Stock of the week: BlackRock

Summary:

  • BlackRock is world’s biggest asset manager

  • Owner of the biggest ETF family, iShares

  • Company’s actively managed funds have history of outperformance

  • Strong correlation between stock price and S&P 500 valuation

  • Company raised dividend despite first annual asset decline

  • BlackRock (BLK.US) stock is testing important resistance zone

Broad adoption of Internet that begun at the beginning of the turn of the millenia has made financial markets more accessible for many investors. However, even despite this easier access some markets remain out of reach for retail investors. This is where our stock of the week takes the stage. As world’s largest ETF provider BlackRock helps traders from all around the world get indirect exposure to markets that are either closed for regular investors due to regulation issues or too costly to get a direct exposure to. In this report we will look briefly through company’s early years as well as details of its ETF and active asset management businesses.

 

BlackRock enjoyed nice pace of AuM growth since the start of this decade. One can notice that the equity portfolio is the most volatile segment and performance in this field has the biggest impact on the shape of total AuM curve. Source: Bloomberg, XTB Research

Attracting significant fund inflows since the very beginning

Before we take a closer look at current condition of BlackRock let’s briefly go through the history of the company. BlackRock was founded by a group of former investment bankers in 1988 who wanted to create an asset management company for institutional clients that would pay bigger attention to risk management. The company quickly began making profits and, in turn, lured additional capital. Within a few months company’s assets increased over fourfold to $2.7 billion in 1989. BlackRock maintained a strong pace of asset growth in the next years with assets under management increasing to $17 billion at the end of 1992 and and to $165 billion at the end of 1999. The first decade of the new millennium was marked by heightened activity of BlackRock on the M&A market. The company acquired mutual fund business of State Street Research and Management and later on merger with Merrill Lynch Investment Managers. However, probably the most important acquisition for the company occured in mid-2009 when BlackRock bought Global Investors business from Barclays, a unit that included iShares ETF family.

BlackRock is unquestionable leader among ETF providers with almost 60% more assets under management than second-biggest Vanguard. However, one can notice that asset growth rates slowed significantly during this decade whhich may hint that initial, rapid expansion of ETFs is already over. Source: etf.com, XTB Research

Fast forward to ETF industry leader position

Exchange-Traded Funds, or ETFs, are relatively new financial instruments with less than three decades of history. However, despite such a short existence this form of investing won appeal of many investors. Since the financial crisis assets managed by ETFs increased from $700 billion to over $5 trillion now. Superb growth is set to continue with EY forecasting this market to grow to $7.6 trillion by 2020. To picture the scale of the market let’s just say that according to the International Monetary Fund the size of Japan, world’s third biggest economy, was $5.07 trillion in 2018. Trends among ETF investors bode even better for the future. According to the 2018 ETF Investor Study conducted by Charles Schwab millennials (age group: 25-37) are the most interested in ETF products. Moreover, 56% of respondents in this age group confirmed that they have replaced all individual stocks in their portfolios with ETFs. In every age group researched in the study portion of respondents that replaced at least part of their individual stock holdings with ETFs was above 50%. Out of all respondents of the study 54% expressed their desire to increase share of ETFs in their portfolios during the next year. On the other hand, just 4% planned to either moderately or significantly decrease share of ETFs in their investments. Having said that, it looks like there is a bright future ahead of the ETF industry with flexibility of ETFs continuing to attract more and more capital to such investment vehicles. Under such circumstance BlackRock may benefit more than other ETF providers due to its significant market share. Top 10 ETF providers have ETF assets of around $3.2 trillion out of which $1.33 trillion (41.7%) is managed by BlackRock. Size of particular ETFs also plays a role in the investment decision making process as shares of ETFs with more assets tend to be more liquid and in turn investors tend to favor them over smaller peers. Given that 19 out of 50 biggest ETFs come from BlackRock’s iShares family, BlackRock is in good position ahead of industry’s expected further expansion.

BlackRock’s revenue and earnings jumped significantly throughout 2009 after asset manager got control over the iShares ETF family. Since then the company saw its earnings growth ease but profit margin still holds steady in the 25-35% range. Source: Bloomberg, XTB Research

Is active management really that bad?

While ETFs are certainly a key part of BlackRock operations one cannot forget about other funds managed by the company. In fact, iShares ETFs represents less than 30% of total assets under BlackRock’s management. The remaining part, over $4.4 trillion, is ascribed to mutual funds. Popularization of the passive management ideology in for of, for example, ETFs caused number of market participants to question reasonability of paying more for actively managed funds while on average they tend to underperform the broad market.  However, this is not exactly the case for funds managed by BlackRock managers. According to data presented in company’s report for Q4 2018 most of the actively managed funds actually managed to beat benchmarks in the past few years. During the five-year period ended 31 December 2018, 78% of actively managed BlackRock equity funds outperformed market. For three and one-year periods ended on the same day this percentage stood at, respectively, 67% and 50%. This is more than pleasing development given that actively managed funds are usually subject to higher management fees than ETFs and their outperformance is rewarded with a success fee (fee based on the return in excess of a benchmark).

While the scale of price moves of S&P 500 and BlackRock differs, it is hard not to see how this two markets move in tandem. In fact, for the whole period depicted on the chart above correlation coefficient between the two was 78%. Source: Bloomberg, XTB Research

Watch the broad market!

Of course, just as it is the case with any other investment, there are factors that may adversely impact stock price of BlackRock shares. Equities as a category have the biggest share in assets managed by BlackRock. It comes without saying why stocks are poor investment choice at times of significant market downturns. Having said that, asset management firms like BlackRock are likely to experience fund outflows at such times. Lower level of assets would translate into smaller fees which are the major part of BlackRock’s revenue. Summing up, shares of the company are likely to closely resemble broad market performance and it was the case for the major part of the past decade. However, there is also a scope for BlackRock to make some money during periods of stock market declines in order to at least partially offset aforementioned potential earnings drop. As a portion of BlackRock’s funds are closed-end funds it is easy for the company to predict when shares may be needed at hand in order to settle redemption requests. Spare for these periods, the company is free to lend part of equities held by its funds to short-sellers for a premium. Logically, demand for such services should increase at times of elevated risks and smaller appetite for stocks. Unfortunately, in BlackRock’s financial statements revenue earned by securities lending unit is presented jointly with investment advisory and administration fees therefore the exact impact of these activities on company’s overall performance is hard to assess.

BlackRock stayed reluctant to lowering dividend payout even during periods of declining earnings. While the last quarter of the previous year was tough for BlackRock as well as other asset managers, the company still continued with dividend hikes. Source: Bloomberg, XTB Research

Company with ability and desire to pay dividends

BlackRock is regularly sharing profits with shareholders. The company did not skip a single dividend payout since 2004. Moreover, during the 2004-2018 period asset manager did not raise dividend just once, in 2009, as it was recovering from the aftermath of the financial crisis and made a major acquisition of Barclays’ Global Investors business. Payout ratio in range of 40-50% may allow BlackRock maintain its dividend policy also during turbulent times. Moreover, retaining reasonable portion of earnings within the company is beneficial as it provides company with cash pile needed for further expansion, for example through acquisitions. This seems true for BlackRock as even despite deterioration in business in the final quarter of 2018 and the first annual decline of assets in history the company decided to increase quarterly dividend payout from $3.13 to $3.30.

Correlation between BlackRock (BLK.US) and S&P 500 index broke during the third quarter of 2018. However, both markets began to move in tandem once again at the beginning of Q4 when  S&P 500 plunged from record highs. Ongoing recovery may be put at risk in case bulls once again fail to break above the resistance zone ranging $436-443. Source: xStation5

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