iShares Help BlackRock Salvage Q2 Results As Other Asset Classes See Large Outflows

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Late last week, BlackRock (NYSE:BLK) managed to beat investor expectations with its Q2 results despite a rather lukewarm performance for the period. [1] This was largely due to the low expectations investors had for the financial services industry for a turbulent quarter. Although a recovery in fee revenues helped BlackRock report better top line figures compared to those for the exceptionally poor first quarter, the asset management giant reported a year-on-year reduction in revenues. This can be attributed to sizable outflows for most of BlackRock’s fund offerings.

While we maintain our $375 price estimate for BlackRock’s shares, we recognize the potential downside presented by growing uncertainty about the state of the global economy in light of the U.K.’s unexpected decision to exit the EU. With future rate hikes by the Fed also tied up with the Brexit, BlackRock may witness continued revenue headwinds in the U.S. over the next few quarters. Our price estimate is roughly 10% ahead of the current market price.

See our full analysis for BlackRock

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Operationally, Things Weren’t Great For BlackRock In Q2

BLK_Q2_EBTDiff

The table above summarizes the factors that aided BlackRock’s pre-tax profit figure for Q2 2016 compared to the figures in Q2 2015 and Q1 2016. Notably, revenues fell considerably compared to Q2 2015, with the impact being mitigated to an extent by a reduction in compensation expenses. While there was a marked improvement in revenues as well as costs compared to Q1, it should be noted that BlackRock recorded a $76 million restructuring cost in the previous quarter. Taking this into account, expenses nudged roughly 3% higher quarter-on-quarter on an adjusted basis. You can see how changes in BlackRock’s operating expenses affects our price estimate by making changes to this chart.

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 done well to keep quarterly costs roughly around the $1.65 billion mark over the last three years. That said, it should be mentioned that BlackRock announced plans to cut as many as 400 jobs at the end of Q1. [2] The corresponding one-time costs could be responsible in part for the elevated employee costs for this quarter.

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. BLK_Q2_AUMDiff

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. Just $1.5 billion in net new assets were added by BlackRock across its long-term funds for Q2 2016, as opposed to $36 billion in Q1 2016. More importantly, the company witnessed outflows from its active and passive equity funds, active fixed income funds, multi-asset class funds, and also its core alternative investment funds. The only funds to record sizable net inflows for the quarter were BlackRock’s equity and fixed income iShares, which saw $3.4 billion and $10 billion in new cash added in Q2.

Notably, strong improvements in market valuation of securities helped BlackRock report total long-term assets in excess of $4.5 trillion for the first time this quarter. As the company also finished integrating a portfolio of money market funds from Bank of America in Q2, its cash management fund assets reached a record $375 billion – taking total assets under management to just under $4.9 trillion. BlackRock’s iShares offerings continue to swell in size and now account for nearly a quarter of all assets, as seen in the chart below.

BLK_Q2_AUMSplit

BlackRock Needs To Look Into Its Underperforming Active Funds

Like in the first quarter of 2016, an important factor that weighed on BlackRock’s results for Q2 was poor performance-related fees. The company reported $74 million in these fees for Q2 2016 – better than the dismal $34 million in Q1 2016, but well below the $136 million figure for Q2 2015. These fees were lower across offerings, indicating that BlackRock’s actively-managed equity and fixed income funds performed worse than the benchmarks they tracked. Only 53% of the assets in taxable fixed income funds and 43% of those in tax-exempt fixed income funds performed better than the benchmark or peer median over a one-year horizon.

Poor performance by actively-managed funds not only hurts fee revenues in a given quarter, but also tends to result in cash outflows over subsequent periods as investors move their money to better-performing funds offered by competitors. This can have a negative impact on BlackRock’s revenues over coming quarters, as active funds generally generate much higher fees as a percentage of assets compared to ETFs and passive funds.

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Notes:
  1. 2Q16 Earnings Release, BlackRock Investor Relations, Jul 14 2016 []
  2. BlackRock to Cut About 400 Jobs, The Wall Street Journal, Mar 30 2016 []