Striving For Scale

January 22, 2010

What were the strategic considerations behind BlackRock’s purchase of Barclays Global Investors, and what are the implications for both passive and active management firms?

The impact of the US$13.5 billion purchase of iShares and Barclays Global Investors (BGI) by BlackRock last month has so far been surprisingly muted.

When news of the deal broke last June, many thought BlackRock was buying iShares to package its active management expertise into ETFs. Bradley Kay, ETF analyst at Morningstar in Chicago, said: “The true excitement was that BlackRock would bring its fixed income active management expertise into ETFs.”

Despite the mixed success of active ETFs, a number of big active asset managers are moving into the space. Pimco, for example, has launched a number of active fixed income ETFs over the past year.

But iShares has no immediate plans to launch active ETFs in Europe. “We believe we have enough to do driving interest and assets to existing products,” said Rory Tobin, head of the international iShares business. “Everyone is interested in active ETFs, but there is more interest among the ETF issuer community than our client base,”

Tobin argues that there are still issues to address before launching active ETFs. “Everyone thinks it’s a novel thing to do, but there are challenges in terms of portfolio management. What happens if it doesn’t deliver against performance expectations?”

So instead of the expected move into active ETFs, the focus at the moment seems to be on continuity. “It is remarkable how little change we have seen,” said Kay. “iShares has maintained its independence and entrepreneurial spirit, the vibrancy that comes with rapid growth; they’re still expanding into new markets, creating new products. iShares seems to have maintained its own spirit after the acquisition.”

Corporate culture may remain unchanged, but assets have more than doubled. Prior to the BGI deal, BlackRock had around US$1.3 trillion in assets. Add to that the US$1.5 trillion at BGI and the combined balance sheet is larger than that of the US Federal Reserve.

The US$13.5 billion paid by BlackRock in debt and equity puts a relatively high 8.3 times EBITDA (earnings before tax, interest, depreciation and amortisation) multiple on the transaction. The deal has made the US money manager the biggest on the planet, with more than US$3 trillion in assets under management, and in the process has transformed BlackRock from a specialist fixed income manager into a diversified asset manager with capabilities in both passive and active management.

The deal has given BlackRock dominance of the fast-growing ETF market. And not just in the US, where iShares’ 186 funds account for more than half of all ETF assets (according to BlackRock data for end-December 2009). In Europe, too, iShares dominates the ETF market, with 38% of assets, leaving nearest rival Lyxor Asset Management trailing in second place with 20%.

Globally, the picture is similar. iShares is the largest ETF provider in the world, ranked by both number of products (more than 400) and assets, with a 47% market share. That dwarfs nearest rival State Street Global Advisors, which has less than half the market share (16%).

So it’s small wonder that Laurence Fink, BlackRock’s founder and chief executive, became interested when he first heard that BGI’s iShares unit was up for sale.

It was a tortuous and complicated route to securing iShares. For two months, it looked as if the unit would almost certainly go to private equity firm CVC Capital Partners, which won an auction for iShares (and iShares alone) back in April. The transaction looked to be practically a done deal. At that point, BGI, the unit housing iShares, was not even up for sale.

However, under an unusual ‘go shop’ clause, iShares’ owners (Barclays) were keeping their options open. They continued looking around to see if there was another buyer. And when news of the BlackRock deal emerged, there was another surprise. BlackRock was buying not just the iShares unit, for which CVC Capital Partners had promised US$4.2 billion, but all of BGI.

According to Rich Kushel, vice chairman of BlackRock, a key attraction of iShares was that its passive capabilities complemented BlackRock’s active strengths. “Our clients are looking more for comprehensive solutions and, as part of that, our ability to access high quality, liquid beta is critically important.”

Many in the industry underestimate the difficulties of providing passive solutions, adds Kushel. “There are differences between beta providers and we believe iShares is the finest in the business. People talk about beta generation as if it’s easy to go out and get it but it’s not, and the last couple of years have proved that.”


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