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BlackRock Has Gotten Bigger, but Not Necessarily Better

The next few years present another test for BlackRock's investment culture.

Michael Herbst, 05/06/2010

It's no secret that BlackRock BLK has grown by leaps and bounds in recent years. That growth has been fueled in part by increased demand for its asset-management and risk-management expertise, particularly in the wake of 2008's market meltdown. Yet most of the firm's expansion has come through acquisitions, notably through its 2006 deal to acquire Merrill Lynch Investment Management and its 2009 purchase of Barclays Global Investors. Those deals have made it the largest publicly traded asset manager in the world, with roughly $3.4 trillion under management as 2009 ended.

Mergers and acquisitions in asset management frequently lead to disappointing results for investors, thanks to cultural differences among organizations, operational challenges, personnel turnover, or a combination of those and other unforeseen factors. Given BlackRock's recent growth spurt and the challenges that may lie ahead, there's no guarantee that it will consistently or uniformly produce better results for mutual fund investors.

Points in BlackRock's Favor
There are several factors that increase the likelihood of investors' success. BlackRock executives are seasoned business builders and have proved thoughtful in their approach to acquisitions. They typically move quickly and decisively, which can ease the friction of combining varying investment organizations under one roof. They've also maintained a high degree of control at the corporate level, which sharply reduces the chance of the wholesale shifts in investment policy or attempted makeovers that caused many other asset-management firms to stumble over the years. In addition, BlackRock remains almost exclusively an asset manager. That last point sets BlackRock apart from some other large firms in which an asset-management operation may be forced to compete with a company's other business units (such as broker/dealer operations, record keeping, proprietary trading, or investment banking) for time, support, or resources.

Furthermore, BlackRock has shown a consistent ability and willingness to invest heavily in its investment personnel and risk-management resources. All BlackRock portfolio managers globally use the firm's formidable BlackRock Solutions portfolio-monitoring and risk-management technology platform. This common system eases some of the technological and operational challenges of its acquisitions. For instance, the former MLIM managers who came onboard in 2006 now use BRS to monitor their portfolios, and BGI was a BRS client for years before 2009's transaction. BlackRock also boasts a deep team of risk-management personnel with an independent reporting structure, which reinforces the firm's established philosophy regarding risk and risk management. Those resources are no panacea, but they help support the various teams that have become part of BlackRock over the years, and they help establish an environment conducive to consistent, repeatable investment success.

BlackRock also continues to take steps to improve the stability and quality of its portfolio management teams. In some cases, that has meant leaving well enough alone, as it did with its current municipal-bond team and the crew backing BlackRock Global Allocation MDLOX. Both of them joined BlackRock via MLIM, though during that integration process the firm did winnow down the legacy BlackRock municipal team. BlackRock also stuck with the team backing BlackRock Energy & Resources SSGRX, which came into the fold through the 2005 acquisition of State Street Research and Management.

In other cases, BlackRock has consolidated or made management changes at less impressive funds, including BlackRock Fundamental Growth MDFGX and BlackRock Aurora SSRAX. The firm also has hired new talent to reinforce its research capabilities, as it did in early 2009 when it acquired the hedge fund R3 Capital Partners, which rounded out its expertise in nongovernment mortgage-backed securities and high-yield debt. Helix Financial Group, a 2010 acquisition, has augmented its mortgage research efforts. In combination, such efforts represent BlackRock's ongoing commitment to strengthen areas of its asset-management operation.PAGEBREAK

Growing Pains
That's not to say BlackRock hasn't hit some big bumps along the way. Its taxable fixed-income group, long the heart of the firm, has seen the departure of several senior investment professionals in recent years, including Keith Anderson, co-founder and former chief investment officer for fixed income, as well as several other portfolio managers. Fellow BlackRock veteran Scott Amero, who had more recently filled the global chief investment officer for fixed-income chair, is slated to leave in 2010's second half. The taxable fixed-income group reorganized in early 2009 to provide more separation between portfolio management and other duties and to provide greater incentives to the group's analyst team. BlackRock alum Curtis Arledge returned to the fold from Wachovia in late 2008 and has since become the fixed-income CIO, serving alongside deputy CIOs Rick Reider (who joined BlackRock in 2009 via R3 Capital Partners) and BlackRock veteran Scott Thiel. Arledge and longtime portfolio manager Matthew Marra are now charged with direct oversight of BlackRock's taxable fixed-income mutual funds. The reorganization ought to provide clearer accountability for the funds' performance, yet it remains to be seen if the group's investment philosophy and process will remain as cohesive as it had been in the past.

BlackRock's reputation for risk management also took a few lumps during 2007-09's market turmoil. For instance, significant bets on nongovernment commercial mortgage-backed securities and financial firms' debt stung most of the firm's taxable fixed-income mutual fund lineup, including funds such as BlackRock Government Income CCGAX, in which investors might not have expected such meaningful stakes in nongovernment fare. In addition, the firm's real estate practice hit a speed bump with its investment in New York City's Stuyvesant Town and Peter Cooper Village and had to hand over the properties to creditors in early 2010.

To be fair, the past few years' market environment has been truly extraordinary, and other firms fared much worse than BlackRock overall. It's also safe to say that BlackRock's risk-management practice remains a valuable resource for its portfolio managers, and the firm has been thoughtful in revisiting aspects of its risk-monitoring process, so it's better able to detect problems such as those that flared up during the credit crisis. Yet the firm's recent stumbles are a sign its investment culture is not as monolithic or cohesive as it might have been in its earlier days. Going forward, the challenge of maintaining a strong investment culture across a growing range of teams with varying investment backgrounds and perspectives is a tall order.

What Will the Next Chapter Bring?
Much has been made about the potential advantages of BlackRock's 2009 acquisition of Barclays Global Investors, but that transaction is by no means a slam-dunk success for investors in BlackRock funds. BGI's expertise in passive investing, including its iShares exchange-traded funds, and in asset allocation indeed complements BlackRock's historical emphasis on fundamental, active management in equities and fixed income. The firm's newly expanded Multi-Asset Client Solutions group could help harness that broader range of capabilities and lead to new portfolio solutions or new multiasset strategies for financial advisors and investors. In addition, BlackRock has announced plans to build out BGI's trading platform, which theoretically could lead to lower trading costs for BlackRock funds. Those efforts are in the early stages, and it will take several years to see whether the firm's expanded resources can truly benefit investors.

In addition, the cultural divide between BlackRock and BGI is arguably wider than in it may have been in the firm's earlier acquisitions, and that integration is proving a bit more difficult. So far, most departures in the wake of the BGI deal have involved noninvestment personnel. BlackRock has been careful in defining areas in which legacy BlackRock and legacy BGI personnel now work together, and others in which they continue to work more independently. Even so, should departures from the combined firm begin to include more portfolio management personnel, that would be a red flag for investors.

In its pre-BlackRock days, BGI also had been less transparent about some of its investment strategies, such as its LifePath target-date funds. With BGI under its umbrella, BlackRock is now one of the largest players in target-date funds and target-date-oriented collective investment trusts, both of which are used increasingly in companies' 401(k) or other defined contribution plans. Although BlackRock has expressed willingness to share more information about its LifePath funds with Morningstar, it hadn't done so as of April 2010.

In summary, BlackRock has thus far avoided many of the perils that befall asset-management organizations following acquisitions. Its skilled executive leadership, significant and sustained investment in portfolio management and risk management, and better-than-average corporate culture give it a running start. Even so, the firm faces a gargantuan challenge in maintaining and strengthening its investment culture across asset classes and investment styles. In lesser hands, that challenge would be cause for great concern. The burden of proof now rests with BlackRock to demonstrate that it can defy the odds and nurture an investor-focused corporate culture in the wake of its largest acquisition to date. 

Michael Herbst is a mutual fund analyst with Morningstar.

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