Strong Inflows Into iShares, Cost Focus Helps BlackRock’s Q3 Results, But Industry Headwinds To Hurt Profits Going Forward

BlackRock (NYSE:BLK) reported strong performance figures for the third quarter last week, with the world’s largest asset manager continuing to leverage its strength in the ETF industry to boost revenues even as it keeps a close watch on its operating expenses. ^[1] The highlight of the results was the increase in BlackRock’s investment advisory fees to an all-time high of $2.55 billion. As this fee income represents a recurring revenues stream for the company (as opposed to more volatile performance-related fees), the overall increase in these fees is a good sign for investors in the long run.

But the global asset management industry is currently undergoing some major changes which we believe will put pressure on BlackRock’s earnings in the future. Firstly, there has been a steady outflow of funds from lucrative actively-managed equity funds for all asset managers over recent quarters, as active funds have been unable to outperform indexed funds or ETFs over recent years. This trend is not expected to change anytime soon. And secondly, the price wars in the rapidly growing ETF industry are only expected to become more intense in light of the Department of Labor’s fiduciary rule governing retirement investment advice. We revised our price estimate for BlackRock’s shares downward from $385 to $380 to reflect the impact of these industry-wide changes on the company. The new price target is roughly 10% ahead of the current market price.

See our full analysis for BlackRock

Revenues Nudged Higher, And So Did Profits..

The table above summarizes the factors that aided BlackRock’s pre-tax profit figure for Q3 2016 compared to the figures in Q3 2015 and Q2 2016. Revenues improved considerably compared to both these quarters, primarily due to an increase in fees from iShares offerings (equity as well as fixed income), as well as from overall strength across fixed income funds for the period. The reduction in revenues by $114 million y-on-y can be explained by the fact that performance fees for Q3 2015 were exceptionally elevated at $208 million. These fees fell to just $58 million in Q3 2016 as broad recoveries in the equity market as well as debt market would have made it more difficult for individual funds to beat the performance of their respective benchmarks.

More importantly, BlackRock reported a reduction in total operating expenses y-on-y as well as q-on-q despite an increase in revenues. We have detailed the importance of cutting costs for BlackRock on numerous occasions in the past, especially given its shifting focus on the retail investor market. This is because the largely untapped retail investor market is heavily influenced by the price of the products offered – requiring BlackRock to set low fees for these products. The company has put in considerable efforts over recent years to rein in costs, and has reported costs roughly around the $1.65-billion mark for each quarter over the last three years. This time around, the figure dipped to below $1.63 billion for the first time since Q1 2014. These benefits likely stemmed from BlackRock’s plan to reduce headcount by around 400 jobs as detailed earlier this year. ^[2] The cost reduction coupled with higher revenues led to an increase in BlackRock’s operating margin (adjusted basis) from 43.9% in Q3 2015 and Q2 2016 to 44.8% in Q3 2016. You can see how changes to BlackRock’s operating margin affects our price estimate by making changes to the chart above.

Outflows For Nearly All Fund Types, Except iShares

The table below captures how BlackRock’s long-term assets under management (AUM) changed year-on-year as well as quarter-on-quarter.

BlackRock offers a complete range of investment products, including actively-managed as well as passively-managed (indexed) equity and fixed income funds, ETFs (iShares) and multi-class asset funds, in addition to currency, commodities, and other alternative investment funds. The company witnessed strong inflows for most of its fund classes over the quarter, with total inflows across long-term funds exceeding $55 billion. To put things in perspective, total inflows for long-term funds were just $1.5 billion in Q2 2016. BlackRock’s popular iShares line of ETF offerings led growth with total inflows of more than $48 billion. BlackRock’s equity and fixed income iShares, saw $25.5 billion and $22.7 billion in new cash added in Q3.

Notably, strong improvements in market valuation of securities helped BlackRock report total long-term assets in excess of $4.7 trillion for the first time this quarter. Taken together with cash management fund assets of a just under $390 billion and other advisory assets of $10 billion, BlackRock’s total assets under management swelled to an unprecedented $5.1 trillion by the end of Q3. BlackRock’s iShares offerings continue to grow in size and now account for almost 24% of all assets, as seen in the chart below.

But Active Equity Funds Are Falling Out Of Favor With Investors

BlackRock’s average performance-related fees for the three quarters of 2016 have been just $55 million – in stark comparison for the average quarterly figure of $155 million for 2015. These fees have fallen across offerings year-on-year with BlackRock’s actively-managed equity and fixed income funds performing worse than the benchmarks they tracked for the third consecutive quarter. Only 59% of the assets in taxable fixed income funds and 60% of those in tax-exempt fixed income funds performed better than the benchmark or peer median over a one-year horizon. These figures are far worse for actively managed equity funds, where more than 50% of them have lagged benchmarks.

While poor performance by actively-managed funds has hurt fee revenues, they have triggered sizable outflows in funds out of them over recent quarters. Total outflows from active equity funds in Q3 exceeded $7.8 billion – bringing the total outflows from these funds for year-to-date 2016 to $15.7 billion. Now active equity funds demand much higher base fees (roughly 0.6% of assets for BlackRock) compared to indexed equity funds (around 0.05% of assets). And they also attract sizable performance-related fees. If these outflows continue for too long, there will be a visible negative impact on BlackRock’s revenues.

View Interactive Institutional Research (Powered by Trefis):
Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap
More Trefis Research

1. 3Q16 Earnings Release, BlackRock Investor Relations, Oct 18 2016 [↩]
2. BlackRock to Cut About 400 Jobs, The Wall Street Journal, Mar 30 2016 [↩]