BlackRock’s Alternative Investment Business Could Gain Significantly From Potential Calpers Deal

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BlackRock (NYSE:BLK) is reportedly in talks with the California Public Employees’ Retirement System (Calpers) to manage all or part of the latter’s private equity investments – currently valued at around $26.2 billion. A possible deal between the largest asset manager and the largest U.S. pension fund works in favor of both parties. While Calpers will expect better returns from its private equity portfolio at lower costs, BlackRock’s revenues would benefit from a larger alternative investment portfolio.

Over recent years, BlackRock has focused on growing its alternative investment funds, as the significantly higher revenue potential from these offerings complement the rapid growth in its low-cost ETF offerings. Although BlackRock’s strategy of growing its alternative investments business has largely revolved around real estate, improved macroeconomic conditions over recent years makes private equity investments an attractive area of growth for the company.

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We maintain a price estimate of $440 for BlackRock’s stock, which is slightly ahead of the current market price.

See our full analysis for BlackRock

The alternative investment business is an important part of BlackRock’s business model – contributing roughly 7.5% of its total value, according to our analysis. The business includes core alternative investments as well as investments in currencies and commodities. While BlackRock has reduced its exposure to currencies and commodities over recent years, the increasing importance of core alternatives in its asset base is evidenced by the fact that these assets swelled from $68 billion at the end of 2012 to almost $98 billion by the end of Q2 2017.

There are two important reasons for this trend. Firstly, the demand for alternative investment options that yield higher returns has increased substantially over the last few years, given the impact of low interest rates prevalent around the globe. And secondly, the overall improvement in economic conditions has emboldened asset managers to grow their alternative investment offerings, as they have higher revenue potential compared to traditional mutual fund offerings. To put things in perspective, BlackRock earns operating fees which are over 0.6% of the total assets managed by its alternative investment funds, as opposed to fees of under 0.2% for actively-managed fixed-income funds and a substantially lower 0.05% for passive fixed-income funds. More importantly, performance-related fees for alternative funds average 0.3% – well above the 0.04% figure for passively-managed equity funds.

The higher revenue potential has driven a push in alternative investment offerings by BlackRock over recent years. In addition to launching several exchange-traded funds (ETFs) focused on real estate as well as other alternative investment strategies, the company has also made several long-term infrastructure investments globally. The ongoing talks to manage Calpers’ private equity portfolio mark the latest step by BlackRock to increase its presence in this alternative investment space. If BlackRock wins the mandate to manage all $26.2 billion on Calpers’ private equity portfolio, the asset manager’s core alternative investment portfolio would jump by almost 27% from $97.6 billion to $123.8 billion.

We currently estimate that the size of assets managed by BlackRock’s alternative investment offerings will increase by 4-5% annually over coming years from a combination of organic growth as well as targeted acquisitions. You can see how faster growth in this figure can positively impact the company’s share value by making changes to the chart below.

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