Gary Shedlin – CFO
Roger Freeman - Barclays Capital
BlackRock, Inc. (BLK) Barclays 2013 Global Financial Services Conference September 9, 2013 9:45 AM ET
Roger Freeman - Barclays Capital
We’re going to go ahead and get started. Good morning. My name is Roger Freeman. I am the analyst covering the brokers, exchanges and asset managers here. I’d like to welcome BlackRock up next. They have been coming to our conference every year. We are happy to have them back in the first of many series of three asset managers we have presenting this morning. With us from the company is Gary Shedlin, the CFO, a new face at BlackRock but better known in the Wall Street having been in senior roles in investment banking at Morgan Stanley and Citigroup previously. So with that, I will pass over to Gary. Thank you.
Great. Thank you, Roger. Good morning everybody. Hopefully we have a few jet fans here relishing in our first day (inaudible) a season feeling good. Anyway, my name is Gary Shedlin. I’m the CFO of BlackRock and I am excited for the opportunity to be here today.
In the next 20 minutes today, I am going to provide a brief overview of our diversified platform, discuss how we intend to drive organic growth and coupled with the benefits of scale and a sound capital management policy, explaining our plans for delivering shareholder value over the coming years. And I am going to leave some time for Q&A following my formal remarks.
BlackRock is a highly differentiated asset manager with $3.9 trillion in AUM and a business that is diversified across client types, investment styles, products and regions. The breadth of our product offerings and style capabilities enable us to build comprehensive solutions that allow our clients to achieve their desired outcomes. Our diversified platform and global reach also allow us to adapt to changing client needs and be resilient through market cycles. We are the industry leader in advice-driven solutions, risk management and innovation.
Long term net flows of approximately $51 billion in the first half of 2013 speak to the strength of our diversified business model, especially during periods of heightened market volatility. On the client side, during the first quarter, iShares drove strong organic growth. However as liquidity oriented investors risked off the table at the end of the second quarter resulting in negative flows in iShares, our retail and institutional businesses continued to generate healthy flows.
In terms of products, while iShares equity drove first quarter growth, strong fixed income and multi-asset flows paced second quarter growth. In fact, during the second quarter we had 11 individual retail and iShares funds which generated more than $1 billion in net inflows. These products included SIO, our strategic income opportunities funds, MAI, multi-asset income funds and global long short credit, one of our retail alternatives products. All of these are designed for investors seeking non-traditional unconstrained investment solutions.
Finally, continuing the diversification story, we saw strong flows in EMEA and APAC in the second quarter, offsetting weakness in the Americas which had a strong start to the year. Our diversified business model provides stability which in turn allows us to invest in our business with a longer term mindset.
BlackRock has a history of strong performance and a commitment to delivering attractive returns to shareholders. In fact, since going public in 1999, we’ve generated compound annual return to shareholders in excess of 25%. While we are significantly larger today than we were at the time of our IPO, we remain confident that we can generate attractive returns by focusing on three key drivers of shareholder value.
First, delivering organic growth through a commitment through alpha generation, product innovation and broad based distribution. Second, demonstrating the benefits of scale through positive operating leverage and improving margins, and finally, implementing a consistent and predictable capital management policy committed to returning excess cash flow to shareholders. If we can deliver on each of these drivers through market cycles, we will generate earnings growth. If we can differentiate ourselves relative to our peers especially in the context of organic growth, we believe that should afford us a premium multiple and ultimately drive superior total returns and shareholder value creation.
So let’s examine each one of these drivers in a little bit more detail. Over the last several years, BlackRock has delivered solid organic growth in excess of industry averages. During this period, we experienced strong growth in retail and iShares, our higher growth businesses and more moderate growth in our institutional channel. BlackRock generated approximately $130 billion of adjusted net new long term business over the 12 month period ending June 30, representing a 4% organic growth rate for the firm. We target 5% annualized long term organic growth for net new business and we believe this level of organic growth is both achievable and sustainable in stable markets.
As you can see on this chart, we are targeting high single digit organic growth in retail, low double digit organic growth in iShares and low single digit organic growth in our institutional channel. Our retail business represents a significant growth opportunity for BlackRock. Today retail represents 12% of our assets under management and 33% of our base fees. The retail industry is undergoing significant change. Clients are no longer seeking to buy just one product, they are looking for combinations of products and tools to achieve the outcomes they need. As such, we are changing the way we serve financial advisors.
The emergence of the rep as PM advisory model requires a consultative relationship based approach. We believe our broad suite of investment solutions and strong distribution capabilities position us well in this growing component of the retail marketplace. Our growth strategy in retail is focused on three key initiatives. First, we have broadened our products to meet client demands. Innovation will drive new product offerings and we will be a major player in alternatives and outcome oriented investment.
In retail alternatives, we are uniquely positioned to leverage our investment and distribution expertise to deliver institutional quality alternative solutions to retail clients. Our highly experienced team of investment professionals is delivering attractive risk adjusted returns in products like global long short credit and emerging markets long short equities where we have seen over $2 billion inflows this year. In multi-asset where we have unparalleled asset allocation capabilities across active and passive products, our multi-asset income fund have gathered an additional $2 billion in net new assets year to date.
Second, we will enhance our distribution by leveraging our existing strength in the warehouses and penetrating new retail sales channels. In particular, the IRA space is a compelling growth opportunity for us. We have a strong foothold in IRAs through our iShare relationships that have historically had a more blended actively managed retail presence. We will attract this channel aggressively by leveraging the strength of our diverse investment platform and a combined US retail and iShares sale force capable of providing a full range of active and passive solutions on a single platform. We believe we are well positioned to deliver unique value proposition and form lasting partnerships with these independent advisors as they look to grow their businesses.
Lastly, we are committed to delivering the full and unique capabilities that differentiate BlackRock to our clients. As we strive to provide holistic investment solutions, we will leverage our unparalleled technology and risk analytic capabilities in the retail marketplace. BlackRock has a number of proprietary asset allocation models and investment tools which we offer on multiple platforms. These models and tools are a great way for us to provide content to FAs and will contribute to our ability to both raise and retail assets as our clients continue to gravitate towards solutions oriented investing.
We also see some substantial growth opportunities in our iShares business. Today iShares represents 22% of assets under management and 35% of base fees. The global ETF market grew 25% over the last five years, compounded annual 25% and iShares have benefitted from that market expansion. As the shift from active to passive continues and ETFs become building blocks for asset allocation strategies we will see continued adoption of ETFs among both institutional and retail clients.
Consequently, we see substantial additional growth potential in the global ETF market and expect iShares to participate in that growth. In the first half of 2013, iShares generated net new business of $25 billion and an additional $6 billion through August 30. Our growth strategy for iShares has several components. First, in the US, we will expand our share of the buy and hold marketplace. Because investors in this segment are more cost sensitive than investors who ascribe a greater value to liquidity, we launched the iShares Core series in October of last year. Since the launch through the second quarter, we’ve gotten more than $12 billion of net new assets. A critical part of our buy and hold strategy is our strategic alliance with Fidelity which will deliver significant value to investors across a range of ETF initiatives, including providing millions of Fidelity customers increased and improved access to a broad selection of iShares products.
Second, we will continue to grow globally. ETFs currently represent a small portion of global capital market assets and have significant organic growth potential as client adoption rates increase. To supplement this organic growth, we’ve also grown via acquisition where we can expedite our access to unique products and our new markets. Most recently, we acquired the Credit Suisse ETF business representing a new opportunity for us in the Swiss market.
Finally, product innovation and extension, including the fixed income marketplace will be a critical element of our growth story for iShares. Fixed income ETFs currently represent only 0.3% of the $98 trillion global bond market. We recently launched iShares Bonds, a unique fixed maturity corporate bond product. We believe this is a sizable opportunity and will unlock new customer segments, including small and mid-cap banks, insurance companies and corporate investment portfolios.
Before moving on, I’d like to take a moment to comment on recent activity in the broader ETF marketplace. As you are all aware, we experienced outflows at the end of the second quarter as clients utilized iShares to express their views on global capital markets. In this period of heightened market volatility, our products performed as they were intended to, affording our clients the ability to trade in and out of exposures in a timely transparent and cost effective manner. As the leader in the ETF industry, BlackRock is focused on educating investors both in terms of products and the broader mechanics of the ETF ecosystem to more fully understand the unique value proposition of iShares and our broader business.
Institutional, this is a more mature business and represents 66% of our assets and 32% of base fees. Our institutional business is organized into specialized client teams across the globe equipped with the expertises of clients with similar needs. Our approach to clients is straightforward: Take the time to clearly understand their specific needs and provide them with either individual or bundle investment strategies and/or bespoke, outcome oriented solutions.
The institutional industry is evolving and our growth strategy has three components. First, we will focus on specific institutional market segments to offset the slow secular decline of the defined benefit marketplace. We expect several specialized client segments, including financial institutions, official institutions and defined contribution to deliver strong growth and we are well positioned to address these demands. Since 2011, AUM in these focused segments has grown at an 18% compound annual growth rate and today accounts for more than 36% of total institutional assets under management.
In our defined contribution business, we are capturing significant flows in our multi-asset target date products. BlackRock introduced LifePath, the industry’s first target date fund more than 20 years ago and in the second quarter, we generated $4.5 billion of net inflows representing 26% annualized organic growth in that product suite. Today we are the fourth largest defined contribution manager in the United States and manage over $73 billion in our LifePath product making us the third largest target date manager as well.
Second, we will leverage our existing client relationships by cross-selling more products and services. More than 80% of our top 50 clients invest across three or more investment products. The comparable statistics for our top 500 clients is 35%. We are well positioned to deepen our relationships with these broader set of clients by leveraging the expertise we’ve built in servicing the top 50, expanding our strategic client program and developing an enhanced specialist to specialist sales model.
The final element of our institutional strategy is to focus on building and leading the industry in outcome-oriented client solutions. More and more of our clients are seeking answers to problems and questions rather than looking to buy specific products. The [alternative] capabilities of BlackRock solutions enable us to model client portfolios, understand their challenges and develop solutions so they can achieve desired outcomes. These comprehensive investment risk advisory and analytical capabilities are a significant competitive advantage as we accelerate our growth towards outcome oriented investing. We can analyze, stress test and perform risk assessments on portfolios on behalf of our clients and we can do it in days, not months. Rather than pitching the client with product we can model the impact of a solutions-based approach and demonstrate how that solution will perform in any market scenario.
BlackRock solutions is comprised of two main functions, Aladdin, our industry-leading investment and risk management platform, including risk analytics and portfolio tools and our financial markets advisory business which provides targeted advice and solutions to solve clients’ complex capital market challenges, including the recently announced engagement for the Royal Bank of Scotland on behalf of Her Majesty's Treasury.
Our Aladdin business oversees $14 trillion of assets across the product spectrum. These long-term relationships generate recurring revenue, strong future growth prospects. In 2012, almost 75% of total BlackRock solutions revenue came from our Aladdin business which is growing at a compound annual growth rate of 17% since 2007.
Now that we’ve discussed the elements of our organic growth strategy, let’s turn to the second driver of shareholder value, operating leverage. The strength and stability of our business model and financial results are attributable to a diverse platform, the benefits of scale and disciplined expense management. The BGI acquisition doubled the size of the firm at the end of 2009. On a pro forma full year basis for that year, the margin for the combined firm would have been 36.9%. We were able to grow margins by 240 basis points in the first year to north of 39% and have achieved another 100 basis points of margin expansion in the past two years with further momentum in the first half and we have done that while making healthy investments in our business.
Scale is an important driver of this margin improvement, especially in passive leveraging the substantial investment in our brand campaign and in our ability to absorb the increased costs of regulation and compliance that are impacting all financial service companies, including asset managers. While scale will generate an upward bias in margin over the long term, flows, [FMEX] and beta will have an impact on margin quarter to quarter. As an example, we entered into second quarter with lower assets under management and the quarterly average as markets traded off in late May and June. In addition, we saw a larger negative beta impact in some of our higher fee products such as the natural resources and emerging markets that created some run rate headwinds into the third quarter.
Notwithstanding the impact that quarter to quarter volatility can create, in a stable market environment we would not expect to see a margin below 40%. Our business diversity and scale generate at stable and significant cash flow that affords us the opportunity to invest for growth in both attractive and challenging markets. And while we appreciate the benefits of higher margins, we do not manage the firm to a specific margin target and will not forego growth opportunities in that regard. We are committed to dual objectives, running the firm as efficiently as possible while also investing for future growth.
Finally, [let’s discuss], driver of shareholder value capital management. We are committed to using our cash flow to optimize shareholder value. We will prioritize our use of cash to first invest in our business either to derive outright growth or to optimize our operational infrastructure and regulatory and compliance readiness and then return the balance to shareholders. Our capital repatriation strategy will be balanced between a consistent and predictable dividend policy and share repurchases. We will not accumulate excess cash in our balance sheet.
Notwithstanding two transformational deals, we have successfully grown the firm organically through truly and targeted investments. These expenditures have helped us drive our client businesses, enhance our talent, especially around our investment capabilities, support product innovation and strengthen the BlackRock and iShares brands. Investing in our infrastructure is critical to maintaining our unique strength and competitive advantage, especially as it relates to Aladdin and optimizing the client experience of BlackRock. While our peers have alluded to spending more on technology and compliance, we are advantaged in two ways. First, our BlackRock solutions capability means that technology spending actually helps drive revenue and enhance client service, and second, our scale helps us absorb compliant costs with the reduced relative impact to our bottom line.
At times, we will also invest in our business through acquisition. However this will not be transformative or a large-scale. They will be tactical and they will be disciplined. Any transaction will be supported by a strong strategic rationale and will enhance or complement our current capabilities. We will utilize stringent financial targets and be ever mindful of further rates associated with the risk free return from share repurchases. After investing in our business, we are committed to returning the balance of our cash flow to shareholders. Depending on market conditions, we anticipate our dividend payout ratio will remain in the range of 40% to 50%. Since inception in 2003, our per share dividend has increased every year with the except of 2009 when it was flat and has grown at a compounded annual rate of more than 23% over that time period.
As Bank of America and Barclays have exited their strategic shareholdings, our public float now affords us the opportunity to be more consistent and predictable with respect to share repurchases. We do not intend to be market timers. We repurchased $250 million in each of the first two quarters of 2013 and in the current market environment see that as a good trending rate moving forward. In total, the aggregate level of our dividends and our share repurchases will be funded out of operating cash flow, not incremental leverage.
So to sum up, we plan to drive shareholder value by optimizing organic growth, leveraging the benefits of scale and increased operating margins and implementing a consistent and predictable capital management policy. No doubt, beta (inaudible) in the outcome in any one quarter or year but through market cycles, if we can execute on the growth strategies that I have outlined today we’re confident that we can continue to deliver superior total returns in the coming years much as we have since our IPO.
That concludes my planned remarks and with that Roger, I’d like to open it up for questions.
Roger Freeman - Barclays Capital
While we are waiting, just on the scale for me, how much is your scale you think will help you sort of resist some of the price pressure whether it’s through carrying more distribution costs or reducing fees on your products that affect (inaudible) number of your competitors?
I think the benefit of our scale is that year in and year out we’re able to generate a significant amount of cash flow certainly over and above our internal needs. And so we’re certainly not immune from the pricing pressures of the overall market seeing and we’re ever mindful obviously of market share and how important that is to the growth story of this Blackrock. But we can clearly make investment decisions with longer term, we don't have to react to date quarter in or quarter out, because we feel very comfortable with the broader diversity of the business which lends itself to stability.
Yeah, hi, can you spend a little up in it on maybe the money market industry and how the increased regulatory environment and the rising interest rate environment will impact BlackRock influence?
Sure, so I think if I understood, there are two questions, one is money markets and one is rising interest rates or maybe they are linked. So on the money market industry and the evolution of change there, we’re obviously very supportive of anything that seeks to basically make that critical marketplace more stable for our clients and we have been highly supportive and hopefully we view as helpful in terms of trying to drive some of that regulatory change. As you may know letters to respond to the current proposals which company either has (inaudible) gates or potentially both are due this month, we have been working incredibly hard with our clients to basically understand their reaction to the proposal and try and we will continue to try to basically propose board in a way that makes sense. And we anticipate submitting the common letter later this month.
More broadly for us we don't think there is going to be a significant impact on our business. I mean the real question is where is the money going to go. There is clearly going to be money in motion, there’s prime, non-prime, there’s mutual fund assets moving to separate accounts, money moving to banks, I think in all those cases we will have to basically see how it plays out but we are not anticipating any significant change in our business and we are not supportive of any change that makes the business less systemic and more stable.
As it relates to your second question which is the impact of rising rates, in terms of our business we have about $1.2 trillion of fixed-income assets and clearly as rates go up the value of those assets like any market that has beta will change day-to-day. So we will obviously bear the brunt of rates going up on a declining value of those assets on which we make our fees. On the other hand, really we can’t control data. So we really think more about the flow part of it and basically how we are going to hold on to the assets. And I think in that regard about 75% of our institutional – of our fixed-income book of business is institutional, primarily insurers, pension plans and the like, they tend to be more strategic, their investments tend to basically be locked in on a liability basis. And so they don’t move as quickly and I think we saw that frankly last quarter when many people were expecting significant outflows in the fixed income side of our book which we just didn’t see.
The second issue is on retail and there are some good news, bad news there. Over the last two years, I think it’s pretty clear that we did not keep pace with some of our competitors in terms of our core product in the retail channel. The good news is that when those assets turned outflows, we were not nearly as well as impacted as others. Additional good news is we've been pretty good, I mean you’ve all heard Larry speak at lengths about the great rotation within fixed income which we have been seeing. We are very well positioned in unconstrained product, whether it's through SIO which I talked about, retail alternatives like global long short credit, we’ve actually been picking up pretty significant market share as we have seen positive inflows into that business. So I think more broadly we are not very troubled by it. We see really good performance on the unconstrained side, we’re actually even seeing better performance on the core side. Some of our competitors are likely to see some changes as 2008 years roll off their five-year track record and actually I think we’re pretty bullish on our fixed income.
Can you provide some detail on their ownership of iShares, retail institutional hedge funds et cetera? Thank you.
I think we obviously have a sense as to where some (inaudible) but there is not a lot of transparency, we obviously rely on data coming from third parties in terms of thinking about that. I do think that we are making a strong push on the retail side to basically broaden the use of iShares both in the US obviously some of our buy and hold strategy where we are trying very hard in the buy and hold market where obviously iShares is part of all of our holistic solutions oriented dialogue with the street, which is a key reasonably put together basically our traditional iShares sales force in our US retail sales force. So we are very mindful about that. And we are critically focused on trying to grow both parts of that business.
But as it relates to exactly what percentage is attributable to institutional, retail at any given point, it’s a tough statistic which we just – we don’t talk a lot about because we just don’t have tremendous confident in those these days. But it’s a key part of the growth strategies that I talked about.
Hi there, what are your expectations regarding the S&P rating and then also how will assist the designation change or modify your capital management plans?
The S&P rating, obviously they have changed their outlook on us which is clearly attributable to the new CFO. But I think we are certainly comfortable they laid out a pretty clean expectation of what’s going to drive the rating. They have set kind of two times leverage bar at the top and kind of a one times at the bottom where we potentially could be upgraded. Relatively important to us obviously but we don’t manage the business to the S&P rating at any point in time. I think as it relates to leveraging more broadly we will have a natural deleveraging that will occur just [a portion of] the fact that we don’t really see any need to lever the business other than the leverage maturity there which we will obviously seek to maintain. So as our EBITDA grows with a constant level of long-term debt of $5 billion we are going to see a natural deleveraging of the business which we will be mindful of and I think it potentially creates opportunities for us tactically as things come up. But we certainly don't have any desire or intent to basically delever the firm other than through natural EBITDA growth.
As it relates to the SIFI designation, the SIFI runs around a potential designation. I wish I could tell you where we are on that. I mean we just – we know that there is activity. We know that our [S Dodd] has basically created a study by the office of financial research that’s been going on for over a year now. We've had no transparency into their deliberations for their take that they are taking. Obviously that’s frustrating but it is what it is. I read the much – I am sure many of you in the room have read the SIFI designation papers on GE or AIG, and we obviously heard about the deliberations for [NAT in full]. When I read them trying to be as unbiased as I possibly can be, I just don't see us in that same vein. We are not levered significantly, we have no wholesale funding. We don’t sell insured product to the retail marketplace. There is no part of our balance sheet that’s reliant upon the government stepping in. I personally don’t see it. I mean we have – our economic balance sheet is a sum total of $10 billion of which a third is in cash, a third is in receivables and $1.5 billion is basically seed capital and fund investment capital supporting our own business. We don’t take deposits. I mean I just don’t see the logic of land bust to become a SIFI. But that’s just my personal opinion, we basically have, there is little insight as to the current deliberations. I wish I could say more.
Roger Freeman - Barclays Capital
Anyone else? Okay, thanks Gary.
Roger, thank you also being here. Appreciate it.