We're upgrading BlackRock’s Parent Pillar rating to Positive from Neutral.
BlackRock is big, complex firm with a lot of challenges and issues, but it has demonstrated a commitment to improve on a number of fronts, including lowering fees, increasing manager ownership, and bringing its scale and technical prowess to bear on serving clients. Consequently, we’ve raised the firm’s Parent rating to Positive from Neutral.
BlackRock is the largest asset manager in the world, with more than $5 trillion in assets under management. Its investments span multiple styles, distribution channels, and product types, seemingly defying categorization. However, that has changed in recent years. Indeed, the firm’s passive strategies recently accounted for more than $3 trillion of assets thanks to strong global growth of its iShares exchange-traded funds, especially its popular Core series. On the flip side, the firm’s active equity business remains a small and shrinking portion of total investment assets at just 6% of assets. Because of this, the firm’s nucleus is increasingly the low-cost building blocks that comprise its large and fast-growing passives franchise.
BlackRock is hardly a creature of indexing and ETFs alone, however. Active fixed income remains one of the firm’s fortes, accounting for $750 million, or 15% of assets. What’s reassuring, though, are signs that the firm is committed to using its scale to reduce the cost not just of its passive products but also its active bond strategies, where it has aggressively lowered fees. Consequently, nearly all of firm’s U.S. bond funds recently ranked among the cheapest two quintiles of their peer groups.
While the same can’t be said of the firm’s U.S. active equity mutual funds--only half of which rank in the two lowest and a third of which rank in the highest two quintiles--the firm has done enough fee cutting to bring its average Morningstar Fee Level (which takes only U.S. mutual fund assets into account) lower than around two thirds of other firms. That represents meaningful progress from a few years ago, when BlackRock’s Morningstar Fee Level rank was merely average. Globally, fees are also favorable--two thirds of funds that earn a Morningstar Fee Level charge fees in the lowest two quintiles of peers.
We’ve also been encouraged by more widespread manager ownership of fund shares. As BlackRock began to pay a portion of managers' bonuses in the equivalent of fund shares that vest over three years, firmwide investment rose. Looking at only vested shares, just 40% of the firm’s U.S. mutual fund assets were in vehicles in which at least one of the managers invested $1 million or more in 2014. Today, it is nearly 60%.
Constantly Seeking an Edge
One could argue that these improvements reflect one of BlackRock’s more identifiable traits--its relentlessness. The firm is seemingly always searching for an edge and to press whatever advantages it can find. For example, as mentioned, BlackRock has increasingly used its scale to lower costs and achieve ubiquity in certain segments, such as ETFs. It can also be seen in BlackRock’s ambitious plan to remake itself into a technology provider, an evolution that will see BlackRock's Aladdin, its vaunted risk- and portfolio management system, play an increasingly prominent role in the firm’s future.
This bold move into technology bears watching. True, BlackRock is no stranger to leveraging and commercializing technology. The firm has repackaged the BlackRock Solutions asset-allocation and risk-management tools it uses as its own IT backbone, making them available to advisors and institutions. In 2015, it rolled out a web-based iRetire tool harnessed to its Aladdin platform and bought FutureAdvisor, a robo-advisor that uses algorithms to deliver investing advice. The firm also sells Aladdin to competitors in the asset-management industry. Yet, BlackRock founder and CEO Larry Fink has indicated that he believes technology will contribute as much as 30% of the firm’s revenue (versus around 7% today) in five years and is investing heavily here.
While it’s common for diversified financial-services firms like banks to draw on a diverse set of capabilities, including technology, it’s unusual for pure-play asset managers to make it a cornerstone of their strategy like BlackRock is doing. That raises questions about the firm’s focus going forward and, in turn, its investment priorities. For instance, how will the firm balance its desire to grow its technology footprint while at the same time supporting its core investment management franchise? Does the firm begin to think differently about lowering costs, pursuing active-investing excellence, and retaining key investment personnel? Are investment products the end or merely the means to an end in a broader ecosystem that BlackRock technology enables? How does the definition of investor success evolve?
BlackRock is famously competitive, so we would not expect the firm to approach investment management with anything less than its hallmark intensity. But that zeal can raise questions of its own, like whether BlackRock is patient enough to nurse struggling strategies to health when a rough patch hits. Take the firm’s fundamental active-equity complex, for instance, which BlackRock has shaken up several times since 2012, most recently in March 2017 when the firm announced it would shift $7 billion in active equity assets to the firm’s San Francisco-based Scientific Active Equity group. True, the affected strategies and managers had hardly inspired deep confidence. But it raises the question of whether BlackRock--a firm unaccustomed to failure--has the resolve to see a turnaround through.
For a firm of BlackRock’s sheer scale and diversity, there’s also the question of what is, and isn’t, within its circle of competence, and the lengths to which it will go to appeal to the various constituencies it aspires to serve. For instance, the firm has blanketed the ETF space with scores of different strategies, some of them highly specialized and potentially prone to misuse. This can lead one to wonder what is off-limits.
Then there’s the matter of the other key constituency BlackRock must serve--its public company shareholders. There’s nothing indicting about being a publicly traded asset manager, and, indeed, we highly rate the stewardship practices of some public firms like T. Rowe Price. But it’s unquestionable that public ownership can entail potential pressures that private firms don’t face.
Perhaps that was illustrated most vividly in BlackRock’s decision to launch its low-cost Core family of ETFs a few years ago. We have no quarrel with those ETFs, which are a generally sturdy group of diversified funds available at a very low price. (We highly rate a number of them.) But what was notable was BlackRock’s decision to not cut the cost of an existing series of very popular ETFs--which the Core series more or less cloned--instead. Why did BlackRock take this tack? The firm maintains that the two series target different investor types--the Core series is aimed at long-term allocators, while the existing series is meant for traders with shorter horizons who prize liquidity. While that might be true, it seems likely that economics--namely, the revenue hit that BlackRock would have taken if it slashed the price of its existing series, and the attendant risk that the hit would be received poorly by shareholders and Wall Street--informed the move.
Nevertheless, the firm’s strengths outweigh these constructive concerns. Its ambitious transformation to a technology-driven business bears watching, as does its handling of struggling capabilities, such as its active-equity franchise. But in general, we expect investors in BlackRock funds to get a fair shake, as the firm’s products are generally inexpensive, managers ownership has increased meaningfully, and the business should be able to press several competitive advantages to investors’ benefit in the future.