ETFs Key Driver For BlackRock Earnings

NEW YORK (Reuters) – BlackRock, the world's biggest asset manager, on Wednesday reported double-digit profit gains but missed revenue forecasts, results that underscore pressure on the fund industry as investors plow money into lower-cost index funds.

Investors poured $82.2 billion into index funds and iShares exchange-traded funds during the first quarter that ended March 31, while its pricier active funds posted $1.8 billion in withdrawals.

Total assets under management grew to $5.4 trillion.

"Stepping back, the quarter likely has mixed implications for both [BlackRock] and the industry at large," Citigroup analyst William Katz said in a note.

Consolidation Coming

Chief Executive Officer Larry Fink told Reuters in a telephone interview that he is considering three or four small acquisition transactions that would be focused on shoring up the company's technology and its investment expertise in different assets and within new geographic regions.

"I believe you're going to see a consolidation in our industry."

BlackRock shares were down in early trading, about 1.3%.

Financial markets traded vibrantly last quarter as a new U.S. president and Congress took office, and investors tried to size up whether they would pass tax and other reforms that could give new life to an aging bull market in U.S. stocks.

Investors increasingly are choosing to make those bets—whether optimistic or pessimistic—using ETFs that track indexes at a relatively low cost. Very few companies in the industry have been able to build a successful index fund franchise, and the flight of customers to lower-cost products has consequently squeezed margins.

iShares Acquisition Key For BlackRock

BlackRock, which bought iShares from Barclays in 2009, is an exception. Wall Street has rewarded it with a price-to-earnings ratio of 20.1, compared with 16.8 for a grouping of the company's rivals measured by Thomson Reuters.

BlackRock's net income rose to $862 million, or $5.23 per share, in the first quarter, from $657 million, or $3.92 per share, a year earlier. Excluding items, the company earned $5.25 per share. That beat the $4.89 forecast of analysts polled by Thomson Reuters and was helped by a lower tax rate.

Revenues of $2.8 billion missed forecasts by nearly 2%.

While assets grew 22.2% over the year prior, fees for managing those assets and lending out the securities grew by a smaller 12.1%.

ETFs & Index Funds Brought In All Net Inflows

Last quarter, iShares and index funds brought in all of the net money that went into the BlackRock's "long-term" products, a grouping that excludes funds where investors park cash.

BlackRock has been pushing investors to use ETFs more often and in new ways. ETFs were initially seen as devices used to track stock indexes. But BlackRock has aggressively marketed fixed-income ETFs to institutions that normally use bonds.

That approach paid off. U.S.-based bond ETFs attracted record cash last quarter, according to researcher Morningstar, and iShares took in $4 in $10 of that money.

BlackRock also created a low-cost lineup of 25 "Core" ETFs for everyday investors to use to build a basic portfolio. The funds compete on price with BlackRock's most aggressive price-slashing rivals, Vanguard Group and Charles Schwab.

Those 25 Core ETFs accounted for 54% of iShares inflows last quarter.

Lower Fees Price Of Success

Yet success in that category has come at the cost of lowering fees, which BlackRock last did for Core in October.

And in a sign of how high the bar is for growth in the ETF business, iShares' share of U.S. assets in that business is under 39%, down from a peak under BlackRock ownership of 47%.

Last month, BlackRock said it would cut jobs and fees while relying more on computers to assemble its investment portfolios, a flurry of changes meant to jump-start its lagging stock-picking franchise. The changes affect 11% of its $275 billion active stock fund business.

By BlackRock's own figures, 51% of assets in its traditionalist "Fundamental" active stock funds are lagging their benchmark over five years. That compares to 90% for BlackRock's data-driven "Scientific" funds and 88% for its taxable bond funds.

Cutting Fees Boosts Returns

It remains to be seen what effect the new changes will have. All else equal, cutting fees boosts performance.

But transferring management of some traditionalist funds to Scientific teams comes with its own risks, including scaring away existing investors, and creating a new reliance on computer models that may not deliver in increasingly competitive markets.

"They can't do anything about the environment for active management," said Tom Brakke, who consults asset managers.