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BlackRock Sends in the Clones

Implications of the company’s decision to remove some of its active stock-fund managers.

John Rekenthaler, 03/31/2017

You've Been Automated!
The news that BlackRock sidelined seven of its equity-fund managers didn’t make many front pages, but within the small world of professional money management it was a big story indeed. The world’s largest investment manager--Vanguard is the leading mutual fund company both in the United States and globally, but BlackRock runs more assets in all forms--swapped living, breathing people for stock-picking models. Fear the rise of the machines.

Said BlackRock CEO Larry Fink, “The democratization of information has made it much harder for active management. We have to change the ecosystem--that means relying more on big data, artificial intelligence, factors, and models within quant and traditional investment strategies.”

For those who don’t speak investment jargon, Fink meant that fund managers no longer benefit from trade secrets. Back in the day, corporate executives freely chatted with investment professionals, particularly those who held their company’s shares and/or controlled a great deal of money. They would discuss their company’s latest developments, as well that those of their industry. That information gave fund managers a significant edge on the rest of us.

That benefit is mostly gone. The SEC has tightened its interpretation of prohibited communications, so that executives have become more circumspect. They can sometimes be tempted into disclosures, which is one reason fund managers still seek personal meetings, but the opportunities have diminished. Plus, blogs have largely supplanted the executives’ industry updates.

Also, competition has increased. Although Fink’s decision reduces the mutual fund manager count by seven, there are nevertheless more actively managed U.S. stocks today than there were 20 years ago. And as fund companies these days are more likely to name an investment team to run a fund rather than a single “star” manager, the number of official portfolio managers has grown at an even higher rate. These days, there are more rivals to beat.

The Battle Continues
Of course, switching from humans to algorithms doesn’t eliminate the contest; as before, BlackRock must outdo its opponents to earn its management fees. The company hopes that by being earlier than most to embrace artificial intelligence, and being larger than all, that it will enjoy a competitive advantage. That seems plausible. But even if BlackRock’s change does improve its funds’ returns, there remains the question of sustainability. Success breeds imitators, and imitators erode success. Winning investment management demands constant reinvention.

To summarize the first and most important lesson of BlackRock’s announcement: The demise of the traditional portfolio manager continues. Because of mergers and liquidations, there are fewer actively managed U.S. stock funds today than there were last year; and now, per BlackRock’s example, those that continue to exist might concede to clones. That's bad news for stock-market junkies who wish to enter the investment business. Eventually, if enough funds convert, the level of competition will decline such that active managers will have an opportunity. But we are currently far from that point.

Doing It All
Another takeaway: It is hard to win across all asset classes. BlackRock is the world’s largest active fixed-income manager and the biggest exchange-traded fund provider. Each of those are huge endeavors. It took three decades, and intense focus from senior management, to build that bond-market expertise. Winning the ETF asset battle was another struggle. Seeking excellence with actively managed stock funds might have been one ambition too far.

is vice president of research for Morningstar.

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