BlackRock shifts focus to portfolio construction

BlackRock Inc. is restructuring to concentrate more on portfolio construction and less on marketing traditional active and passive strategies.

The New York-based mega manager has a laser focus on four areas:

• Shifting to a portfolio construction approach for clients from a concentration on individual product selection.
• Satisfying investor demand in areas including illiquid alternatives, exchange-traded funds, factor-based investment strategies, and retirement plan design and investment management.
• Expanding the firm's technology prowess, including the development of a new defined contribution plan platform in partnership with Microsoft Corp.
• Increasing distribution capability in high-growth markets worldwide, especially in China and the rest of the Asia-Pacific region.

"Everything we are doing reflects our focus on the long term. This focus helps us keep us ahead of the changes in the market, staying in front of the needs of our clients and making sure that we're staying in front of our industry ... it guides our investments in our own business so that we are efficiently providing the full breadth of BlackRock's capabilities," said Laurence D. Fink, BlackRock's chairman and CEO, during the firm's Jan. 16 fourth-quarter earnings call.

Mr. Fink and other BlackRock executives were not available to provide more detail about the firm's restructuring plans.

In conjunction with the restructuring, BlackRock announced on Jan. 10 it will lay off 500 employees, or 3% of its workforce, over the next few weeks and bring on an unspecified number of new employees with needed skill sets.

"Market uncertainty is growing, investor preferences are evolving and the ecosystem in which we operate is becoming increasingly complex," said Robert Kapito, co-founder and president, in an internal memo obtained by Pensions & Investments.

The planned staff cuts are firmwide, across all departments and locations, and will happen over the next few weeks, changing "the size and shape of our workforce," Mr. Kapito said in the memo.

BlackRock's headcount was 14,000 as of Sept. 30, according to the firm's most recent 10-Q filing with the Securities and Exchange Commission.

The firm took a $60 million hit in the form of restructuring charge on its fourth-quarter balance sheet, mostly composed of severance and accelerated amortization of previously granted deferred compensation awards, Gary S. Shedlin, chief financial officer, told analysts on the earnings call.

BlackRock spokeswoman Melissa Garville declined to specify which areas of the firm will have the largest personnel cuts.

Investment industry observers were not surprised by BlackRock's restructuring plans and generally were supportive.

"The franchise continues to get stronger as BlackRock's management continues to be active in appropriating capital to the right growth areas," said Macrae Sykes, a research analyst at G.research LLC, the investment research affiliate of GAMCO Investors Inc. Both firms are located in Rye, N.Y.

"In what was a pretty awful quarter for the investment industry, BlackRock generated good flows, especially in ETFs," Mr. Sykes said.

Net inflows to BlackRock's long-term strategies totaled $43.6 billion in the fourth quarter, up from $10.6 billion in the previous quarter but down from $80.6 billion a year earlier.

As Mr. Sykes noted, the firm's ETF franchise experienced a peak quarterly net inflow of $81.4 billion in the last quarter, up from $33.7 billion in the prior three-month period and $54.8 billion in the year-earlier quarter.

The firm's total assets declined 7.3% to $5.976 trillion in the quarter ended Dec. 31 and 5% from the end of 2017.

"Given the tough environment in the fourth quarter, it's not surprising that investors moved money out of equity and fixed income," said Kevin P. Quirk, principal in Casey Quirk, a practice of New York-based Deloitte Consulting.

"For broad asset managers and especially passive managers, if pricing for indexed products drops to essentially zero as many predict, these companies need to figure out where to make money in other ways," Mr. Quirk said.

Mr. Fink is putting his money — and the firm's money — on capitalizing on investors "fundamentally questioning the composition of their portfolios. The industry is shifting from approach of picking product or stocks to one of building portfolios," he said on the earnings call.

BlackRock is seeing "an acceleration of barbelling (within) client portfolios with (indexing) and ETFs and factors, on one hand, and illiquid alternatives, on the other hand. The demand has never been greater for technology to manage risk and build more resilient portfolios," Mr. Fink added.

"Larry clearly was telegraphing his intention to significantly emphasize the firm's portfolio construction capability with more focus on using ETFs and factor-based strategies on the recent earnings call," said Michael Falk, partner at money management consultant Focus Consulting Group Inc., Long Grove, Ill.

Mr. Falk said BlackRock has internal capability now to apply a quantitative process based on alternative risk premiums implemented with ETFs to generate similar or better returns than traditional, actively managed strategies.

"Real active management these days is portfolio construction. Security selection is passe," Mr. Falk said, adding that "if we take what Larry said literally, BlackRock's active management strategies are under immense threat."

About 65%, or $3.908 trillion, of BlackRock's assets were managed in lower-cost indexed strategies, including ETFs, as of Dec. 31, and 27% was actively managed. The balance of the firm's assets is in cash or advisory strategies, the firm's most recent earnings report shows.

The firm's net revenue in the fourth quarter was $3.434 billion, down 4% from the quarter ended Sept. 30 and down 8.8% from the year-earlier quarter.

BlackRock is in the midst of mapping out what Mr Fink described on the earnings call as an "exciting collaboration" to expand the firm's footprint in the defined contribution plan market.

Mr. Fink expressed strong optimism about the firm's new partnership with Microsoft to address the growing retirement challenges in the U.S.

BlackRock and Microsoft announced the partnership in December, with little detail. Mr. Fink offered more information on the earnings call, noting that the deal combines "Microsoft's technology strengths with BlackRock's investment capabilities to jointly explore next-generation retirement solutions. Our goal is simplifying the saving process and enabling people to make better investment decisions that lead to secure financial futures."

Mr. Fink said BlackRock will expand its defined contribution offerings for the firm's existing institutional clients with technology that will help them better serve their employees.