BlackRock management was quick to invoke the market carnage of the first half when it revealed the return on investment last week. "2022 ranks as the worst start in 50 years for both stocks and bonds," Chairman and CEO Larry Finck he said on his earnings call.
While few companies can avoid what the market throws at them, some are at least trying to outdo it. BlackRock is giving up more and more: at the end of June, only about a quarter of its assets were actively managed to beat a benchmark, instead of tracking it smoothly as passive strategies are designed to do. That's less than a third when BlackRock acquired Barclays Global Investors in 2009 to become the leading exchange-traded fund player.
Within the equity business, the divergence is especially pronounced. Throughout the industry, assets have trickled down from active to passive strategies. In BlackRock's case, about $21 billion has been diverted from working capital in the last decade, with $730 billion flowing into indexed capital. The company's passive stock holdings are now 10 times larger than its active business, although it operates some active multi-asset and alternative strategies that bridge the gap.
For portfolio managers on the fixed income side, the evolution of the business portends an ominous future.
BlackRock's roots are in active fixed income. Fink founded the company in 1988 around strategies that "emphasize value creation through stock selection...and are implemented by a team of highly skilled portfolio managers employing a strictly disciplined investment process," according to the 1999 listing prospectus.
Although the firm also launched the first bond domiciled in the US. exchange traded fund in December 2002, it did not reach the same level as stock ETFs. In BlackRock's case, $280 billion has continued to flow into active fixed income over the last 10 years. Fixed income is most of what remains of the company's actively managed businesses: It had $954 billion in actively managed bond funds as of June 30, compared with $393 billion in actively managed stocks. Liabilities have grown, but they are only 1.5 times greater than assets in fixed income, a much smaller difference than in equities.
All that may be about to change. The collapse of bond markets this year has taken money out of active fixed-income funds. BlackRock saw clients withdraw more than $20 billion during the first half of the year in a loss that has caused more than $200 billion to leave the industry. Some of that is accumulating in passive funds, in particular ETFs, where BlackRock is collecting more than its fair share. So far this year, it has made $39 billion of new money in ETFs and $25 billion in other index strategies. The passive shift that started in equities is now accelerating in fixed income.
Until recently, bond ETFs were viewed with suspicion. In 2015, investor Carl Icahn, sitting next to Fink on television, called BlackRock "an extremely dangerous company." His reason was that the firm's ETFs embed illiquid bonds in inadequate liquid wrappers. "You're going to hit a black rock," he said.
However, during the panic of March 2020, when bond markets froze, ETFs performed efficiently. They went on to discount the value of the underlying bonds, but that did not lead to a fire sale of the securities. Instead of transmitting stress, bond ETFs absorbed it while providing investors with much-needed liquidity. This real-life stress test validated the structure, and now that bonds are falling, money is pouring out.
On his earnings call, Fink explained the benefits. He noted that investors are using ETFs to quickly and efficiently gain exposure to thousands of global bonds and recalibrate their portfolios. "The challenges associated with high inflation and rising interest rates are attracting more first-time bond ETF users and prompting existing investors to find new ways to use ETFs in their portfolios," he said.
For now, BlackRock's fixed income portfolio managers are mounting a solid defense. Unlike his peers in equities, his performance has been relatively strong. In the first six months of the year, the funds they supervised fell 10.6%, slightly better than the company's fixed income ETFs. According to the company, about half of taxable fixed income assets are outperforming their benchmark on a one-year perspective, compared to about a third of traditionally managed equity assets.
But if fixed income goes the way of equities, the divergence between passive flows and active flows will only grow. "These are the early days of a major transformation of how people invest in fixed income," Fink said last week. "We expect the bond ETF industry to nearly triple to $5 trillion in AUM by the end of the decade."
By then, BlackRock could be much bigger, but its fortunes will remain firmly tied to the markets.
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