Historically the New York-based asset manager BlackRock International has never set out to be a big hitter. It has preferred to build up its score steadily.
Ralph Schlosstein, the co-founder and president of BlackRock agrees that, for the fixed income business for which his firm is best known, this an apt analogy: “In fixed income, in our liquidity products and in our quantitative equity products we strive to produce a very high ratio of return to risk. That is generally done by relatively consistent, modest amounts of excess performance, quarter by quarter.”
BlackRock’s conservative management of bond portfolios has made it a natural choice for US pension funds that are looking for a manager who will beat their benchmarks without taking much risk.
Yet over the past five years, BlackRock has begun to hit out to the boundary. It has done this principally by diversifying its capabilities and pitching them at wider, international markets.
BlackRock is now one of the 20 largest asset managers in the world, with $428bn assets under management at the end of the third quarter. Over $94bn (€79bn) of this is in non-US assets in over 40 countries. It is currently in the process of opening offices in Munich and London.
Schlosstein and his co-founder Laurence Fink, BlackRock’s current chairman and chief executive officer, together with six other partners, set up the firm in 1988: “Larry was at First Boston and I was at Lehman. There had been an explosion in the new knowledge base and new technology in the fixed income markets, and we both felt that a gap had developed between the knowledge base and technology that existed on the Wall Street side to make these products, and the knowledge base and technology that existed in the money management industry.
“At the end of the month our clients would send us their portfolios, ask us what they owned and how it would perform in different interest rate environments, and tell us to mark it to market for them.
“Both Larry and I reached the conclusion independently and then together that perhaps we could add a little value relative to that.”
Much of BlackRock’s success in fixed income asset derives from its bond analytics operation, BlackRock Solutions. Its systems cover the fixed income universe and enable a manager to allocate trades, check compliance and run ‘what if’ scenarios.
BlackRock Solutions’ largest client is BlackRock itself, which runs $265bn in fixed income through their systems. But it also sells its trading system to third parties that manage large fixed-income portfolios.
Its biggest third-party client is Freddie Mac, one of two large quasi-state companies that underwrite most US mortgages. It runs its entire balance sheet of more than $600bn off BlackRock Solutions technology. Frank Russell also uses BlackRock Solutions to provide fixed income analytics to its clients. Currently, it is estimated that over $3trn of positions use BlackRock Solutions technology.
The third-party business ensures that BlackRock Solutions stays on its toes, says Schlosstein. “Having outside clients raises the bar for what we’re providing to ourselves. You can’t win a big risk management or technology client without having state of the practice disaster recovery, and you can’t win a client without having state-of-the-practice documentation of programming and developments.
“Those things are not typically part of the core competency of a money manager organisation, but as our second business they’ve become second nature to us. They give us a lot more belt and braces than most firms.”
BlackRock Solutions has been behind the rapid growth in the money management side of the business, he says. “When we started in 1988 people focused 90% on return and 10% on risk – if that. Today it’s accepted practice that one has to look at both the return and the risk on equal footing.”
BlackRock’s technological edge has enabled it to answer the growing demand for transparency, says Schlosstein. “One of the things that we make available to our clients, for example, is a proprietary website where they can view their portfolio at any hour of the day. Because we have such rigorous capabilities we’re not afraid of having a client who will effectively electronically walk into our office at two in the morning and look at the portfolio.
“There are not many money managers who have the technological and risk management rigour that we have who are comfortable letting the clients have the window on the sausage factory. Over the next four or five years that will become expected practice in our business.”
Besides setting up a second business, BlackRock has also diversified its revenue sources. A key part of this diversification has been an expansion of its equities mandates. Two years ago its assets under management totalled almost $300bn, with only $14bn in equities. Today, the equities share has risen to $33bn.
BlackRock began diversifying into equities when it attracted a European equities team from Scottish Widows Investment Management (now SWIP) in 2000. Led by Albert Morillo, the team had an impressive record of outperformance against the sector average, running highly concentrated portfolios.
Schlosstein says BlackRock hired the team because it liked the way it worked. “We’ve never gone out and said we have to be in a particular business so let’s go hire some people. We’ve always been very sensitive to finding the right people and that’s typically what’s caused us to enter a business.
“The lift-out from Scottish Widows was a great example of that. We didn’t have some secret strategy at BlackRock that we wanted to be in European equities. We happened to find a really strong team and built a business around them.”
Black Rock moved further into equities in 2004 with the acquisition of SSRM, the holding company of State Street Research and Management and State Street Realty. The move had three main objectives, says Schlosstein – to increase the scale and the diversity of BlackRock’s equity business, to increase the scale of its mutual fund business and to diversify into real estate equities.
Before the acquisition, BlackRock had real estate debt under management but no equities. It now manages some $7bn of real estate equities. “We identified real estate equities as an area of high interest to many of our institutional clients. We looked at a number of managers in that area for potential acquisition and we were fortunate to acquire a very strong team.”
The objective now is to develop the real estate business beyond the US, he says. “Our hope is to diversify real estate globally as we have our equity businesses and our bond businesses.”
The State Street Research deal also brought with it $20bn equities. After the acquisition BlackRock had $33bn of equities under management and $265bn in fixed income – a ratio of eight to one.
The revenue contribution was more significant. Schlosstein says: “Because of the higher fees associated with equities, equity revenues are almost 50% of what our fixed income revenues are in longer-dated products.”
He says BlackRock is now well diversified globally. “Half our net new assets added in 2004 came from outside of the US. So last year we got 50% of our growth from 20% of our asset base.
“In Europe we’re bringing our broad spectrum of capabilities to the market place. Three or four years ago the name of BlackRock was not so broadly known in Europe. That has changed quite dramatically in the last two to three years. And now we have quite a broad base of clients in Europe across a number of products.
“The growth area for us in recent times has been the global bond area. But we also have mortgage-backed security and high-yield mandates. We have US investment grade mandates, Eurobond mandates as well as our European equity mandates.”
BlackRock has also established itself as a manager of insurance assets.
“We’ve made good inroads into the Lloyd’s market in London, and we also have a number of major insurance clients in continental Europe.
“One of the reasons we have had as much success in the insurance and financial institutions business is that we can customise a solution to meet their liabilities. Insurance companies, particularly the publicly traded ones, are very oriented towards having an earnings stream that has the same risk profile as their liabilities.
“To date we have in excess of $75bn in mandates with insurers and institutions and more than 95% of those mandates have customised benchmarks based on liabilities.”
So far pension funds have shown less interest than insurers in asset liability matching, says Schlosstein. However, this could change, he suggests, if interest rates began to move up. “The fact that interest rates are as low as they are today is an effective barrier to wholesale adoption of an asset liability approach by pension fund managements. If interest rates were higher, you would see a dramatic increase of focus by pension funds on asset-liability management.” Future growth at BlackRock is likely to be organic rather than through acquisitions, he says. “We have enormous opportunities to grow organically. We’ve been in business 17 and a half years and we’ve done one acquisition, and we certainly don’t feel compelled to do any more than that.”
Maintaining a culture of excellence is more important than mapping out a future strategy, Schlosstein suggests. “The strategy of this business is not really that hard. It is the execution that’s hard. What makes a successful money manager - which is what we live and die for every day - is delivering to clients what you promise in the investment performance area, doing an A-plus job servicing the clients, and not making operational and compliance mistakes.
“If you do those three things you actually take share from your competitors. If you do those three things you have a great business.”