BlackRock’s Decision To Extend Price Cuts To Smart Beta ETFs Should Help Grow Revenue

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Last week, BlackRock (NYSE:BLK) raised the stakes in the ongoing price war among ETF industry incumbents by slashing expense ratios for many of its smart beta ETF offerings. [1] The asset management giant is already the leader in the ETF industry with a global market share of more than 35%, but the increasing popularity of ETFs among retail investors (who tend to be more sensitive to costs), and the impending fiduciary law from the U.S. Department of Labor (which makes cost an important criteria for financial advisers while recommending investments) has intensified price-based competition in the industry over recent months. After all, ETFs from different companies that have identical investment strategies usually have similar performances – making the expense ratio a critical factor behind an investor’s preference of a particular ETF over another.

It should be noted that BlackRock faces the most competition in the low-cost ETF market from Vanguard and Charles Schwab, who have captured a sizable share of this segment. While BlackRock’s latest move included a reduction in expense ratios for two of its core ETF offerings, most of the cuts were aimed at the smart beta ETF sub-segment, where Goldman Sachs (NYSE:GS) is seeing rapid growth. Considering the fact that smart beta ETFs have a much higher expense ratio on average compared to the core ETF lineup, faster growth in assets for the former should speed up growth in BlackRock’s top line in the long run.

We maintain a $380 price estimate for BlackRock’s stock, which is slightly below the current market price.

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See our full analysis for BlackRock

The best indicator of the popularity of ETFs and other exchange traded products (ETPs) is the fact that the industry has grown to larger than $3.4 trillion in size (as of November 2016) from being a largely obscure investment option at the turn of the century. [2] The reason for this growth is that ETFs provide investors a cheap and convenient way to put their money into fixed income, equity, currency, commodities and other investment markets. And with the popularity really only skyrocketing in the past few years, the industry has the potential to continue to grow considerably in the future.

The largest avenue of growth for ETF providers over the coming years is expected to be the retail investor market, which remains extremely under-served. As retail investors are much more sensitive to expense ratios, asset managers have been trying to attract them with a string of low-cost ETFs. This in turn has triggered a price war among incumbents in the ETF industry – largely thanks to the popularity of low-cost, core ETFs from Vanguard. Over recent years, Vanguard has seen the best growth globally among retail investors thanks to the proven track record of its low-cost ETF lineup.

The ETF price war started out in the U.S. in 2013, and spread quickly to Europe and the rest of the world in early 2014. Since then, the largest ETF players – BlackRock, Vanguard, State Street and Charles Schwab among others – have announced reduction in expense ratios for many of their ETF offerings from time to time. However, all of BlackRock’s expense ratio revisions were restricted to its “core” ETFs until now.

The recently announced round of expense ratio cuts by BlackRock includes six of its smart beta ETFs. Smart beta ETFs combine the characteristics of both active- and passively-managed funds to improve returns or reduce risk at lower overall costs. [3] Notably, the six ETFs affected have just over $550 million in assets under management – making them a very small part of the $128 billion in total assets BlackRock manages across Smart Beta ETFs. [4] BlackRock may be effectively testing the waters with these cuts to see if lowering the fees leads to a faster rate of growth in assets for Smart Beta ETFs.

This is important in the long run, as BlackRock’s Smart Beta ETFs have an average expense ratio of ~0.3% compared to a figure of ~0.05% for its “core” ETFs. This means that for each dollar that flows into BlackRock’s Smart Beta ETFs, the company earns roughly six times more fees compared to core ETFs. So BlackRock’s revenues will grow at a faster rate if inflows into Smart Beta ETFs outpace those into the low-cost core ETFs. This in turn will positively impact ETF fees – something we highlighted in detail in an earlier article. You can see how changes in ETF fees impact BlackRock’s share price by making changes to the chart below.

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Notes:
  1. BlackRock Cuts Fees on ETFs as Price War Moves to Smart Beta, Bloomberg, Dec 19 2016 []
  2. Global ETF and ETP Assets, ETFGI Website []
  3. Smart Beta, BlackRock Smart Beta ETF Marketing Material []
  4. BlackRock’s Smart Beta Website []