index provider, pursuant to its index methodology. The companies included in the Underlying Index have significant business operations in the ownership, management and/or production of natural resources in energy, agriculture, precious or industrial metals, timber and water resources sectors, as determined by the index provider, pursuant to its index methodology. As of October 31, 2022, there were 120 issues in the Underlying Index. Northern Trust Investments, Inc. (“NTI”) uses a “passive” or indexing approach to try to achieve the Fund’s investment objective and a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on global equities generally traded lower. Through Q4 of 2021, U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. Commodity and natural resources prices surged in Q1 of 2022 as we believe investor concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the potential impact of sanctions from the U.S. and European countries on overall global commodity prices. As part of these sanctions, Russian equity securities were removed from market indices in early March. Many commodity and natural resources prices moved higher during the fiscal year, especially crude oil, refined oil products and grains. Supplies of these raw materials from Russia and Ukraine were disrupted leading to concerns over shortages in 2022 and beyond. The sudden removal of energy supplies in Q1 of 2022 due to sanctions against Russian energy exports, combined by production discipline by the Organization of Petroleum Exporting

 

   FLEXSHARES ANNUAL REPORT     27  


Table of Contents

 

FlexShares® Morningstar®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Global Upstream Natural Resources Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

Countries (OPEC) and limitations on oilfield equipment and labor all combined to lower global supplies while energy demand remained fairly steady. European natural gas price increases reached record highs as Russia severally restricted supplies. West Texas Intermediate (“WTI”) crude oil prices began the fiscal year near $84 per barrel, spiked to over $120 per barrel in March and again in Q3 of 2022 eventually ending the fiscal year over $85 per barrel1. U.S. natural gas futures were up nearly 53%2 during the same time span, while Euro natural gas futures were 30% higher after raising as much as 380%3 by August.

 

In an attempt to combat inflation, the U.S. Federal Reserve (the “Fed”) raised the key interest rate4 by 0.25% in March 2022 and signaled more aggressive key interest rate hikes may be necessary. In Q2 of 2022, the Fed moved forward with two more rounds of key interest rate rate hikes in an effort to combat rising inflation as seen in the Consumer Price Index.5 The Fed continued raising the key interest rate again with two 0.75% increases in July and September. Due to these continuing key interest rate hikes, the U.S. dollar (USD) rose significantly in comparison to other global currencies. A stronger USD is typically a negative for global commodity prices and negatively impacts U.S. investors’ returns on foreign equity holdings.

 

Overall Industrial metals prices, such as copper, aluminum, zinc and tin were lower for the fiscal year. Prices fell during the period as China, the top marginal consumer of many of these metals, shutdown major areas of the country due to the country’s zero-COVID virus policy. Additionally, China’s real estate sector saw a slowdown due to the COVID shutdowns and leverage concerns among many property developers, thereby slowing construction. Prices were volatile during the period as concerns over supplies normally derived from Russia plus the uncertainty over future global growth with tightening Central Bank monetary policies and the European energy crisis. Precious metals prices were lower as higher interest rates and the strong USD lessened demand. Lithium saw strong price performance due to increasing environmental battery demand and continued challenges in supplies.

Grains posted strong price performance for a third straight year as the Ukraine conflict, droughts in Europe and other grain growing regions limited global supplies. Protein prices (cattle, hogs, poultry, and fish) also posted strong price performance. U.S. fertilizer chemicals (potash, nitrogen, phosphate) were all materially higher on increased input costs, supply constraints and global demand. U.S. lumber prices were especially volatile during the fiscal year. Continued housing demand combined with lumber mill capacity issues drove lumber futures prices6 up significantly by end of Q1 of 2022. We believe once U.S. mortgage rates moved higher in response to the change in the Fed’s monetary policy and housing demand fell, lumber futures subsequently declined by the end of the fiscal year.

 

For the 12-month period ended October 31, 2022, the Underlying Index outperformed the global natural resource equity markets, as defined by the S&P Global Natural Resources Index7, by +681 basis points (bps)8. Due to the Underlying Index’s focus on the upstream section of the natural resource supply chain, security selection in Energy aided returns. Sector allocation and security selection in Agriculture, Metals and Timber also benefitted performance versus the benchmark. The Water Resources sector was a drag on performance as higher interest rates negatively impacted returns due to the capital intensive nature of the sector. Tracking difference for the period between the Fund’s NAV and the Underlying Index was -76 bps, which is reflective of the Fund’s management fee (-46 bps), futures (-19 bps), foreign dividend tax differential treatment (+4 bps), securities lending (+3 bps), security selection (-1 bps), transaction costs (-3 bps), and other expenses including compounding of expenses during rising markets (-14 bps).

 

The Morningstar Global Upstream Natural Resources Index is the intellectual property (including registered trademarks) of Morningstar and/or its licensors (“Licensors”), which is used under license. The securities based on the Index are in no way sponsored, endorsed, sold or promoted by Morningstar and its Licensors and neither of the Licensors shall have any liability with respect thereto.

 

 

1 

Source: Bloomberg, USCRWTIC Index (October 31, 2021 – October 31, 2022).

 

2 

Source: Bloomberg, NGUSHHUB Commodity (October 31, 2021 – October 31, 2022).

 

3 

Source: Bloomberg, TTFG1MON Commodity (October 31, 2021 – October 31, 2022).

 

4 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

5 

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

 

 

6 

Source: Bloomberg, LB1 Lumber Generic Near Term Commodity Contract (October 31, 2021 – October 31, 2022).

 

7 

The Standard & Poor’s Global Natural Resources Index includes 90 of the largest publicly-traded companies in natural resources and commodities businesses that meet specific investability requirements, offering investors diversified and investable equity exposure across 3 primary commodity-related sectors: agribusiness, energy, and metals & mining.

 

8 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

28    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® STOXX®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Global Broad Infrastructure Index Fund Ticker:  NFRA

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     5 Year     Fund
Inception
10/8/2013
 
 

 

 

 

FlexShares STOXX® Global Broad Infrastructure Index Fund (Based on Net Asset Value)

    -13.92     -0.28     2.85     4.80

FlexShares STOXX® Global Broad Infrastructure Index Fund (Based on Market Price)

    -13.90     -0.26     2.87     4.81

STOXX® Global Broad Infrastructure Index

    -13.99     -0.39     2.73     4.70

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.48% and the net expense ratio is 0.47%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the STOXX Global Broad Infrastructure Index (the “Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that, in aggregate, offer broad exposure to publicly traded developed- and emerging-market infrastructure companies, including U.S. companies, as defined by STOXX Ltd. (“STOXX”) pursuant to its index methodology. As of October 31, 2022, there were 176 issues in the Underlying Index. Northern Trust Investments, Inc. (“NTI”) uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on global equities generally traded lower. Through Q4 of 2021 global equity markets rose as economic data suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. Global equities declined in Q1 of 2022 as concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. As part of these sanctions, Russian equity securities were removed from major global indices in March of 2022. The selloff in global equities accelerated in Q2 and Q3 of 2022 as the continued war in Ukraine, rising inflation, energy shortages and tightening monetary policy increased the risk of a global recession. Global equities traded higher in October of 2022 as corporate earnings reported over the month were generally better than expected.

 

The Underlying Index had a negative total return during the 12 months ended October 31, 2022, and underperformed the global infrastructure market, as defined by

 

   FLEXSHARES ANNUAL REPORT     29  


Table of Contents

 

FlexShares® STOXX®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Global Broad Infrastructure Index Fund (cont.)

 

 

 

 

 

 

PORTFOLIO ANALYSIS (cont.)

 

the S&P Global Infrastructure Index,1 by -8.56%. The Underlying Index’s exposures to the communication, energy, utilities and social infrastructure sectors negatively contributed to Fund performance, while exposure to transportation infrastructure positively benefited Fund performance. The tracking difference between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was +7 basis points (“bps”)2, which is reflective of the Fund’s management fee (-47 bps), stock selection/futures (+5 bps), securities lending (+3 bps), dividend tax differential (+49 bps), India Cap Gain Taxes (-1 bps) and compounding of tracking error over time (-2 bps).

 

The STOXX Global Infrastructure Index is the intellectual property (including registered trademarks) of STOXX Limited, Zurich, Switzerland and/or its licensors (“Licensors”), which is used under license. The securities based on the Index are in no way sponsored, endorsed, sold or promoted by STOXX and its Licensors and neither of the Licensors shall have any liability with respect thereto.

 

1 

The S&P Global Infrastructure Index is designed to track 75 companies from around the world chosen to represent the listed infrastructure industry while maintaining liquidity and tradability.

 

2 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

30    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Global Quality Real Estate Index Fund Ticker:  GQRE

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     5 Year     Fund
Inception
11/5/2013
 
 

 

 

 

FlexShares Global Quality Real Estate Index Fund (Based on Net Asset Value)

    -23.51     -5.01     -0.46     3.33

FlexShares Global Quality Real Estate Index Fund (Based on Market Price)

    -23.82     -5.09     -0.52     3.32

FTSE EPRA/NAREIT Developed IndexSM

    -24.95     -6.32     -0.17     2.20

Northern Trust Global Quality Real Estate IndexSM

    -23.75     -5.26     -0.60     3.22

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.46% and the net expense ratio is 0.45%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Northern Trust Global Quality Real Estate IndexSM (the “Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that, in aggregate, possess greater exposure to quality, value and momentum factors relative to the Northern Trust Global Real Estate Index (the “Parent Index”), a float-adjusted market-capitalization weighted index of publicly traded equity securities of U.S. and non-U.S. real estate investment trusts and real estate operating companies. In addition, the Underlying Index is designed to include companies with enhanced risk-return characteristics relative to the global publicly traded real-estate market by featuring quality, value and momentum risk premiums, which Northern Trust Investments, Inc. (“NTI”) believes have been historically demonstrated over a full market cycle. As of October 31, 2022, there were 145 issues in the Underlying Index. NTI uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on global equities generally traded lower. Through Q4 of 2021 global equity markets rose as economic data suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. Global equities declined in Q1 of 2022 as concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. As part of these sanctions, Russian equity securities were removed from major global indices in March of 2022. The selloff in global equities accelerated in Q2 and Q3 of 2022 as the continued war in Ukraine, rising inflation, energy shortages and tightening monetary policy increased the risk of a

 

   FLEXSHARES ANNUAL REPORT     31  


Table of Contents

 

FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Global Quality Real Estate Index Fund (cont.)

 

 

 

 

 

 

PORTFOLIO ANALYSIS (cont.)

 

global recession. Global equities traded higher in October of 2022 as corporate earnings reported over the month were generally better than expected.

 

The Underlying Index had a negative total return during the 12 months ended October 31, 2022, but outperformed the global equity real estate markets, as defined by the FTSE EPRA/NAREIT Developed Net Index1, by 1.20%. The quality2 and momentum3 factor exposures of the Underlying Index were positive drivers of Fund performance while the value4 factor exposure was a negative driver of Fund performance. Overall, the positive exposure to quality and momentum was enough to offset the headwinds from the negative performance derived from the value exposure. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the period was +24 basis points (“bps”)5, which is reflective of the Fund’s management fee (-45 bps), stock selection/futures (+34 bps), securities lending (+2 bps), dividend tax differential (+37 bps), performance calculation differences between the Underlying Index and the Fund (-1 bp) and compounding of tracking error over time (-3 bps).

 

1 

The FTSE EPRA/NAREIT Developed Net Index is an index designed to track the performance of listed real estate companies in both developed and emerging countries worldwide.

 

2 

The quality factor is a factor that seeks to identify companies that exhibit financial strength and stability relative to the Parent Index.

 

3 

The momentum factor is a factor that reflects market sentiment and changes in a security price over a given time period.

 

4 

The value factor is a factor reflecting the current worth of a company relative to its own historical value, book value or valuation versus peers.

 

5 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

32    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Real Assets Allocation Index Fund Ticker:  ASET

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     5 Year     Fund
Inception
11/23/2015
 
 

 

 

 

FlexShares Real Assets Allocation Index Fund (Based on Net Asset Value)

    -11.49     1.19     3.40     5.03

FlexShares Real Assets Allocation Index Fund (Based on Market Price)

    -11.46     1.18     3.34     5.05

MSCI ACWI Index

    -19.96     4.84     5.24     7.29

Northern Trust Real Assets Allocation IndexSM

    -11.34     1.32     3.52     5.16

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 1.05% and the net expense ratio is 0.57%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Northern Trust Real Assets Allocation IndexSM (the “Underlying Index”). The Fund is a fund of funds and seeks to achieve its investment objective by investing primarily in the shares of other FlexShares ETFs (each an “Underlying Fund,” and together, the “Underlying Funds”) that are eligible for inclusion in the Underlying Index, rather than in securities of individual companies. The Underlying Funds themselves seek investment results corresponding to their own respective underlying indexes. The Underlying Funds invest primarily in separate sets of securities representing or providing exposures to global “real assets.” Real assets are defined by the index provider as physical or tangible assets. Examples of real assets include but are not limited to commodities, precious metals, oil, and real estate. Each Underlying Fund has its own risk profile and will contribute differently to the overall risk profile of the Fund. Each of the Underlying Funds invests in equity securities that are traded in or are issued by companies domiciled in global developed or emerging markets (including the U.S.). Certain of the Underlying Funds may invest in publicly traded units of master limited partnerships and real estate investment trusts. As of October 31, 2022, there were three Underlying Funds in the Underlying Index. Northern Trust Investments, Inc. (“NTI”) uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI generally intends to replicate the constituent securities of the Underlying Index to manage the Fund but may use representative sampling in certain circumstances. “Representative sampling” means investing in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. When the Fund uses representative sampling, it may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on global equities generally traded lower. Through Q4 of 2021 global equity markets rose as economic data suggested continued growth, allaying concerns

 

   FLEXSHARES ANNUAL REPORT     33  


Table of Contents

 

FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Real Assets Allocation Index Fund (cont.)

 

 

 

 

 

 

PORTFOLIO ANALYSIS (cont.)

 

over a spike in Covid cases due to the Omicron variant. Global equities declined in Q1 of 2022 as concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. As part of these sanctions, Russian equity securities were removed from major global indices in March of 2022. The selloff in global equities accelerated in Q2 and Q3 of 2022 as the continued war in Ukraine, rising inflation, energy shortages and tightening monetary policy increased the risk of a global recession. Global equities traded higher in October of 2022 as corporate earnings reported over the month were generally better than expected.

 

The Underlying Index had a negative total return during the 12 months ended October 31, 2022, but outperformed the global equity markets, as defined by the MSCI All Country World Index (ACWI)1 by 8.62%. The Underlying Index outperformed the MSCI All Country World Index due to the Underlying Index’s greater allocation to infrastructure relative to its real estate allocation, as well as its inclusion of natural resources, which had a positive total return for the 12 months. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the period was -15 basis points (“bps”)2, which is largely reflective of the Fund’s management fee (-57 bps), a reimbursement amount equal to the Acquired Fund Fees and Expenses attributable to the Fund’s investments in the Underlying Funds (+46 bps), stock selection/futures (-3 bps) and performance calculation differences between the Underlying Index and the Fund (-1 bp).

 

1 

The Morgan Stanley Capital International All Country World Index is a market-capitalization-weighted index maintained by Morgan Stanley Capital International (MSCI) and is designed to provide a broad measure of stock performance throughout the world.

 

2 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

34    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Quality Dividend Index Fund Ticker:  QDF

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     5 Year     Fund
Inception
12/14/2012
 
 

 

 

 

FlexShares Quality Dividend Index Fund (Based on Net Asset Value)

    -8.29     6.90     7.31     10.86

FlexShares Quality Dividend Index Fund (Based on Market Price)

    -8.27     6.89     7.31     10.87

Russell 1000® Index

    -16.38     9.98     10.20     12.74

Northern Trust Quality Dividend IndexSM

    -7.95     7.45     7.84     11.39

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.38% and the net expense ratio is 0.37%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that correspond generally, before fees and expenses, to the price and yield performance of the Northern Trust Quality Dividend IndexSM (the “Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that, in aggregate, possess greater financial strength and stability characteristics relative to the Northern Trust 1250 Index (the “Parent Index”)1. In addition, the Underlying Index is designed to select companies from the Parent Index that have enhanced risk-return characteristics and that in the aggregate have the potential to generate income in excess of the income generated by securities in the Parent Index with a beta2 that is similar to that of the Parent Index. As of October 31, 2022, there were 127 issues in the Underlying Index. Northern Trust Investments, Inc. (“NTI”) uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on domestic equities generally traded lower. Through Q4 of 2021 U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. U.S. equities declined in Q1 of 2022 as concerns over rising inflation were intensified by

 

1 

Northern Trust 1250 Index is a float-adjusted market-capitalization weighted index comprised of U.S. domiciled large- and mid-capitalization companies.

 

2 

A statistical measure of the volatility, or sensitivity, of rates of return on a portfolio or security compared to a market index and time period. The beta for an ETF measures the expected change in return of the ETF relative to the return of a designated index. By definition, the beta of the Standard & Poor’s (“S&P”) 500 Index is 1.00. Accordingly, a fund with a 1.10 beta is expected to perform 10% better than the S&P 500 Index in rising markets and 10% worse in falling markets.

 

   FLEXSHARES ANNUAL REPORT     35  


Table of Contents

 

FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Quality Dividend Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. In an attempt to combat inflation, the U.S. Federal Reserve (the “Fed”) raised the key interest rate3 by 0.25% in March 2022 and signaled more aggressive key interest rate hikes may be necessary. Q1 of 2022 also saw a wide variance in sector performance as energy companies had outsized positive performance while the technology and communication services sectors were the worst performers. The selloff of U.S. equities accelerated in Q2 of 2022 as the Fed moved forward with aggressive key interest rate hikes to seek to combat rising inflation. The Fed increased the key interest rate 0.50% in May and 0.75% in June while signaling additional aggressive key interest rate hikes at future meetings were likely. Economic data was better than expected, but there were some signals that a slowdown may be coming. U.S. equity markets continued lower in Q3 of 2022 as the Fed continued raising the key interest rate with two 0.75% increases in July and September. Gross Domestic Product data showed year-over-year growth to be negative for Q2 of 2022, marking the second consecutive quarter of negative growth. Domestic equities rebounded in October of 2022 as corporate earnings reported over the month were generally better than expected. Sector performance dispersion was again large as the energy sector continued to outpace the rest of the U.S. equity market.

 

Because of the changes in growth expectations and the rising rate environment, U.S. domestic investments trended downward during the 12 months ended October 31, 2022 and we believe the dividend yield factor4 was a positive driver of Fund performance as higher yielding investments outperformed lower yielding and non-dividend paying investments. In addition, we believe that the changes experienced in the macroeconomic environment as well as the increase in interest rates were conducive to high quality factor5 companies, resulting in the high-quality factor exposure augmenting Fund performance over the

12 months. Overall, the positive performance derived from the dividend and quality factor exposures of the Underlying Index were the primary sources of the Underlying Index’s outperformance against the Russell 1000® Index6 by 8.43%. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was -34 basis points (“bps”)7, which is reflective of the management fee (-37 bps), stock selection/futures (-1 bps), securities lending (+3 bps), and compounding of tracking error over time (+1 bps).

 

 

3 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

4 

Dividend yield factor is a factor that seeks to identify companies that realize a dividend yield above the Parent Index.

5 

The quality factor is a factor that seeks to identify companies that exhibit stable returns relative to the market.

 

6 

The Russell 1000® Index refers to a stock market index that represents the 1000 top companies in the United States.

 

7 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

 

36    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® Quality   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Dividend Defensive Index Fund Ticker:  QDEF

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     5 Year     Fund
Inception
12/14/2012
 
 

 

 

 

FlexShares Quality Dividend Defensive Index Fund (Based on Net Asset Value)

    -7.53     5.86     7.51     10.78

FlexShares Quality Dividend Defensive Index Fund (Based on Market Price)

    -7.48     5.87     7.53     10.78

Russell 1000® Index

    -16.38     9.98     10.20     12.74

Northern Trust Quality Dividend Defensive IndexSM

    -7.09     6.23     8.10     11.33

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.38% and the net expense ratio is 0.37%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that correspond generally, before fees and expenses, to the price and yield performance of the Northern Trust Quality Dividend Defensive IndexSM (the “Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that, in aggregate, possess greater financial strength and stability characteristics relative to the Northern Trust 1250 Index (the “Parent Index”)1. In addition, the Underlying Index is designed to select companies from the Parent Index that have enhanced risk-return characteristics and that in the aggregate have the potential to generate income in excess of the income generated by securities in the Parent Index with a beta2 that is lower in relation to that of the Parent Index. As of October 31, 2022, there were 109 issues in the Underlying Index. Northern Trust Investments, Inc. (“NTI”) uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on domestic equities generally traded lower. Through Q4 of 2021 U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. U.S. equities declined in Q1 of 2022 as concerns over rising inflation were intensified by

 

1 

Northern Trust 1250 Index is a float-adjusted market-capitalization weighted index comprised of U.S. domiciled large- and mid-capitalization companies.

 

2 

A statistical measure of the volatility, or sensitivity, of rates of return on a portfolio or security compared to a market index and time period. The beta for an ETF measures the expected change in return of the ETF relative to the return of a designated index. By definition, the beta of the Standard & Poor’s (“S&P”) 500 Index is 1.00. Accordingly, a fund with a 1.10 beta is expected to perform 10% better than the S&P 500 Index in rising markets and 10% worse in falling markets.

 

   FLEXSHARES ANNUAL REPORT     37  


Table of Contents

 

FlexShares® Quality   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Dividend Defensive Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. In an attempt to combat inflation, the U.S. Federal Reserve (the “Fed”) raised the key interest rate3 by 0.25% in March 2022 and signaled more aggressive key interest rate hikes may be necessary. Q1 of 2022 also saw a wide variance in sector performance as energy companies had outsized positive performance while the technology and communication services sectors were the worst performers. The selloff of U.S. equities accelerated in Q2 of 2022 as the Fed moved forward with aggressive key interest rate hikes to seek to combat rising inflation. The Fed increased the key interest rate 0.50% in May and 0.75% in June while signaling additional aggressive key interest rate hikes at future meetings were likely. Economic data was better than expected, but there were some signals that a slowdown may be coming. U.S. equity markets continued lower in Q3 of 2022 as the Fed continued raising the key interest rate with two 0.75% increases in July and September. Gross Domestic Product data showed year-over-year growth to be negative for Q2 of 2022, marking the second consecutive quarter of negative growth. Domestic equities rebounded in October of 2022 as corporate earnings reported over the month were generally better than expected. Sector performance dispersion was again large as the energy sector continued to outpace the rest of the U.S. equity market.

 

Because of the changes in growth expectations and the rising rate environment, U.S. domestic investments trended downward during the 12 months ended October 31, 2022 and we believe the dividend yield factor4 was a positive driver of Fund performance as higher yielding investments outperformed lower yielding and non-dividend paying investments. In addition, we believe that the changes experienced in the macroeconomic environment as well as the increase in interest rates were conducive to high quality factor5 companies, resulting in the high-quality factor exposure augmenting Fund performance over the 12 months. Overall, the positive performance derived

from the dividend and quality factor exposures along with the low beta factor exposures of the Underlying Index were the primary sources of the Underlying Index’s outperformance against the Russell 1000® Index6 by 9.29%. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was -44 basis points (“bps”)7, which is reflective of the management fee (-37 bps), stock selection/futures (-10 bps), securities lending (+3 bps), performance calculation differences between the Underlying Index and the Fund (-1 bp), and compounding of tracking error over time (+1 bps).

 

 

3 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

4 

Dividend yield factor is a factor that seeks to identify companies that realize a dividend yield above the Parent Index.

 

5 

The quality factor is a factor that seeks to identify companies that exhibit stable returns relative to the market.

 

6 

The Russell 1000® Index refers to a stock market index that represents the 1000 top companies in the United States.

 

7 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

38    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® Quality   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Dividend Dynamic Index Fund Ticker:  QDYN

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     5 Year     Fund
Inception
12/14/2012
 
 

 

 

 

FlexShares Quality Dividend Dynamic Index Fund (Based on Net Asset Value)

    -9.23     10.00     8.86     11.52

FlexShares Quality Dividend Dynamic Index Fund (Based on Market Price)

    -9.20     10.02     8.89     11.52

Russell 1000® Index

    -16.38     9.98     10.20     12.74

Northern Trust Quality Dividend Dynamic IndexSM

    -8.87     10.39     9.20     11.90

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.38% and the net expense ratio is 0.37%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that correspond generally, before fees and expenses, to the price and yield performance of the Northern Trust Quality Dividend Dynamic IndexSM (the “Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that, in aggregate, possess greater financial strength and stability characteristics relative to the Northern Trust 1250 Index (the “Parent Index”)1. In addition, the Underlying Index is designed to select companies from the Parent Index that have enhanced risk return characteristics and that in the aggregate have the potential to generate income in excess of the income generated by securities in the Parent Index with a beta2 that is higher in relation to that of the Parent Index. As of October 31, 2022, there were 124 issues in the Underlying Index. Northern Trust Investments, Inc. (“NTI”) uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on domestic equities generally traded lower. Through Q4 of 2021 U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. U.S. equities declined in Q1 of 2022 as concerns over rising inflation were intensified by

 

1 

Northern Trust 1250 Index is a float-adjusted market-capitalization weighted index comprised of U.S. domiciled large- and mid-capitalization companies.

 

2 

A statistical measure of the volatility, or sensitivity, of rates of return on a portfolio or security compared to a market index and time period. The beta for an ETF measures the expected change in return of the ETF relative to the return of a designated index. By definition, the beta of the Standard & Poor’s (“S&P”) 500 Index is 1.00. Accordingly, a fund with a 1.10 beta is expected to perform 10% better than the S&P 500 Index in rising markets and 10% worse in falling markets.

 

   FLEXSHARES ANNUAL REPORT     39  


Table of Contents

 

FlexShares® Quality   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Dividend Dynamic Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. In an attempt to combat inflation, the U.S. Federal Reserve (the “Fed”) raised the key interest rate3 by 0.25% in March 2022 and signaled more aggressive key interest rate hikes may be necessary. Q1 of 2022 also saw a wide variance in sector performance as energy companies had outsized positive performance while the technology and communication services sectors were the worst performers. The selloff of U.S. equities accelerated in Q2 of 2022 as the Fed moved forward with aggressive key interest rate hikes to seek to combat rising inflation. The Fed increased the key interest rate 0.50% in May and 0.75% in June while signaling additional aggressive key interest rate hikes at future meetings were likely. Economic data was better than expected, but there were some signals that a slowdown may be coming. U.S. equity markets continued lower in Q3 of 2022 as the Fed continued raising the key interest rate with two 0.75% increases in July and September. Gross Domestic Product data showed year-over-year growth to be negative for Q2 of 2022, marking the second consecutive quarter of negative growth. Domestic equities rebounded in October of 2022 as corporate earnings reported over the month were generally better than expected. Sector performance dispersion was again large as the energy sector continued to outpace the rest of the U.S. equity market.

 

Because of the changes in growth expectations and the rising rate environment, U.S. domestic investments trended downward during the 12 months ended October 31, 2022 and we believe the dividend yield factor4 was a positive driver of Fund performance as higher yielding investments outperformed lower yielding and non-dividend paying investments. In addition, we believe that the changes experienced in the macroeconomic environment as well as the increase in interest rates were conducive to high quality factor5 companies, resulting in the high-quality factor exposure augmenting Fund performance over the 12 months. Because U.S. equities moved lower over the

12 months, we believe that the high beta exposure detracted from Fund performance. Overall, the positive performance derived from the yield and quality factor exposures of the Underlying Index were enough to offset the negative performance of its high beta exposure leading to the Underlying Index’s outperformance against the Russell 1000® Index6 by 7.51%. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was -36 basis points (“bps”)7, which is reflective of the management fee (-37 bps), stock selection/futures (-3 bps), securities lending (+3 bps) and compounding of tracking error over time (+1 bp).

 

 

3 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

4 

Dividend yield factor is a factor that seeks to identify companies that realize a dividend yield above the Parent Index.

 

5 

The quality factor is a factor that seeks to identify companies that exhibit stable returns relative to the market.

 

6 

The Russell 1000 Index refers to a stock market index that represents the 1000 top companies in the United States.

 

7 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

40    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® International   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Quality Dividend Index Fund Ticker:  IQDF

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     5 Year     Fund
Inception
4/12/2013
 
 

 

 

 

FlexShares International Quality Dividend Index Fund (Based on Net Asset Value)

    -24.11     -2.92     -2.35     0.98

FlexShares International Quality Dividend Index Fund (Based on Market Price)

    -24.52     -2.98     -2.44     0.96

MSCI AC World ex USA Index

    -24.73     -1.68     -0.60     2.39

Northern Trust International Quality Dividend IndexSM

    -24.06     -2.66     -2.20     1.30

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.48% and the net expense ratio is 0.47%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that correspond generally, before fees and expenses, to the price and yield performance of the Northern Trust International Quality Dividend IndexSM (the “Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that, in aggregate, possess greater financial strength and stability characteristics relative to the Northern Trust International Large Cap Index (the “Parent Index”)1. In addition, the Underlying Index is designed to select companies from the Parent Index that have enhanced risk return characteristics and that in the aggregate have the potential to generate income in excess of the income generated by securities in the Parent Index with a beta2 that is similar to that of the Parent Index. As of October 31, 2022, there were 202 issues in the Underlying Index. Northern Trust Investments, Inc. (“NTI”) uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on international equities generally traded lower. Over the course of the 12-month period the U.S. dollar (USD) rose significantly and negatively impacted U.S. investors as returns in international currencies generally were hurt by the rising USD. Through Q4 of 2021, international equities

 

1 

Northern Trust International Large Cap Index is a float-adjusted market-capitalization weighted index comprised of non-U.S. domiciled large- and mid-capitalization companies.

 

2 

A statistical measure of the volatility, or sensitivity, of rates of return on a portfolio or security compared to a market index and time period. The beta for an ETF measures the expected change in return of the ETF relative to the return of a designated index. By definition, the beta of the Standard & Poor’s (“S&P”) 500 Index is 1.00. Accordingly, a fund with a 1.10 beta is expected to perform 10% better than the S&P 500 Index in rising markets and 10% worse in falling markets.

 

   FLEXSHARES ANNUAL REPORT     41  


Table of Contents

 

FlexShares® International   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Quality Dividend Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

traded lower as the rapid spread of the Omicron variant of Covid-19 stoked fears that a new round of lockdowns in China would hinder growth in the region. International equity markets continued to decline in Q1 of 2022 as Russia launched a full scale invasion into Ukraine and the U.S. and its European allies responded with sanctions. As part of these sanctions, Russian equity securities were removed from major international market indices in March. The selloff in international equities accelerated in Q2 and Q3 of 2022 as the continued war in Ukraine, rising inflation, energy shortages and tightening monetary policy increased the risk of a global recession. As global central banks struggled to keep pace with the aggressive key interest rate3 hikes by the U.S. Federal Reserve, the increasing interest rate differential caused the USD to strengthen versus many global currencies. International equities generally traded higher in October of 2022 as corporate earnings showed resilience and investors interpreted statements by the European Central Bank regarding the likelihood of a recession as a potential reprieve to further key interest rate hikes in the near future.

 

Because of the changes in growth expectations and the rising rate environment, international investments trended downward during the 12 months ended October 31, 2022 and we believe the dividend yield factor4 was a positive driver of Fund performance as high yielding investments outperformed low yielding and non-dividend paying investments. In addition, we believe that the changes experienced in the macroeconomic environment as well as the increase in interest rates were conducive to high quality factor5 companies, resulting in the high-quality factor exposure augmenting Fund performance over the 12 months. Overall, the positive performance derived from the dividend and quality factor exposures of the Underlying Index were the primary sources of the Underlying Index’s outperformance against the MSCI ACWI ex USA Index6 by 0.67%. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was -5 basis points (“bps”)7, which is reflective of the Fund’s management fee (-47 bps), stock selection/futures

(+32 bps), securities lending (+5 bps), performance calculation differences between the Underlying Index and the Fund (+3 bps), and compounding of tracking error over time (+2 bps).

 

 

3 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

4 

Dividend yield factor is a factor that seeks to identify companies that realize a dividend yield above the Parent Index.

 

5 

The quality factor is a factor that seeks to identify companies that exhibit stable returns relative to the market.

6 

The Morgan Stanley Capital International All Country World Index Ex-U.S. is a market-capitalization-weighted index maintained by Morgan Stanley Capital International (MSCI) and is designed to provide a broad measure of stock performance throughout the world, with the exception of U.S.-based companies.

 

7 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

 

42    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® International   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Quality Dividend Defensive Index Fund Ticker:  IQDE

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     5 Year     Fund
Inception
4/12/2013
 
 

 

 

 

FlexShares International Quality Dividend Defensive Index Fund (Based on Net Asset Value)

    -22.06     -2.89     -2.37     0.52

FlexShares International Quality Dividend Defensive Index Fund (Based on Market Price)

    -22.29     -2.98     -2.53     0.48

MSCI AC World ex USA Index

    -24.73     -1.68     -0.60     2.39

Northern Trust International Quality Dividend Defensive IndexSM

    -21.86     -2.57     -2.13     0.98

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.48% and the net expense ratio is 0.47%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that correspond generally, before fees and expenses, to the price and yield performance of the Northern Trust International Quality Dividend Defensive IndexSM (the “Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that, in aggregate, possess greater financial strength and stability characteristics relative to the Northern Trust International Large Cap Index (the “Parent Index”)1. In addition, the Underlying Index is designed to select companies from the Parent Index that have enhanced risk return characteristics and that in the aggregate have the potential to generate income in excess of the income generated by securities in the Parent Index with a beta2 that is less than that of the Parent Index. As of October 31, 2022, there were 210 issues in the Underlying Index. Northern Trust Investments, Inc. (“NTI”) uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on international equities generally traded lower. Over the course of the 12-month period the U.S. dollar (USD) rose significantly and negatively impacted U.S. investors as returns in international currencies generally were hurt by the rising dollar. Through Q4 of 2021, international equities

 

1 

Northern Trust International Large Cap Index is a float-adjusted market-capitalization weighted index comprised of non-U.S. domiciled large- and mid-capitalization companies.

 

2 

A statistical measure of the volatility, or sensitivity, of rates of return on a portfolio or security compared to a market index and time period. The beta for an ETF measures the expected change in return of the ETF relative to the return of a designated index. By definition, the beta of the Standard & Poor’s (“S&P”) 500 Index is 1.00. Accordingly, a fund with a 1.10 beta is expected to perform 10% better than the S&P 500 Index in rising markets and 10% worse in falling markets.

 

   FLEXSHARES ANNUAL REPORT     43  


Table of Contents

 

FlexShares® International   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Quality Dividend Defensive Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

traded lower as the rapid spread of the Omicron variant of Covid-19 stoked fears that a new round of lockdowns in China would hinder growth in the region. International equity markets continued to decline in Q1 of 2022 as Russia launched a full scale invasion into Ukraine and the U.S. and its European allies responded with sanctions. As part of these sanctions, Russian equity securities were removed from major international market indices in March. The selloff in international equities accelerated in Q2 and Q3 of 2022 as the continued war in Ukraine, rising inflation, energy shortages and tightening monetary policy increased the risk of a global recession. As global central banks struggled to keep pace with the aggressive key interest rate3 hikes by the U.S. Federal Reserve, the increasing interest rate differential caused the USD to strengthen versus many global currencies. International equities generally traded higher in October of 2022 as corporate earnings showed resilience and investors interpreted statements by the European Central Bank regarding the likelihood of a recession as a potential reprieve to further key interest rate hikes in the near future.

 

Because of the changes in growth expectations and the rising rate environment, international investments trended downward during the 12 months ended October 31, 2022 and we believe the dividend yield factor4 was a positive driver of Fund performance as high yielding investments outperformed low yielding and non-dividend paying investments, as was the low beta exposure. In addition, we believe that the changes experienced in the macroeconomic environment as well as the increase in interest rates were conducive to high quality factor5 companies, resulting in the high-quality factor exposure augmenting Fund performance over the 12 months. Overall, the positive performance derived from the dividend, quality and low beta factor exposures of the Underlying Index were the primary sources of the Underlying Index’s outperformance against the MSCI ACWI ex USA Index6 by 2.87%. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was -20 basis points (“bps”)7, which is reflective of the Fund’s management fee (-47 bps), stock selection/futures (+8 bps), securities lending (+6 bps),

performance calculation differences between the Underlying Index and the Fund (+1 bps), India Cap Gain Tax (+7 bps) and compounding of tracking error over time (+5 bps).

 

 

3 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

4 

Dividend yield factor is a factor that seeks to identify companies that realize a dividend yield above the Parent Index.

 

5 

The quality factor is a factor that seeks to identify companies that exhibit stable returns relative to the market.

 

6 

The Morgan Stanley Capital International All Country World Index Ex-U.S. is a market-capitalization-weighted index maintained by Morgan Stanley Capital International (MSCI) and is designed to provide a broad measure of stock performance throughout the world, with the exception of U.S.-based companies.

 

7 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

44    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® International   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Quality Dividend Dynamic Index Fund Ticker:  IQDY

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     5 Year     Fund
Inception
4/12/2013
 
 

 

 

 

FlexShares International Quality Dividend Dynamic Index Fund (Based on Net Asset Value)

    -25.48     -1.03     -0.88     2.46

FlexShares International Quality Dividend Dynamic Index Fund (Based on Market Price)

    -26.15     -1.23     -1.01     2.43

MSCI AC World ex USA Index

    -24.73     -1.68     -0.60     2.39

Northern Trust International Quality Dividend Dynamic IndexSM

    -25.46     -0.73     -0.65     2.85

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.48% and the net expense ratio is 0.47%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that correspond generally, before fees and expenses, to the price and yield performance of the Northern Trust International Quality Dividend Dynamic IndexSM (the “Underlying Index”). The Underlying Index is designed to reflect the performance of a selection of companies that, in aggregate, possess greater financial strength and stability characteristics relative to the Northern Trust International Large Cap Index (the “Parent Index”)1. In addition, the Underlying Index is designed to select companies from the Parent Index that have enhanced risk return characteristics and that in the aggregate have the potential to generate income in excess of the income generated by securities in the Parent Index with a beta2 that is higher than that of the Parent Index. As of October 31, 2022, there were 204 issues in the Underlying Index. Northern Trust Investments, Inc. (“NTI”) uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on international equities generally traded lower. Over the course of the 12-month period the U.S. dollar (USD) rose significantly and negatively impacted U.S. investors as returns in international currencies generally were hurt by the rising dollar. Through Q4 of 2021, international equities traded lower as the rapid spread of the Omicron variant of Covid-19 stoked fears that a new round of

 

1 

Northern Trust International Large Cap Index is a float-adjusted market-capitalization weighted index comprised of non-U.S. domiciled large- and mid-capitalization companies.

 

2 

A statistical measure of the volatility, or sensitivity, of rates of return on a portfolio or security compared to a market index and time period. The beta for an ETF measures the expected change in return of the ETF relative to the return of a designated index. By definition, the beta of the Standard & Poor’s (“S&P”) 500 Index is 1.00. Accordingly, a fund with a 1.10 beta is expected to perform 10% better than the S&P 500 Index in rising markets and 10% worse in falling markets.

 

   FLEXSHARES ANNUAL REPORT     45  


Table of Contents

 

FlexShares® International   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Quality Dividend Dynamic Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

lockdowns in China would hinder growth in the region. International equity markets continued to decline in Q1 of 2022 as Russia launched a full scale invasion into Ukraine and the U.S. and its European allies responded with sanctions. As part of these sanctions, Russian equity securities were removed from major international market indices in March. The selloff in international equities accelerated in Q2 and Q3 of 2022 as the continued war in Ukraine, rising inflation, energy shortages and tightening monetary policy increased the risk of a global recession. As global central banks struggled to keep pace with the aggressive key interest rate3 hikes by the U.S. Federal Reserve, the increasing interest rate differential caused the USD to strengthen versus many global currencies. International equities generally traded higher in October of 2022 as corporate earnings showed resilience and investors interpreted statements by the European Central Bank regarding the likelihood of a recession as a potential reprieve to further key interest rate hikes in the near future.

 

Because of the changes in growth expectations and the rising rate environment, international investments trended downward during the 12 months ended October 31, 2022 and we believe the dividend yield factor4 was a positive driver of Fund performance as high yielding investments outperformed low yielding and non-dividend paying investments. In addition, we believe that the changes experienced in the macroeconomic environment as well as the increase in interest rates were conducive to high quality factor5 companies, resulting in the high-quality factor exposure augmenting Fund performance over the 12 months. Because international equities moved lower over the 12 months we believe that the high beta exposure detracted from Fund performance. Overall, the positive performance derived from the yield and quality factor exposures of the Underlying Index were not enough to offset the negative performance of its high beta exposure leading to the Underlying Index’s underperformance against the MSCI ACWI ex USA Index6 by 0.73%. Tracking difference between the Fund’s NAV and the Underlying Index’s total return

for the 12-month period was -2 basis points (“bps”)7, which is reflective of the Fund’s management fee (-47 bps), stock selection/futures (+2 bps), securities lending (+8 bps), dividend tax differential (-1 bps), performance calculation differences between the Underlying Index and the Fund (+27 bps), India Cap Gain Tax (+7 bps) and compounding of tracking error over time (+2 bps).

 
3 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

4 

Dividend yield factor is a factor that seeks to identify companies that realize a dividend yield above the Parent Index.

 

5 

The quality factor is a factor that seeks to identify companies that exhibit stable returns relative to the market.

6 

The Morgan Stanley Capital International All Country World Index Ex-U.S. is a market-capitalization-weighted index maintained by Morgan Stanley Capital International (MSCI) and is designed to provide a broad measure of stock performance throughout the world, with the exception of U.S.-based companies.

 

7 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

46    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® iBoxx®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

3-Year Target Duration TIPS Index Fund Ticker:  TDTT

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     5 Year     10 Year     Fund
Inception
9/19/2011
 
 

 

 

 

FlexShares iBoxx 3-Year Target Duration TIPS

       

Index Fund (Based on Net Asset Value)

    -4.41 %*      2.55     1.26     1.38

FlexShares iBoxx 3-Year Target Duration TIPS

       

Index Fund (Based on Market Price)

    -4.36     2.57     1.27     1.39

iBoxx 3-Year Target Duration TIPS Index

    -4.19     2.73     1.44     1.55

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.19% and the net expense ratio is 0.18%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that, before fees and expenses, correspond generally to the price and yield performance of the iBoxx 3-Year Target Duration TIPS Index (the “Underlying Index”). The Underlying Index reflects the performance of a selection of inflation protected public obligations of the U.S. Treasury (“TIPS”), with a targeted average modified adjusted duration,1 as defined by IHS Markit as the index provider, of approximately three years. The Underlying Index includes publicly issued TIPS that have maturity dates of at least one year but not more than ten years from an index rebalancing date. As of October 31, 2022, there were 18 TIPS in the Underlying Index. Northern Trust Investments, Inc. (“NTI”) uses a “passive” or indexing approach to achieve the Fund’s investment objective. NTI generally intends to replicate the constituent securities of the Underlying Index to manage the Fund but may use representative sampling in certain circumstances. “Representative sampling” means investing in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. When the Fund uses representative sampling, it may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on domestic equities generally traded lower. Through Q4 of 2021 U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. U.S. equities declined in Q1 of 2022 as concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. In an attempt to combat inflation, the U.S. Federal Reserve (the “Fed”) raised the key interest rate2 by 0.25% in March 2022

 

1 

The duration calculated from the real modified duration of a TIPS security, adjusted for the market’s estimated beta for a TIPS security versus a nominal Treasury security due to the actual and expected changes in inflation.

 

2 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

   FLEXSHARES ANNUAL REPORT     47  


Table of Contents

 

FlexShares® iBoxx®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

3-Year Target Duration TIPS Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

and signaled more aggressive key interest rate hikes may be necessary. In Q1 of 2022 the Fed indeed moved to tighten monetary conditions. Our analysis suggests that by early in Q1 of 2022 investors anticipated the need for the Fed to address higher inflation and the U.S. yield curve steepened—which meant that short term interest rates fell faster than long term interest rates. Intermediate Treasury yields, defined as Treasury bonds equal to or less than 10 years to maturity, moved higher. This movement of yields eventually led to an inverting of the yield curve which happens when the 2-year maturing note yields more than the corresponding yield on a 10-year bond. The Fed increased the key interest rate 0.50% in May and 0.75% in June while signaling additional aggressive key interest rate hikes at future meetings were likely. as the Fed continued raising the key interest rate with two 0.75% increases in July and September.

 

Fed rate actions and U.S. inflation results had a major impact on real yields3 during the period which steadily increased with Fed key interest rate hikes. Short-term real yields increased the most as the key interest rate moved above 3.00% while intermediate and long-term, those bonds with greater than 15+ years to maturity, real yields also increased. We believe that investor expectations for rebounding corporate revenues and earnings along with investor pursuit of higher yields led to increased demand for U.S. corporate credit securities.

 

Intermediate-term4 credit spreads5 trended lower into the fiscal year. Further robust economic recovery and consumer/business spending helped drive average Intermediate-term option adjusted spreads (OAS)6 to 63 basis points (“bps”)7 in comparison to comparable maturing Treasury securities by fiscal year from 94 bps at the beginning of the fiscal year8.

 

TIPS inflation breakeven9 spreads in the 10-year maturity and shorter moved lower during the fiscal

year as investors weighed the impact of Fed actions and geopolitical events on future inflation potential. We believe that inflationary pressures from supply constraints and wage pressures were being offset by demand destruction, often from the impact of higher energy costs. Inflation expectations remain elevated versus recent history and against Fed policy levels. By the end of the fiscal year, TIPS breakeven spreads were: 1-year -50 bps, 5-year -27 bps, 10-year -8 bps and 30-year +23 bps.

 

The highest U.S. inflation rate in 30 years along with rising real interest rates during the fiscal year led to a negative total return performance for both the Fund and the Underlying Index. For the 12-month period, the NAV performance of the Fund outperformed the Bloomberg U.S. TIPS 1-10 Year Index10 by +278 bps due in part to lower overall duration in the 1–3-year section of the TIPS yield curve with rising real interest rates. Tracking difference between the Fund’s NAV and the Underlying Index for the 12-month period was -22 bps, reflective of the Fund’s management fee (-18 bps), duration and curve positioning (+4 bps), security selection (-2 bps) and other factors (-6 bps).

 

The iBoxx 3-Year Target Duration TIPS Index is the intellectual property (including registered trademarks) of Markit iBoxx and/or its licensors (“Licensors”), which is used under license. The securities based on the Index are in no way sponsored, endorsed, sold or promoted by Markit iBoxx and its Licensors and neither of the Licensors shall have any liability with respect thereto.

 

 

3 

A real yield is the yield to the investor that has been adjusted to remove the effects of inflation.

 

4 

Intermediate-term bonds typically mature between 3–10 years.

 

5 

Credit spread is the difference in yield between one debt security and another debt security with the same maturity but of lesser quality.

 

6

The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate or portfolio and typically the Treasury securities yield (often referred to as the risk-free rate) and that spread is added to the fixed-income security for comparison purposes.

 

7 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

8 

Source: Bloomberg, in this analysis we are making a comparison between the difference of the Option Adjusted Spread of intermediate-term investment grade corporate bonds using data available on the Bloomberg US Intermediate Corporate Bond Index as of October 31, 2021 – October 31, 2022.

 

9 

Bloomberg. In this analysis we are making a comparison between the difference in the nominal yield and real yield rates of the 1-year, 5-year, 10-year and 30-year maturities using data available as of October 31, 2021 and October 31, 2022.

 

10 

The Bloomberg US Treasury Inflation Notes: 1-10 Year \Index (Series-L) measures the performance of the US Treasury Inflation Protected Securities (TIPS) market with less than 10 years to maturity.

 

48    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® iBoxx®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

5-Year Target Duration TIPS Index Fund Ticker:   TDTF

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     5 Year     10 Year     Fund
Inception
9/19/2011
 
 

 

 

 

FlexShares iBoxx 5-Year Target Duration TIPS

       

Index Fund (Based on Net Asset Value)

    -9.42 %*      2.32     1.16     1.60

FlexShares iBoxx 5-Year Target Duration TIPS

       

Index Fund (Based on Market Price)

    -9.44     2.33     1.15     1.61

iBoxx 5-Year Target Duration TIPS Index

    -9.25     2.52     1.33     1.76

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.19% and the net expense ratio is 0.18%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that, before fees and expenses, correspond generally to the price and yield performance of the iBoxx 5-Year Target Duration TIPS Index (the “Underlying Index”). The Underlying Index reflects the performance of a selection of inflation protected public obligations of the U.S. Treasury (“TIPS”), with a targeted average modified adjusted duration,1 as defined by IHS Markit as the index provider, of approximately five years. The Underlying Index includes publicly issued TIPS that have maturity dates of at least three years but not more than twenty years from an index rebalancing date. As of October 31, 2022, there were 26 TIPS in the Underlying Index. Northern Trust Investments, Inc. (“NTI”) uses a “passive” or indexing approach to achieve the Fund’s investment objective. NTI generally intends to replicate the constituent securities of the Underlying Index to manage the Fund but may use representative sampling in certain circumstances. “Representative sampling” means investing in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. When the Fund uses representative sampling, it may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on domestic equities generally traded lower. Through Q4 of 2021 U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. U.S. equities declined in Q1 of 2022 as concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. In an attempt to combat inflation, the U.S. Federal Reserve (the “Fed”) raised the

 

1 

The duration calculated from the real modified duration of a TIPS security, adjusted for the market’s estimated beta for a TIPS security versus a nominal Treasury security due to the actual and expected changes in inflation.

 

   FLEXSHARES ANNUAL REPORT     49  


Table of Contents

 

FlexShares® iBoxx®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

5-Year Target Duration TIPS Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

key interest rate2 by 0.25% in March 2022 and signaled more aggressive key interest rate hikes may be necessary. In Q1 of 2022 the Fed indeed moved to tighten monetary conditions. Our analysis suggests that by early in Q1 of 2022 investors anticipated the need for the Fed to address higher inflation and the U.S. yield curve steepened— which meant that short term interest rates fell faster than long term interest rates. Intermediate Treasury yields, defined as Treasury bonds equal to or less than 10 years to maturity, moved higher. This movement of yields eventually led to an inverting of the yield curve which happens when the 2-year maturing note yields more than the corresponding yield on a 10-year bond. The Fed increased the key interest rate 0.50% in May and 0.75% in June while signaling additional aggressive key interest rate hikes at future meetings were likely. as the Fed continued raising the key interest rate with two 0.75% increases in July and September.

 

Fed rate actions and U.S. inflation results had a major impact on real yields3 during the period which steadily increased with Fed key interest rate hikes. Short-term real yields increased the most as the key interest rate moved above 3.00% while intermediate and long-term, those bonds with greater than 15+ years to maturity, real yields also increased. We believe that investor expectations for rebounding corporate revenues and earnings along with investor pursuit of higher yields led to increased demand for U.S. corporate credit securities. Intermediate-term4 credit spreads5 trended lower into the fiscal year. Further robust economic recovery and consumer/business spending helped drive average Intermediate-term option adjusted spreads (OAS)6 to 63 basis points (“bps”)7 in comparison to comparable maturing Treasury securities by fiscal year from 94 bps at the beginning of the fiscal year8.

TIPS inflation breakeven9 spreads in the 10-year maturity and shorter moved lower during the fiscal year as investors weighed the impact of Fed actions and geopolitical events on future inflation potential. We believe that inflationary pressures from supply constraints and wage pressures were being offset by demand destruction, often from the impact of higher energy costs. Inflation expectations remain elevated versus recent history and against Fed policy levels. By the end of the fiscal year, TIPS breakeven spreads were: 1-year -50 bps, 5-year -27 bps, 10-year -8 bps and 30-year +23 bps.

 

The highest U.S. inflation rate in 30 years along with rising real interest rates during the fiscal year led to positive total return performance for both the Fund and the Underlying Index. For the 12-month period, the NAV performance of the Fund underperformed the Bloomberg U.S. TIPS 1-10 Year Index10 by -30 bps due to higher duration positioning of the Underlying Index against the backdrop of falling real interest rates. Tracking difference between the Fund’s NAV and the Underlying Index for the 12-month period was -17 bps, reflective of the Fund’s management fee (-18 bps), duration and curve positioning (-4 bps), security selection (+3 bps), trading and pricing differences (+8 bps), and other factors (-6 bps).

 

The iBoxx 5-Year Target Duration TIPS Index is the intellectual property (including registered trademarks) of Markit iBoxx and/or its licensors (“Licensors”), which is used under license. The securities based on the Index are in no way sponsored, endorsed, sold or promoted by Markit iBoxx and its Licensors and neither of the Licensors shall have any liability with respect thereto.

 

 

2 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

3 

A real yield is the yield to the investor that has been adjusted to remove the effects of inflation.

 

4 

Intermediate-term bonds typically mature between 3–10 years.

 

5 

Credit spread is the difference in yield between one debt security and another debt security with the same maturity but of lesser quality.

 

6 

The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate or portfolio and typically the Treasury securities yield (often referred to as the risk-free rate) and that spread is added to the fixed-income security for comparison purposes.

 

7 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

8 

Source: Bloomberg, in this analysis we are making a comparison between the difference of the Option Adjusted Spread of intermediate-term investment grade corporate bonds using data available on the Bloomberg US Intermediate Corporate Bond Index as of October 31, 2021 – October 31, 2022.

 

9 

Bloomberg. In this analysis we are making a comparison between the difference in the nominal yield and real yield rates of the 1-year, 5-year, 10-year and 30-year maturities using data available as of October 31, 2021 and October 31, 2022.

 

10 

The Bloomberg US Treasury Inflation Notes: 1-10 Year \Index (Series-L) measures the performance of the US Treasury Inflation Protected Securities (TIPS) market with less than 10 years to maturity.

 

50    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® Disciplined   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Duration MBS Index Fund Ticker:   MBSD

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year      5 Year      Fund
Inception
9/3/2014
 
 

 

 

 

FlexShares Disciplined Duration MBS Index Fund (Based on Net Asset Value)

    -12.16     -2.69      -0.55      0.27

FlexShares Disciplined Duration MBS Index Fund (Based on Market Price)

    -12.40     -2.72      -0.55      0.26

ICE BofA Merrill Lynch® Constrained Duration US Mortgage Backed Securities IndexSM

    -11.57     -2.23      -0.01      0.75

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.21% and the net expense ratio is 0.20%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the ICE BofA® Constrained Duration US Mortgage Backed Securities Index (the “Underlying Index”). The Underlying Index reflects the performance of a selection of investment-grade US agency residential mortgage-backed pass-through securities (“MBS”). Pursuant to the Underlying Index’s methodology, index constituents are adjusted to achieve an effective duration1 that is generally between 3.25 and 4.25 years. As of October 31, 2022, there were 129 securities in the Underlying Index. Northern Trust Investments, Inc. (“NTI”) uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on domestic equities generally traded lower. Through Q4 of 2021 U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. U.S. equities declined in Q1 of 2022 as concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. In an attempt to combat inflation, the U.S. Federal Reserve (the “Fed”) raised the key interest rate2 by 0.25% in March 2022

 

   FLEXSHARES ANNUAL REPORT     51  
1 

Effective duration provides a measure of a fund’s interest-rate sensitivity and the longer a fund’s duration, the more sensitive the fund is to shifts in interest rates. Duration also gives an indication of how a fund’s NAV will change as interest rates change. A fund with a five-year duration would be expected to lose 5% of its NAV if interest rates rose by 1 percentage point or gain 5%, if interest rates fell by 1 percentage point. Morningstar surveys fund companies for this information.

 

2 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.


Table of Contents

 

FlexShares® Disciplined   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Duration MBS Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

and signaled more aggressive key interest rate hikes may be necessary. In Q1 of 2022 the Fed indeed moved to tighten monetary conditions. Our analysis suggests that by early in Q1 of 2022 investors anticipated the need for the Fed to address higher inflation and the U.S. yield curve steepened—which meant that short term interest rates fell faster than long term interest rates. Intermediate Treasury yields, defined as Treasury bonds equal to or less than 10 years to maturity, moved higher. This movement of yields eventually led to an inverting of the yield curve which happens when the 2-year maturing note yields more than the corresponding yield on a 10-year bond. The Fed increased the key interest rate 0.50% in May and 0.75% in June while signaling additional aggressive key interest rate hikes at future meetings were likely. as the Fed continued raising the key interest rate with two 0.75% increases in July and September.

 

Fed rate actions and U.S. inflation results had a major impact on real yields3 during the period which steadily increased with Fed key interest rate hikes. Short-term real yields increased the most as the key interest rate moved above 3.00% while intermediate and long-term, those bonds with greater than 15+ years to maturity, real yields also increased. We believe that investor expectations for rebounding corporate revenues and earnings along with investor pursuit of higher yields led to increased demand for U.S. corporate credit securities.

 

Intermediate-term4 credit spreads5 trended lower into the fiscal year. Further robust economic recovery and consumer/business spending helped drive average Intermediate-term option adjusted spreads (OAS)6 to 63 basis points (“bps”)7 in comparison to comparable maturing Treasury securities by fiscal year from 94 bps at the beginning of the fiscal year8.

Rising interest rates eventually drove down housing sales and mortgage applications as average 30-year mortgage rates (Freddie Mac Index) rose dramatically from 3.22% to 7.08% during the fiscal year9. Existing home sales saw a 32% decrease10 while new housing starts saw an decrease of over 9% for the fiscal year.11

 

Highest inflation in 30 years along with falling real interest rates during the fiscal year led to positive total return performance for both the Fund and the Underlying Index. For the 12-month period, the NAV performance of the Fund outperformed the Bloomberg U.S. Mortgage Backed Securities Index12 by +30 bps due to the Underlying Index’s exposure to a selection of higher coupon13, more seasoned MBS securities which outperformed newer MBS due in part to less principal prepayment risk. Tracking difference between the Fund’s NAV and the Underlying Index’s total return for the 12-month period was -101 bps, reflective of the Fund’s management fee (-20 bps), trading costs and fees (-8 bps), pricing differences (-83 bps), yield curve positioning (-21 bps), sector allocation (-5 bps), security selection (+37 bps), and other factors (-1 bps).

 

The ICE BofAML Constrained Duration US Mortgage Backed Securities Index is the intellectual property (including registered trademarks) of ICE BofAML and/or its licensors (“Licensors”), which is used under license. The securities based on the Index are in no way sponsored, endorsed, sold or promoted by ICE BofAML and its Licensors and neither of the Licensors shall have any liability with respect thereto.

 

 

3 

A real yield is the yield to the investor that has been adjusted to remove the effects of inflation.

 

4 

Intermediate-term bonds typically mature between 3–10 years.

 

5 

Credit spread is the difference in yield between one debt security and another debt security with the same maturity but of lesser quality.

 

6 

The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate or portfolio and typically the Treasury securities yield (often referred to as the risk-free rate) and that spread is added to the fixed-income security for comparison purposes.

 

7 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

8 

Source: Bloomberg, in this analysis we are making a comparison between the difference of the Option Adjusted Spread of intermediate-term investment grade corporate bonds using data available on the Bloomberg US Intermediate Corporate Bond Index as of October 31, 2021 – October 31, 2022.

 

 

9 

Source: Bloomberg. Federal Home Loan Mortgage Corp. Primary Mortgage Market Survey. October 31, 2021 through November 1, 2022.

 

10 

Source: Bloomberg. National Association of Realtors, US Existing Homes Sales, September 30, 2021 through September 30, 2022.

 

11 

Source: Bloomberg. U.S. Census Bureau, Us New Privately Owned Housing Unites Starts, October 31, 2021 through October 31, 2022.

 

12 

The Bloomberg US Mortgage Backed Securities Index tracks fixed-rate agency mortgage backed passthrough securities guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC).

 

13 

A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity.

 

52    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® Credit-Scored   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

US Corporate Bond Index Fund Ticker:   SKOR

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

*

The hybrid index performance information reflects the performance of the Northern Trust Credit-Scored US Corporate Bond IndexSM (Previous Index) through April 30, 2020 and the Northern Trust US Corporate Bond Quality Value IndexSM thereafter. The Previous Index terminated as of May 1, 2020.

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     5 Year     Fund
Inception
11/12/2014
 
 

 

 

 

FlexShares Credit-Scored US Corporate Bond Index Fund (Based on Net Asset Value)

    -12.91     -2.03     0.56     1.50

FlexShares Credit-Scored US Corporate Bond Index Fund (Based on Market Price)

    -12.79     -1.99     0.53     1.51

Bloomberg Intermediate U.S. Corporate Index

    -12.18     -2.08     0.52     1.49

Northern Trust US Corporate Bond Quality Value IndexSM

    -12.37     -1.43 %*      1.09 %*      1.95 %* 

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.23% and the net expense ratio is 0.22%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the Northern Trust US Corporate Bond Quality Value IndexSM (the “Underlying Index”). The Underlying Index reflects the performance of a broad universe of intermediate maturity, US-dollar denominated investment grade corporate bonds that can potentially deliver a higher total return than the overall investment grade corporate bond market, as represented by the Northern Trust US Investment-Grade Corporate Bond IndexSM (the “Parent Index”).1 The Underlying Index begins with the Parent Index and then follows a rules-based methodology to select and weight securities, subject to certain constraints, to optimize the Underlying Index’s exposure to a combined proprietary, value score2 and a proprietary quality score3, as determined by Northern Trust Investments, Inc. (“NTI”), in its capacity as index provider. Utilizing the value and quality scores, the Underlying Index methodology seeks to identify bonds that are trading at market prices that are lower relative to levels implied by their fundamentals, thus creating a potential opportunity for capital appreciation and higher income compared to the broader investment grade corporate bond market. As of October 31, 2022, there were 2,357 issues in the Underlying Index. NTI uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment

 

1 

The Northern Trust US Investment Grade Corporate Bond IndexSM is a market-capitalization weighted index comprised of U.S. dollar-denominated investment grade corporate bonds.

 

2 

The value score is a quantitative measure of the relative attractiveness of each security’s valuation compared to market price or relative valuation versus other similar securities, and is computed based on market and fundamental measures, including issuer default risk.

 

3 

The quality score is a quantitative ranking based on: (a) an assessment of management efficiency (e.g., corporate finance activities); (b) profitability (reliability and sustainability of financial performance); and (c) financial solvency (e.g., debt servicing capacity).

 

   FLEXSHARES ANNUAL REPORT     53  


Table of Contents

 

FlexShares® Credit-Scored   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

US Corporate Bond Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on domestic equities generally traded lower. Through Q4 of 2021 U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. U.S. equities declined in Q1 of 2022 as concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. In an attempt to combat inflation, the U.S. Federal Reserve (the “Fed”) raised the key interest rate4 by 0.25% in March 2022 and signaled more aggressive key interest rate hikes may be necessary. In Q1 of 2022 the Fed indeed moved to tighten monetary conditions. Our analysis suggests that by early in Q1 of 2022 investors anticipated the need for the Fed to address higher inflation and the U.S. yield curve steepened—which meant that short term interest rates fell faster than long term interest rates. Intermediate Treasury yields, defined as Treasury bonds equal to or less than 10 years to maturity, moved higher. This movement of yields eventually led to an inverting of the yield curve which happens when the 2-year maturing note yields more than the corresponding yield on a 10-year bond. The Fed increased the key interest rate 0.50% in May and 0.75% in June while signaling additional aggressive key interest rate hikes at future meetings were likely. as the Fed continued raising the key interest rate with two 0.75% increases in July and September.

Fed rate actions and U.S. inflation results had a major impact on real yields5 during the period which steadily increased with Fed key interest rate hikes. Short-term real yields increased the most as the key interest rate moved above 3.00% while intermediate and long-term, those bonds with greater than 15+ years to maturity, real yields also increased. We believe that investor expectations for rebounding corporate revenues and earnings along with investor pursuit of higher yields led to increased demand for U.S. corporate credit securities. Intermediate-term6 credit spreads7 trended lower into the fiscal year. Further robust economic recovery and consumer/business spending helped drive average Intermediate-term option adjusted spreads (OAS)8 to 63 basis points (“bps”)9 in comparison to comparable maturing Treasury securities by fiscal year from 94 bps at the beginning of the fiscal year.10

 

During the fiscal year, the Fund’s NAV underperformed the Bloomberg U.S. Intermediate Corporate Bond Index11 by -5 bps due in part to the Fund’s management fee. During the fiscal year, relative overweight allocations to fixed income securities in financials, real estate investment trusts (“REIT”) and utilities sectors along with security selection in the banking and utility sectors added to Fund performance while a relative underweighting to the communications sector and security selection in the industrials sector detracted from performance. The tracking difference between the Fund’s NAV and the Underlying Index’s return for the fiscal year was -64 bps, which is reflective of the Fund’s management fee (-22 bps), trading costs and fees (-14 bps), pricing differences (+1 bps), sector and security selection (-31 bps), yield curve positioning (+1 bps), and other factors (+1 bp).

 

 

4 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

5 

A real yield is the yield to the investor that has been adjusted to remove the effects of inflation.

 

6 

Intermediate-term bonds typically mature between 3–10 years.

 

7 

Credit spread is the difference in yield between one debt security and another debt security with the same maturity but of lesser quality.

 

8 

The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate or portfolio and typically the Treasury securities yield (often referred to as the risk-free rate) and that spread is added to the fixed-income security for comparison purposes.

 

9 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

10 

Source: Bloomberg, in this analysis we are making a comparison between the difference of the Option Adjusted Spread of intermediate-term investment grade corporate bonds using data available on the Bloomberg US Intermediate Corporate Bond Index as of October 31, 2021 – October 31, 2022.

 

11 

Bloomberg US Intermediate Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market that have between 1 and up to, but not including, 10 years to maturity.

 

54    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® Credit-Scored   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

US Long Corporate Bond Index Fund Ticker:   LKOR

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

 

LOGO

 

*

The hybrid index performance information reflects the performance of the Northern Trust Credit-Scored US Long Corporate Bond IndexSM (Previous Index) through April 30, 2020 and the Northern Trust US Long Corporate Bond Quality Value IndexSM thereafter. The Previous Index terminated as of May 1, 2020.

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     5 Year     Fund
Inception
9/23/2015
 
 

 

 

 

FlexShares Credit-Scored US Long Corp Bond Index Fund (Based on Net Asset Value)

    -31.58     -7.41     -1.56     1.29

FlexShares Credit-Scored US Long Corp Bond Index Fund (Based on Market Price)

    -31.22     -7.16     -1.54     1.36

Bloomberg Long U.S. Corporate Index

    -31.04     -7.83     -1.75     1.30

Northern Trust US Long Corporate Bond Quality Value IndexSM

    -31.16     -6.59 %*      --0.84 %*      1.95 %* 

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.23% and the net expense ratio is 0.22%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the Northern Trust US Long Corporate Bond Quality Value IndexSM (the “Underlying Index”). The Underlying Index reflects the performance of a broad universe of longer term maturity, US-dollar denominated investment grade corporate bonds that can potentially deliver a higher total return than the overall investment grade corporate bond market, as represented by the Northern Trust US Long Corporate Bond IndexSM (the “Parent Index”).1 The Underlying Index begins with the Parent Index and then follows a rules-based methodology to select and weight securities, subject to certain constraints, to optimize the Underlying Index’s exposure to a combined proprietary, value score2 and a proprietary quality score3, as determined by Northern Trust Investments, Inc. (“NTI”), in its capacity as index provider. Utilizing the value and quality scores, the Underlying Index methodology seeks to identify bonds that are trading at market prices that are lower relative to levels implied by their fundamentals, thus creating a potential opportunity for capital appreciation and higher income compared to the broader investment grade corporate bond market. As of October 31, 2022, there were 1,273 issues in the Underlying Index. NTI uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that

 

 

1 

The Northern Trust US Long Corporate Bond IndexSM is a market capitalization weighted index comprised of long-term, U.S. dollar- denominated investment grade corporate bonds.

 

2 

The value score is a quantitative measure of the relative attractiveness of each security’s valuation compared to market price or relative valuation versus other similar securities, and is computed based on market and fundamental measures, including issuer default risk.

 

3 

The quality score is a quantitative ranking based on: (a) an assessment of management efficiency (e.g., corporate finance activities); (b) profitability (reliability and sustainability of financial performance); and (c) financial solvency (e.g., debt servicing capacity).

 

   FLEXSHARES ANNUAL REPORT     55  


Table of Contents

 

FlexShares® Credit-Scored   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

US Long Corporate Bond Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on domestic equities generally traded lower. Through Q4 of 2021 U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. U.S. equities declined in Q1 of 2022 as concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. In an attempt to combat inflation, the U.S. Federal Reserve (the “Fed”) raised the key interest rate4 by 0.25% in March 2022 and signaled more aggressive key interest rate hikes may be necessary. In Q1 of 2022 the Fed indeed moved to tighten monetary conditions. Our analysis suggests that by early in Q1 of 2022 investors anticipated the need for the Fed to address higher inflation and the U.S. yield curve steepened—which meant that short term interest rates fell faster than long term interest rates. Intermediate Treasury yields, defined as Treasury bonds equal to or less than 10 years to maturity, moved higher. This movement of yields eventually led to an inverting of the yield curve which happens when the 2-year maturing note yields more than the corresponding yield on a 10-year bond. The Fed increased the key interest rate 0.50% in May and 0.75% in June while signaling additional aggressive key interest rate hikes at future meetings were likely. as the Fed continued raising the key interest rate with two 0.75% increases in July and September.

Fed rate actions and U.S. inflation results had a major impact on real yields5 during the period which steadily increased with Fed key interest rate hikes. Short-term real yields increased the most as the key interest rate moved above 3.00% while intermediate and long-term, those bonds with greater than 15+ years to maturity, real yields also increased. We believe that investor expectations for rebounding corporate revenues and earnings along with investor pursuit of higher yields led to increased demand for U.S. corporate credit securities. Intermediate-term6 credit spreads7 trended lower into the fiscal year. Further robust economic recovery and consumer/business spending helped drive average Intermediate-term option adjusted spreads (OAS)8 to 63 basis points (“bps”)9 in comparison to comparable maturing Treasury securities by fiscal year from 94 bps at the beginning of the fiscal year.10

 

During the fiscal year, the Fund’s NAV underperformed the Bloomberg U.S. Long Corporate Bond Index11 by +59 bps. During the fiscal year, positive performance from relative sector overweight allocations to fixed income securities in energy, financials and materials sectors added to Fund performance while a relative underweighting to the communications, consumer staples and industrial sectors detracted from performance. The tracking difference between the Fund’s NAV and the combined Underlying Indexes return for the period was -72 bps, which is reflective of the Fund’s management fee (-22 bps), trading costs and fees (-36 bps), pricing differences (-5 bps), sector and security selection (-17 bps), yield curve positioning (+9 bps), and other factors (-1 bp).

 

4 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

5 

A real yield is the yield to the investor that has been adjusted to remove the effects of inflation.

 

6 

Intermediate-term bonds typically mature between 3–10 years.

 

7 

Credit spread is the difference in yield between one debt security and another debt security with the same maturity but of lesser quality.

 

8 

The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate or portfolio and typically the Treasury securities yield (often referred to as the risk-free rate) and that spread is added to the fixed-income security for comparison purposes.

 

9 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

10

Source: Bloomberg, in this analysis we are making a comparison between the difference of the Option Adjusted Spread of intermediate-term investment grade corporate bonds using data available on the Bloomberg US Intermediate Corporate Bond Index as of October 31, 2021 – October 31, 2022.

 

11 

Bloomberg US Long Corporate Bond Index measures the performance of investment grade U.S. corporate bond market with bonds that have a maturity of more than ten years.

 

56    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® High Yield   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Value-Scored Bond Index Fund Ticker:   HYGV

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     3 Year     Fund
Inception
7/17/2018
 
 

 

 

 

FlexShares High Yield Value-Scored US Bond Index Fund (Based on Net Asset Value)

    -13.06     0.53     2.10

FlexShares High Yield Value-Scored US Bond Index Fund (Based on Market Price)

    -12.98     0.52     2.13

ICE BofA® US High Yield Index

    -11.45     0.18     2.06

Northern Trust High Yield Value-Scored US Corporate Bond IndexSM

    -11.93     2.10     3.42

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.38% and the net expense ratio is 0.37%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the Northern Trust High Yield Value-Scored US Corporate Bond IndexSM (the “Underlying Index”). The Underlying Index reflects the performance of a broad universe of US-dollar denominated high yield corporate bonds that seeks a higher total return than the overall high yield corporate bond market, as represented by the Northern Trust High Yield US Corporate Bond IndexSM (the “Parent Index”).1 The securities included in the Underlying Index are a subset of the securities included in the Parent Index. The Underlying Index begins with the Parent Index and then follows a rules-based methodology to select and weight securities, subject to certain constraints, to optimize exposure to a proprietary value score2, as determined by Northern Trust Investments, Inc. (“NTI”), acting in its capacity as index provider. Utilizing the value score, the Underlying Index seeks to select bonds that are trading at market prices which are lower relative to levels implied by their fundamentals, thus creating an opportunity for potential capital appreciation and higher income to the broader market reflected by the Parent Index. As of October 31, 2022, there were 989 issues in the Underlying Index. NTI uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

1 

The Northern Trust High Yield US Corporate Bond IndexSM is a market capitalization weighted index comprised of U.S. dollar- denominated high yield corporate bonds.

 

2 

The value score is a quantitative measure of the relative attractiveness of each security’s valuation compared to market price or relative valuation versus other similar securities, and is computed based on market and fundamental measures, including issuer default risk.

 

   FLEXSHARES ANNUAL REPORT     57  


Table of Contents

 

FlexShares® High Yield   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Value-Scored Bond Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

During the 12 months ending October 31, 2022, prices on domestic equities generally traded lower. Through Q4 of 2021 U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. U.S. equities declined in Q1 of 2022 as concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. In an attempt to combat inflation, the U.S. Federal Reserve (the “Fed”) raised the key interest rate3 by 0.25% in March 2022 and signaled more aggressive key interest rate hikes may be necessary. In Q1 of 2022 the Fed indeed moved to tighten monetary conditions. Our analysis suggests that by early in Q1 of 2022 investors anticipated the need for the Fed to address higher inflation and the U.S. yield curve steepened—which meant that short term interest rates fell faster than long term interest rates. Intermediate Treasury yields, defined as Treasury bonds equal to or less than 10 years to maturity, moved higher. This movement of yields eventually led to an inverting of the yield curve which happens when the 2-year maturing note yields more than the corresponding yield on a 10-year bond. The Fed increased the key interest rate 0.50% in May and 0.75% in June while signaling additional aggressive key interest rate hikes at future meetings were likely. as the Fed continued raising the key interest rate with two 0.75% increases in July and September.

 

Fed rate actions and U.S. inflation results had a major impact on real yields4 during the period which steadily increased with Fed key interest rate hikes. Short-term real yields increased the most as the key interest rate moved above 3.00% while intermediate and long-term,

those bonds with greater than 15+ years to maturity, real yields also increased. We believe that investor expectations for rebounding corporate revenues and earnings along with investor pursuit of higher yields led to increased demand for U.S. corporate credit securities.

 

Intermediate-term5 credit spreads6 trended lower into the fiscal year. Further robust economic recovery and consumer/business spending helped drive average Intermediate-term option adjusted spreads (OAS) to 63 basis points (“bps”)7 in comparison to comparable maturing Treasury securities by fiscal year from 94 bps at the beginning of the fiscal year.

 

High Yield credit spreads from the beginning of the fiscal year raised investors’ uncertainty for corporate revenues and earnings. High Yield8 option adjusted spreads (“OAS”)9 of the ICE BofA US High Yield Index10 declined from 532 bps to 302 bps in early July 2022, then widened to 321 bps at the end of August 2022 and ended the fiscal year at 315 bps.11 We believe the decline in credit spreads was linked to investors continuing search for income, robust economic growth supported by fiscal and monetary policy and lower credit defaults. The Moody’s Investor Services’ annual high yield default rate measure fell from 8.3% in October 2021 to 2.6% as of October 2022.12 Our analysis, based on increasing issuance of new supply, suggests that High Yield investments have benefitted from the post-COVID recovery and access to capital markets as the year-to-date through October 2022 total gross new issuance of U.S. high yield bonds totaled $462 billion, versus the then record of $450 billion issued in 2020 and the $399 billion issued in 2013.13

 

 

3 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

4 

A real yield is the yield to the investor that has been adjusted to remove the effects of inflation.

 

5 

Intermediate-term bonds typically mature between 3–10 years.

 

6 

Credit spread is the difference in yield between one debt security and another debt security with the same maturity but of lesser quality.

 

7 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

8 

High yield are fixed income securities that are rated in the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below.

 

9 

The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate or portfolio and typically the Treasury securities yield (often referred to as the risk-free rate) and that spread is added to the fixed-income security for comparison purposes.

 

10 

The ICE BofA US High Yield Index is market capitalization weighted and is designed to measure the performance of U.S. dollar denominated below investment grade (commonly referred to as “junk”) corporate debt publicly issued in the U.S. domestic market.

 

11 

Source: Bloomberg. In this analysis we are making a comparison between the difference of the Option Adjusted Spread of long-term High Yield corporate bonds using data available on the ICE BofA US High Yield Index as of October 31, 2021 – October 31, 2022.

 

12 

Source: Moodys Investor Services, High Yield Default Recovery Analytics, October 31, 2022.

 

13 

Source: JP Morgan, 2022 High Yield Bond and Leverage Loan Supply Outlook, October 31, 2022.

 

58    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® High Yield   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Value-Scored Bond Index Fund (cont.)

 

 

 

 

 

 

PORTFOLIO ANALYSIS (cont.)

 

During the fiscal year, the Fund’s NAV underperformed the ICE BofA US High Yield Index by -161 bps. During the fiscal year, positive performance from relative sector overweight allocations to fixed income securities in energy, financials and materials sectors added to Fund performance while a relative underweighting to the communications, consumer staples and industrial sectors detracted from performance. The tracking difference between the Fund’s NAV and the combined Underlying Indexes return for the period was -72 bps, which is reflective of the Fund’s management fee (-22 bps), trading costs and fees (-36 bps), pricing differences (-5 bps), sector and security selection (-17 bps), yield curve positioning (+9 bps), and other factors (-1 bp).

 

   FLEXSHARES ANNUAL REPORT     59  


Table of Contents

 

FlexShares® ESG & Climate   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

High Yield Corporate Core Index Fund Ticker:   FEHY

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     Fund
Inception
9/20/2021
 
 

 

 

 

FlexShares ESG & Climate High Yield Corporate Core Index Fund (Based on Net Asset Value)

    -12.47     -11.69

FlexShares ESG & Climate High Yield Corporate Core Index Fund (Based on Market Price)

    -12.52     -11.72

ICE BofA® US High Yield Index

    -11.45     -10.59

Northern Trust ESG & Climate High Yield U.S. Corporate Core Index

    -11.65     -10.85

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2022. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.24% and the net expense ratio is 0.23%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Northern Trust ESG & Climate High Yield U.S. Corporate Core IndexSM (the “Underlying Index”). The Underlying Index seeks to reflect the performance of a selection of U.S.-dollar-denominated high-yield corporate bonds issued by companies that exhibit certain environmental, social and governance (“ESG”) characteristics, while also seeking to provide broad-market, core exposure to U.S.-dollar-denominated high-yield corporate bonds (sometimes referred to as “junk bonds”) of U.S. and non-U.S. issuers. The Underlying Index is designed to minimize tracking differences relative to the performance of the Northern Trust High Yield US Corporate Bond IndexSM (the “Parent Index”) while also seeking (a) an aggregate higher scoring of certain ESG characteristics, as measured by the Northern Trust ESG Vector Score (“ESG Vector Score”), and (b) reduction of aggregate climate-related risk, as measured by certain carbon-related risk metrics, each relative to the Parent Index. As of October 31, 2022, there were 1,119 issues in the Underlying Index. NTI uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on domestic equities generally traded lower. Through Q4 of 2021 U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. U.S. equities declined in Q1 of 2022 as concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. In an attempt to combat inflation, the U.S. Federal Reserve (the “Fed”) raised the

 

60    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® ESG & Climate   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

High Yield Corporate Core Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

key interest rate1 by 0.25% in March 2022 and signaled more aggressive key interest rate hikes may be necessary. In Q1 of 2022 the Fed indeed moved to tighten monetary conditions. Our analysis suggests that by early in Q1 of 2022 investors anticipated the need for the Fed to address higher inflation and the U.S. yield curve steepened—which meant that short term interest rates fell faster than long term interest rates. Intermediate Treasury yields, defined as Treasury bonds equal to or less than 10 years to maturity, moved higher. This movement of yields eventually led to an inverting of the yield curve which happens when the 2-year maturing note yields more than the corresponding yield on a 10-year bond. The Fed increased the key interest rate 0.50% in May and 0.75% in June while signaling additional aggressive key interest rate hikes at future meetings were likely. as the Fed continued raising the key interest rate with two 0.75% increases in July and September.

 

Fed rate actions and U.S. inflation results had a major impact on real yields2 during the period which steadily increased with Fed key interest rate hikes. Short-term real yields increased the most as the key interest rate moved above 3.00% while intermediate and long-term, those bonds with greater than 15+ years to maturity, real yields also increased. We believe that investor expectations for rebounding corporate revenues and earnings along with investor pursuit of higher yields led to increased demand for U.S. corporate credit securities.

 

Intermediate-term3 credit spreads4 trended lower into the fiscal year. Further robust economic recovery and consumer/business spending helped drive average Intermediate-term option adjusted spreads (OAS) to

63 basis points (“bps”)5 in comparison to comparable maturing Treasury securities by fiscal year from 94 bps at the beginning of the fiscal year.

 

High Yield credit spreads from the beginning of the fiscal year raised investors’ uncertainty for corporate revenues and earnings. High Yield6 option adjusted spreads (“OAS”)7 of the ICE BofA US High Yield Index8 declined from 532 bps to 302 bps in early July 2022, then widened to 321 bps at the end of August 2022 and ended the fiscal year at 315 bps.9 We believe the decline in credit spreads was linked to investors continuing search for income, robust economic growth supported by fiscal and monetary policy and lower credit defaults. The Moody’s Investor Services’ annual high yield default rate measure fell from 8.3% in October 2021 to 2.6% as of October 2022.10 Our analysis, based on increasing issuance of new supply, suggests that High Yield investments have benefitted from the post-COVID recovery and access to capital markets as the year-to-date through October 2022 total gross new issuance of U.S. high yield bonds totaled $462 billion, versus the then record of $450 billion issued in 2020 and the $399 billion issued in 2013.11

 

During the fiscal year, the Fund’s NAV underperformed the ICE BofA US High Yield Index by -102 bps. During the fiscal year, negative relative performance from allocation and security selection in health care along with security selection in real estate and sector allocations in industrial and energy offset positive contributions from security selection in energy and communications sectors. The tracking difference between the Fund’s NAV and the Underlying Index’s return for the period was -82 bps, which is reflective of

 

 

1 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

2 

A real yield is the yield to the investor that has been adjusted to remove the effects of inflation.

 

3 

Intermediate-term bonds typically mature between 3–10 years.

 

4 

Credit spread is the difference in yield between one debt security and another debt security with the same maturity but of lesser quality.

 

5 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

6 

High yield are fixed income securities that are rated in the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below.

 

7 

The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate or portfolio and typically the Treasury securities yield (often referred to as the risk-free rate) and that spread is added to the fixed-income security for comparison purposes.

 

8 

The ICE BofA US High Yield Index is market capitalization weighted and is designed to measure the performance of U.S. dollar denominated below investment grade (commonly referred to as “junk”) corporate debt publicly issued in the U.S. domestic market.

 

9 

Source: Bloomberg. In this analysis we are making a comparison between the difference of the Option Adjusted Spread of long-term High Yield corporate bonds using data available on the ICE BofA US High Yield Index as of October 31, 2021 – October 31, 2022.

 

10 

Source: Moodys Investor Services, High Yield Default Recovery Analytics, October 31, 2022.

 

11 

Source: JP Morgan, 2022 High Yield Bond and Leverage Loan Supply Outlook, October 31, 2022.

 

   FLEXSHARES ANNUAL REPORT     61  


Table of Contents

 

FlexShares® ESG & Climate   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

High Yield Corporate Core Index Fund (cont.)

 

 

 

 

 

 

PORTFOLIO ANALYSIS (cont.)

 

the Fund’s management fee (-23 bps), trading costs and fees (-3 bps), pricing differences (-30 bps), sector and security selection (-36 bps), yield curve positioning (+4 bps) and other factors (+6 bp).

 

62    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® ESG & Climate   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Investment Grade Corporate Core Index Fund Ticker:  FEIG

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     Fund
Inception
9/20/2021
 
 

 

 

 

FlexShares ESG & Climate Investment Grade Corporate Core Index Fund (Based on Net Asset Value)

    -19.73     -18.90

FlexShares ESG & Climate Investment Grade Corporate Core Index Fund (Based on Market Price)

    -19.60     -18.77

Bloomberg US Corporate Total Return Value Unhedged Index

    -19.57     -18.70

Northern Trust ESG & Climate Investment Grade U.S. Corporate Core Index

    -19.54     -18.70

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2022. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.13% and the net expense ratio is 0.12%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Northern Trust ESG & Climate Investment Grade U.S. Corporate Core IndexSM (the “Underlying Index”). The Underlying Index seeks to reflect the performance of a selection of U.S.-dollar-denominated corporate bonds issued by companies that exhibit certain environmental, social and governance (“ESG”) characteristics, while also seeking to provide broad-market, core exposure to U.S.-dollar-denominated investment grade corporate bonds of U.S. and non-U.S. issuers. The Underlying Index is designed to minimize tracking differences relative to the performance of the Northern Trust US Corporate Bond IndexSM (the “Parent Index”) while also seeking (a) an aggregate higher scoring of certain ESG characteristics, as measured by the Northern Trust ESG Vector Score (“ESG Vector Score”), and (b) reduction of aggregate climate-related risk, as measured by certain carbon-related risk metrics, each relative to the Parent Index. As of October 31, 2022, there were 3,474 issues in the Underlying Index. NTI uses a “passive” or indexing approach to try to achieve the Fund’s investment objective. NTI uses a representative sampling strategy to manage the Fund. This means that the Fund invests in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The Fund may or may not hold all of the securities that are included in the Underlying Index.

 

During the 12 months ending October 31, 2022, prices on domestic equities generally traded lower. Through Q4 of 2021 U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. U.S. equities declined in Q1 of 2022 as concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. In an attempt to combat inflation, the U.S. Federal Reserve (the “Fed”) raised the

 

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Table of Contents

 

FlexShares® ESG & Climate   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Investment Grade Corporate Core Index Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

key interest rate1 by 0.25% in March 2022 and signaled more aggressive key interest rate hikes may be necessary. In Q1 of 2022 the Fed indeed moved to tighten monetary conditions. Our analysis suggests that by early in Q1 of 2022 investors anticipated the need for the Fed to address higher inflation and the U.S. yield curve steepened—which meant that short term interest rates fell faster than long term interest rates. Intermediate Treasury yields, defined as Treasury bonds equal to or less than 10 years to maturity, moved higher. This movement of yields eventually led to an inverting of the yield curve which happens when the 2-year maturing note yields more than the corresponding yield on a 10-year bond. The Fed increased the key interest rate 0.50% in May and 0.75% in June while signaling additional aggressive key interest rate hikes at future meetings were likely. as the Fed continued raising the key interest rate with two 0.75% increases in July and September.

 

Fed rate actions and U.S. inflation results had a major impact on real yields2 during the period which steadily increased with Fed key interest rate hikes. Short-term real yields increased the most as the key interest rate moved above 3.00% while intermediate and long-term, those bonds with greater than 15+ years to maturity, real yields also increased. We believe that investor expectations for rebounding corporate revenues and earnings along with investor pursuit of higher yields led to increased demand for U.S. corporate credit securities. Intermediate-term3 credit spreads4 trended lower into the fiscal year. Further robust economic recovery and consumer/business spending helped drive average Intermediate-term option adjusted spreads (OAS)5 to 63 basis points (“bps”)6 in comparison to comparable maturing Treasury securities by fiscal year from 94 bps at the beginning of the fiscal year.7

During the fiscal year, the Fund’s NAV underperformed the Bloomberg U.S. Corporate Bond Index8 by -16 bps. During the fiscal year, security selection in the technology sector detracted slightly from performance while security selection in consumers staples aided performance. The tracking difference between the Fund’s NAV and the Underlying Index’s return for the fiscal year was -19 bps, which is reflective of the Fund’s management fee (-12 bps), trading costs and fees (+4 bps), pricing differences (-10 bps), sector and security selection (+18 bps), yield curve positioning (-14 bps) and other factors (-5 bps).

 

 

1 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

2 

A real yield is the yield to the investor that has been adjusted to remove the effects of inflation.

 

3 

Intermediate-term bonds typically mature between 3–10 years.

 

4 

Credit spread is the difference in yield between one debt security and another debt security with the same maturity but of lesser quality.

 

5 

The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate or portfolio and typically the Treasury securities yield (often referred to as the risk-free rate) and that spread is added to the fixed-income security for comparison purposes.

 

6 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

7 

Source: Bloomberg, in this analysis we are making a comparison between the difference of the Option Adjusted Spread of intermediate-term investment grade corporate bonds using data available on the Bloomberg US Intermediate Corporate Bond Index as of October 31, 2021 – October 31, 2022.

 

8 

Bloomberg US Long Corporate Bond Index measures the performance of investment grade U.S. corporate bond market with bonds that have a maturity of more than ten years.

 

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Table of Contents

 

FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Ready Access Variable Income Fund Ticker:   RAVI

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

    1 Year     5 Year     10 Year     Fund
Inception
10/9/2012
 
 

 

 

 

FlexShares Ready Access Variable Income Fund (Based on Net Asset Value)

    -0.94     1.31     1.10     1.09

FlexShares Ready Access Variable Income Fund (Based on Market Price)

    -1.00     1.31     1.50     1.09

Bloomberg Barclays 1-3 Month U.S. Treasury Bill Index

    0.86     1.13     0.66     0.66

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.26% and the net expense ratio is 0.25%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks maximum current income consistent with the preservation of capital and liquidity. The Fund seeks to achieve its investment objective by investing under normal circumstances at least 80% of its total assets in a non-diversified portfolio of fixed-income instruments, including bonds, debt securities and other similar instruments issued by U.S. and non-U.S. public and private sector entities. Such issuers include, without limitation, U.S. and non-U.S. governments and their agencies, instrumentalities or sponsored enterprises, U.S. state and local governments and municipalities, and U.S. and non-U.S. private-sector entities, such as corporations and banks. The average effective duration1, of the Fund will vary based on The Northern Trust Company Investment Policy Committee’s forecast for interest rates and will normally not exceed one year. The dollar-weighted average portfolio maturity of the Fund is normally not expected to exceed two years.

 

During the 12 months ending October 31, 2022, prices on domestic equities generally traded lower. Through Q4 of 2021 U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. U.S. equities declined in Q1 of 2022 as concerns over rising inflation were intensified by Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. In an attempt to combat inflation, the U.S. Federal Reserve (the “Fed”) raised the

 

1 

Average effective duration provides a measure of a fund’s interest-rate sensitivity and the longer a fund’s duration, the more sensitive the fund is to shifts in interest rates. Duration also gives an indication of how a fund’s NAV will change as interest rates change. A fund with a five- year duration would be expected to lose 5% of its NAV if interest rates rose by 1 percentage point, or gain 5%, if interest rates fell by 1 percentage point. Morningstar surveys fund companies for this information.

 

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Table of Contents

 

FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Ready Access Variable Income Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

key interest rate2 by 0.25% in March 2022 and signaled more aggressive key interest rate hikes may be necessary. In Q1 of 2022 the Fed indeed moved to tighten monetary conditions. Our analysis suggests that by early in Q1 of 2022 investors anticipated the need for the Fed to address higher inflation and the U.S. yield curve steepened—which meant that short term interest rates fell faster than long term interest rates. Intermediate Treasury yields, defined as Treasury bonds equal to or less than 10 years to maturity, moved higher. This movement of yields eventually led to an inverting of the yield curve which happens when the 2-year maturing note yields more than the corresponding yield on a 10-year bond. The Fed increased the key interest rate 0.50% in May and 0.75% in June while signaling additional aggressive key interest rate hikes at future meetings were likely. as the Fed continued raising the key interest rate with two 0.75% increases in July and September.

 

Fed rate actions and U.S. inflation results had a major impact on real yields3 during the period which steadily increased with Fed key interest rate hikes. Short-term real yields increased the most as the key interest rate moved above 3.00% while intermediate and long-term, those bonds with greater than 15+ years to maturity, real yields also increased. We believe that investor expectations for rebounding corporate revenues and earnings along with investor pursuit of higher yields led to increased demand for U.S. corporate credit securities. Intermediate-term4 credit spreads5 trended lower into the fiscal year.

 

Further robust economic recovery and consumer/business spending helped drive average Intermediate-term option adjusted spreads (OAS)6 to 63 basis points (“bps”)7 in comparison to comparable maturing

Treasury securities by fiscal year from 94 bps at the beginning of the fiscal year.8

 

For the 12 months ended October 31, 2022, the fund underperformed the generic Treasury Bill index, as defined by the Bloomberg 1-3 Month U.S. Treasury Bill Index9, by -180 bps. The Fund’s exposure to corporate credit, asset-backed securities and longer duration all negatively impacted performance versus the benchmark index.

 

 

2 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

3

A real yield is the yield to the investor that has been adjusted to remove the effects of inflation.

 

4 

Intermediate-term bonds typically mature between 3–10 years.

 

5 

Credit spread is the difference in yield between one debt security and another debt security with the same maturity but of lesser quality.

 

6 

The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate or portfolio and typically the Treasury securities yield (often referred to as the risk-free rate) and that spread is added to the fixed-income security for comparison purposes.

 

7 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

8 

Source: Bloomberg, in this analysis we are making a comparison between the difference of the Option Adjusted Spread of intermediate-term investment grade corporate bonds using data available on the Bloomberg US Intermediate Corporate Bond Index as of October 31, 2021 – October 31, 2022.

 

9 

The Bloomberg 1-3 Month U.S. Treasury Bill Index is designed to measure the performance of public obligations of the U.S. Treasury that have a remaining maturity of greater than or equal to 1 month and less than 3 months.

 

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Table of Contents

 

FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Core Select Bond Fund Ticker:   BNDC

 

 

CUMULATIVE PERFORMANCE

Through October 31, 2022

 

LOGO

 

AVERAGE ANNUAL TOTAL RETURN

For the period ended October 31, 2022

 

     1 Year     3 Year     5 Year     Fund
Inception
11/18/2016
 
  

 

 

 

FlexShares Core Select Bond Fund (Based on Net Asset Value)

     -16.27     -3.61     -0.60     -0.03

FlexShares Core Select Bond Fund (Based on Market Price)

     -16.33     -3.66     -0.66     -0.03

Bloomberg U.S. Aggregate Bond Index

     -15.68     -3.77     -0.54     0.09

 

All data as of 10/31/22. Total returns based on market price do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, these returns would be lower. Total returns based on market price and net asset value (“NAV”) assume that dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. NAV 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. Market price is determined by the midpoint of the bid/ask spread at 4:00 p.m. Eastern Time from the primary listing exchange. Market price returns may vary from NAV returns.

 

Performance quoted represents past performance and does not guarantee future results. The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Unlike the index that the Fund seeks to track, the Fund’s total returns are reduced by operating expenses, such as transaction costs and management fees. An investor cannot invest directly in an index.

 

Performance reflects contractual reimbursements in effect until March 1, 2023. In the absence of such reimbursements, performance would be reduced. The gross expense ratio of the Fund is 0.56% and the net expense ratio is 0.35%. The gross and net expense ratios disclosed are as reported in the Fund’s prospectus, which may differ from the gross and net expense ratios presented in the Fund’s financial reports. Current performance may be higher or lower than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed or sold in the market.

 

FlexShares ETFs’ performance data current to the most recent month-end is available at www.flexshares.com.

 

PORTFOLIO ANALYSIS

 

The Fund seeks total return and preservation of capital. The Fund seeks to achieve its investment objective by investing, under normal circumstances, at least 80% of its net assets in U.S. dollar-denominated investment-grade fixed-income securities either directly or indirectly through exchange-traded funds (“ETFs”) and other registered investment companies (together with ETFs, “Underlying Funds”). The Fund primarily invests in fixed-rate securities of varying maturities, including bonds, debt securities and other similar instruments issued by U.S. public and U.S and non-U.S. private sector entities. Such issuers include, without limitation, U.S. governments and their agencies, instrumentalities or sponsored enterprises, and U.S. and non-U.S. private-sector entities, such as corporations and banks. The Fund may invest in fixed income securities of any maturity.

 

The Fund seeks to provide attractive risk-adjusted performance by investing in a portfolio of fixed-income securities and Underlying Funds. The Fund generally adjusts its allocations to securities based on Northern Trust Investment Inc.’s (“NTI”) assessment of potential changes in interest rate levels, the shape of the yield curve1 and credit spread relationships, which is the difference in yield between one debt security and another debt security with the same maturity but of lesser quality. The Fund also seeks to balance the potential for return and risk while emphasizing liquidity and diversification across a spectrum of U.S. dollar-denominated investment-grade fixed income securities.

 

During the 12 months ending October 31, 2022, prices on domestic equities generally traded lower. Through Q4 of 2021 U.S. equity markets rose as economic data and strong corporate earnings suggested continued growth, allaying concerns over a spike in Covid cases due to the Omicron variant. U.S. equities declined in Q1 of 2022 as concerns over rising inflation were intensified by

 

1 

A yield curve is constructed by plotting a session’s final yields for various maturities including 1-month, 3-month, 6-month, 1-year, 2-year, 3-year, 5-year, 7-year, 10-year, 20-year and 30-year maturities.

 

   FLEXSHARES ANNUAL REPORT     67  


Table of Contents

 

FlexShares®   MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Core Select Bond Fund (cont.)

 

 

PORTFOLIO ANALYSIS (cont.)

 

 

 

Russia’s invasion of Ukraine and the impact subsequent sanctions from the U.S. and European countries had on commodity prices. In an attempt to combat inflation, the U.S. Federal Reserve (the “Fed”) raised the key interest rate2 by 0.25% in March 2022 and signaled more aggressive key interest rate hikes may be necessary. In Q1 of 2022 the Fed indeed moved to tighten monetary conditions. Our analysis suggests that by early in Q1 of 2022 investors anticipated the need for the Fed to address higher inflation and the U.S. yield curve steepened—which meant that short term interest rates fell faster than long term interest rates. Intermediate Treasury yields, defined as Treasury bonds equal to or less than 10 years to maturity, moved higher. This movement of yields eventually led to an inverting of the yield curve which happens when the 2-year maturing note yields more than the corresponding yield on a 10-year bond. The Fed increased the key interest rate 0.50% in May and 0.75% in June while signaling additional aggressive key interest rate hikes at future meetings were likely. as the Fed continued raising the key interest rate with two 0.75% increases in July and September.

 

Fed rate actions and U.S. inflation results had a major impact on real yields3 during the period which steadily increased with Fed key interest rate hikes. Short-term real yields increased the most as the key interest rate moved above 3.00% while intermediate and long-term, those bonds with greater than 15+ years to maturity, real yields also increased. We believe that investor expectations for rebounding corporate revenues and earnings along with investor pursuit of higher yields led to increased demand for U.S. corporate credit securities. Intermediate-term4 credit spreads5 trended lower into the fiscal year. Further robust economic recovery and consumer/business spending helped drive average

Intermediate-term option adjusted spreads (OAS)6 to 63 basis points (“bps”)7 in comparison to comparable maturing Treasury securities by fiscal year from 94 bps at the beginning of the fiscal year.8

 

At the beginning of the fiscal year, the Fund, in comparison to the Bloomberg U.S. Aggregate Bond Index, was generally positioned with an underweight to U.S. Treasuries and mortgage backed securities and an overweight to corporate fixed income on our expectations for lower, but still positive, economic growth and corporate earnings. By the time the Fed commenced raising interest rates in Q1 of 2022, the corporate credit overweight had been reduced, inflation protected public obligations of the U.S. Treasury (“TIPS”) exposure was added for Treasuries and cash balances were maintained. When Fed Chair Powell indicated continued tightening of monetary policy, the corporate overweight had been again reduced and cash balances further increased. By fiscal year end, corporate credit positioning was neutral, Treasuries were still underweight and cash balances were near all-time highs since inception of the Fund. The overall increase in interest rates along with the widening of credit spreads lead to negative total returns for the fiscal year. The Underlying Index had a negative total return during the 12 months ended October 31, 2022, and underperformed the broader bond index, as defined by the Bloomberg U.S. Aggregate Bond Index9, by -59 bps.

 

 

2 

The key interest rate is the interest rate charged to banks when they borrow funds from other banks or from the Federal Reserve, which is the central bank of the U.S. When banks lend money to each other, the key rate is known as the federal funds rate.

 

3 

A real yield is the yield to the investor that has been adjusted to remove the effects of inflation.

 

4 

Intermediate-term bonds typically mature between 3–10 years.

 

5 

Credit spread is the difference in yield between one debt security and another debt security with the same maturity but of lesser quality.

 

6 

The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate or portfolio and typically the Treasury securities yield (often referred to as the risk-free rate) and that spread is added to the fixed-income security for comparison purposes.

 

7 

A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

 

8 

Source: Bloomberg, in this analysis we are making a comparison between the difference of the Option Adjusted Spread of intermediate-term investment grade corporate bonds using data available on the Bloomberg US Intermediate Corporate Bond Index as of October 31, 2021 – October 31, 2022.

 

9 

The Bloomberg US Aggregate Bond Index, or the Agg, is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States.

 

68    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

FlexShares® Trust

Statements of Assets and Liabilities October 31, 2022

 

 

     FlexShares®
US Quality
Low Volatility
Index Fund
    

FlexShares®
Developed Markets ex-US

Quality Low Volatility
Index Fund

   

FlexShares®
Emerging Markets

Quality Low Volatility
Index Fund

   

FlexShares®
Morningstar US

Market Factor Tilt
Index Fund

 

ASSETS

 

Securities, at cost

   $ 150,849,786      $ 66,583,161     $ 9,468,208     $ 931,864,979  

Affiliate securities, at cost

                        507,052  

Securities Lending Reinvestments, at cost

     1,156,911        481,336             203,821,768  
  

 

 

 

Securities, at value†

     161,976,002        60,676,378       8,151,646       1,384,772,126  

Affiliate securities, at value

                        564,807  

Securities Lending Reinvestments, at value

     1,156,911        481,336             203,816,815  

Cash

     284,048        320,646       51,956       10,513,546  

Cash segregated at broker*

     5,315        128,915       13,409       908,884  

Foreign cash††

            355,064       18,459        

Restricted cash**

                         

Due from Authorized Participant

                         

Unrealized appreciation on forward foreign currency contracts

            16,928              

Receivables:

         

Dividends and interest

     347,030        423,339       3,699       940,543  

Securities lending income

     1,588        313             55,141  

Capital shares issued

                         

Investment adviser

                         

Securities sold

            43             7,508,057  

Variation margin on futures contracts

     1,483                    211,227  
  

 

 

 

Total Assets

     163,772,377        62,402,962       8,239,169       1,609,291,146  
  

 

 

 

LIABILITIES

 

Unrealized depreciation on forward foreign currency contracts

            1,982              

Due to brokers

     11,030                     

Payables:

         

Cash collateral received from securities loaned

     1,156,911        481,336             203,821,768  

Deferred compensation (Note 7)

     4,531        2,820       479       139,501  

Investment advisory fees (Note 4)

     28,724        16,314       2,797       282,841  

Trustee fees (Note 7)

     2,658        1,446       341       29,304  

Securities purchased

                         

Deferred non-US capital gains taxes

                  9,995        

Due to Authorized Participant

                        6,617  

Variation margin on futures contracts

            47,316       7,665        

Capital shares redeemed

                        7,597,613  

Other

                  4,000       6,000  
  

 

 

 

Total Liabilities

     1,203,854        551,214       25,277       211,883,644  
  

 

 

 

Net Assets

   $ 162,568,523      $ 61,851,748     $ 8,213,892     $ 1,397,407,502  
  

 

 

 

NET ASSETS CONSIST OF:

 

Paid-in capital

   $ 155,113,380      $ 71,751,996     $ 10,629,918     $ 964,450,457  

Distributable earnings (loss)

     7,455,143        (9,900,248     (2,416,026     432,957,045  
  

 

 

 

Net Assets

   $ 162,568,523      $ 61,851,748     $ 8,213,892     $ 1,397,407,502  
  

 

 

 

Shares Outstanding (unlimited number of shares authorized $ 0.0001 par value)

     3,250,001        2,800,001       400,001       9,250,001  

Net Asset Value

   $ 50.02      $ 22.09     $ 20.53     $ 151.07  

† Securities on loan, at value

   $ 14,183,739      $ 2,551,916     $     $ 275,892,234  

†† Cost of foreign cash

   $      $ 356,137     $ 18,711     $  

 

*

Includes cash pledged by the Fund to cover margin requirements for open futures contracts as of 10/31/22.

 

**

Includes cash pledged by an Authorized Participant for missing deposit securities required to secure Creation Units.

 

See Accompanying Notes to the Financial Statements.

 

   FLEXSHARES ANNUAL REPORT     69  


Table of Contents

 

 

Statements of Assets and Liabilities (cont.)

 

 

     FlexShares®
Morningstar Developed
Markets ex-US Factor
Tilt Index Fund
    FlexShares®
Morningstar Emerging
Markets Factor Tilt
Index Fund
    FlexShares®
US Quality
Large Cap
Index Fund
    FlexShares®
STOXX® US
ESG Select
Index Fund
 

ASSETS

 

Securities, at cost

   $ 462,257,177     $ 227,162,575     $ 126,865,011     $ 169,811,069  

Affiliate securities, at cost

                        

Securities Lending Reinvestments, at cost

     7,591,069       3,027,697       264,465       225,693  
  

 

 

 

Securities, at value†

     435,473,234       206,025,113       125,453,875       170,751,844  

Affiliate securities, at value

                        

Securities Lending Reinvestments, at value

     7,591,069       3,027,697       264,465       225,693  

Cash

     2,167,619       562,244       1,574,827       1,085,736  

Cash segregated at broker*

     1,801,241       293,055       325,154       135,778  

Foreign cash††

     3,688,221       836,493              

Restricted cash**

                        

Due from Authorized Participant

                        

Unrealized appreciation on forward foreign currency contracts

     53,896       37,421              

Receivables:

        

Dividends and interest

     3,851,822       262,703       122,541       110,490  

Securities lending income

     29,235       9,896       790       562  

Capital shares issued

                 2,175,103        

Investment adviser

                        

Securities sold

     172,399             3,195,205        

Variation margin on futures contracts

     47,214                    
  

 

 

 

Total Assets

     454,875,950       211,054,622       133,111,960       172,310,103  
  

 

 

 

LIABILITIES

 

Unrealized depreciation on forward foreign currency contracts

     105,386       32,909              

Due to brokers

                        

Payables:

        

Cash collateral received from securities loaned

     7,591,069       3,027,697       264,465       225,693  

Deferred compensation (Note 7)

     83,761       41,902       4,785       5,691  

Investment advisory fees (Note 4)

     143,260       104,097       28,954       44,385  

Trustee fees (Note 7)

     12,396       6,743       1,402       3,487  

Securities purchased

           5,188       2,135,643        

Deferred non-US capital gains taxes

           720,142              

Due to Authorized Participant

     172,398                    

Variation margin on futures contracts

           177,031       69,533       49,871  

Capital shares redeemed

                 3,254,338        

Other

     13,500       50,000       3,000       1,050  
  

 

 

 

Total Liabilities

     8,121,770       4,165,709       5,762,120       330,177  
  

 

 

 

Net Assets

   $ 446,754,180     $ 206,888,913     $ 127,349,840     $ 171,979,926  
  

 

 

 

NET ASSETS CONSIST OF:

 

Paid-in capital

   $ 593,533,354     $ 300,134,185     $ 133,331,926     $ 177,469,288  

Distributable earnings (loss)

     (146,779,174     (93,245,272     (5,982,086     (5,489,362
  

 

 

 

Net Assets

   $ 446,754,180     $ 206,888,913     $ 127,349,840     $ 171,979,926  
  

 

 

 

Shares Outstanding (unlimited number of shares authorized $ 0.0001 par value)

     8,200,001       4,900,001       2,950,001       1,850,001  

Net Asset Value

   $ 54.48     $ 42.22     $ 43.17     $ 92.96  

† Securities on loan, at value

   $ 52,637,337     $ 8,215,520     $ 7,725,995     $ 9,174,813  

†† Cost of foreign cash

   $ 3,668,199     $ 845,705     $     $  

 

*

Includes cash pledged by the Fund to cover margin requirements for open futures contracts as of 10/31/22.

 

**

Includes cash pledged by an Authorized Participant for missing deposit securities required to secure Creation Units.

 

See Accompanying Notes to the Financial Statements.

 

70    FLEXSHARES ANNUAL REPORT  


Table of Contents

 

 

Statements of Assets and Liabilities (cont.)

 

 

     FlexShares®
STOXX®
Global ESG
Select
Index Fund
     FlexShares®
ESG & Climate US
Large Cap Core
Index Fund
    FlexShares®
ESG & Climate
Developed
Markets ex-US Core
Index Fund
    FlexShares®
ESG & Climate
Emerging
Markets Core
Index Fund
 

ASSETS

 

Securities, at cost

   $ 136,248,995      $ 23,943,923     $ 20,549,885     $ 4,923,430  

Affiliate securities, at cost

                         

Securities Lending Reinvestments, at cost

     442,946                     
  

 

 

 

Securities, at value†

     145,829,313        21,936,504       17,060,066       3,824,002  

Affiliate securities, at value

                         

Securities Lending Reinvestments, at value

     442,946                     

Cash

     630,009        151,787       11,858       19,663  

Cash segregated at broker*

     126,290        4,474       20,924       9,835  

Foreign cash††

     95,996              26,497       17,586  

Restricted cash**

                         

Due from Authorized Participant

                         

Unrealized appreciation on forward foreign currency contracts

     4,596              3,717        

Receivables:

         

Dividends and interest

     347,364        18,395       54,875       4,639  

Securities lending income

     889                     

Capital shares issued

                         

Investment adviser

            19       38        

Securities sold

                        8,982  

Variation margin on futures contracts

                         
  

 

 

 

Total Assets

     147,477,403        22,111,179       17,177,975       3,884,707  
  

 

 

 

LIABILITIES

 

Unrealized depreciation on forward foreign currency contracts

                  927        

Due to brokers

                         

Payables:

         

Cash collateral received from securities loaned

     442,946                     

Deferred compensation (Note 7)

     7,203                     

Investment advisory fees (Note 4)

     50,063        1,618       1,681       610  

Trustee fees (Note 7)

     3,575        68       67       19  

Securities purchased

                        9,533  

Deferred non-US capital gains taxes

                         

Due to Authorized Participant

                         

Variation margin on futures contracts

     48,139        5,608       6,380       6,810  

Capital shares redeemed

                         

Other

            500              
  

 

 

 

Total Liabilities

     551,926        7,794       9,055       16,972  
  

 

 

 

Net Assets

   $ 146,925,477      $ 22,103,385     $ 17,168,920     $ 3,867,735  
  

 

 

 

NET ASSETS CONSIST OF:

 

Paid-in capital

   $ 144,004,252      $ 24,293,000     $ 21,578,641     $ 5,009,376  

Distributable earnings (loss)

     2,921,225        (2,189,615     (4,409,721     (1,141,641
  

 

 

 

Net Assets

   $ 146,925,477      $ 22,103,385     $ 17,168,920     $ 3,867,735  
  

 

 

 

Shares Outstanding (unlimited number of shares authorized $ 0.0001 par value)

     1,250,001        500,000       450,000       100,000  

Net Asset Value

   $ 117.54      $ 44.21     $ 38.15     $ 38.68  

† Securities on loan, at value

   $ 3,600,349      $     $     $  

†† Cost of foreign cash

   $ 96,981      $     $ 26,388     $ 17,868  

 

*

Includes cash pledged by the Fund to cover margin requirements for open futures contracts as of 10/31/22.

 

**

Includes cash pledged by an Authorized Participant for missing deposit securities required to secure Creation Units.

See Accompanying Notes to the Financial Statements.

 

   FLEXSHARES ANNUAL REPORT     71  


Table of Contents

 

 

Statements of Assets and Liabilities (cont.)

 

 

     FlexShares®
Morningstar Global
Upstream Natural
Resources Index
Fund
    FlexShares®
STOXX®
Global Broad
Infrastructure
Index Fund
    FlexShares®
Global Quality
Real Estate
Index Fund
    FlexShares®
Real Assets
Allocation
Index Fund
 

ASSETS

 

Securities, at cost

   $ 5,959,339,348     $ 2,547,512,547     $ 359,689,932     $  

Affiliate securities, at cost

                       34,201,324  

Securities Lending Reinvestments, at cost

     200,125,034       27,954,570       2,527,416        
  

 

 

 

Securities, at value†

     6,820,447,853       2,481,997,953       320,007,900        

Affiliate securities, at value

                       28,858,364  

Securities Lending Reinvestments, at value

     200,121,818       27,954,570       2,527,416        

Cash

     4,814,695       7,771,116       5,463,557       9,903  

Cash segregated at broker*

     3,384,673       2,567,896       1,135,692        

Foreign cash††

     6,014,133       4,017,253       663,461        

Restricted cash**

           203,240              

Due from Authorized Participant

                        

Unrealized appreciation on forward foreign currency contracts

     699,659             42,549        

Receivables:

        

Dividends and interest

     3,760,445       6,674,598       1,333,352        

Securities lending income

     49,883       37,964       4,154        

Capital shares issued

                        

Investment adviser

                        

Securities sold

     166,946       22,061       6,817        

Variation margin on futures contracts

                        
  

 

 

 

Total Assets

     7,039,460,105       2,531,246,651       331,184,898       28,868,267  
  

 

 

 

LIABILITIES

 

Unrealized depreciation on forward foreign currency contracts

     988,169       48,973       28,860        

Due to brokers