BlackRock Management Discusses Q3 2012 Results - Earnings Call Transcript

| About: BlackRock, Inc. (BLK)

BlackRock (NYSE:BLK)

Q3 2012 Earnings Call

October 17, 2012 9:00 am ET


Matthew J. Mallow - Senior Managing Director and General Counsel

Ann Marie Petach - Chief Financial Officer and Senior Managing Director

Laurence Douglas Fink - Executive Chairman, Chief Executive Officer and Chairman of Executive Committee

Robert Steven Kapito - President


Matthew Kelley - Morgan Stanley, Research Division

J. Jeffrey Hopson - Stifel, Nicolaus & Co., Inc., Research Division

Christopher Harris - Wells Fargo Securities, LLC, Research Division

Luke Montgomery - Sanford C. Bernstein & Co., LLC., Research Division

William R. Katz - Citigroup Inc, Research Division

Eric N. Berg - RBC Capital Markets, LLC, Research Division

Matthew J. Mallow

Good morning, everyone. This is Matt Mallow. I'm the General Counsel of BlackRock. And before Larry and Ann Marie make their remarks, let me remind you, as we do at the beginning of each of these calls, that during the course of this call, we may make a number of forward-looking statements, and we call your attention to the fact that BlackRock's actual results may differ from these statements. As you know, BlackRock has filed with the SEC reports which lists some of the factors which may cause our results to differ materially from these statements, and we assume no duty to and we don't undertake to update any of the forward-looking statements that may be made during the course of the call. So with that, I will turn it over to Ann Marie.

Ann Marie Petach

Thanks, Matt. Good morning, everyone. We have a lot to cover today. I'll provide some brief comments then move to the earnings supplement.

We generated a record EPS of $3.47 per share this quarter, reflecting increases in both operating income and revenues of between 3% and 5%. That's compared to both a year ago and to the second quarter. Results were also supported by an increase to 40.7% operating margin that reflects strong cost discipline and performance.

Our earnings growth this quarter reflected the diversity and strength of the BlackRock platform across products, styles and regions; our focus on clients and performance, and Larry is going to talk a lot more about both of those, and building our brand, which I'm going to talk a little more about; and an increase in investor confidence. The market tone improved materially in the third quarter. Average world markets improved more than 3% sequentially and almost 5% compared to 2011. This led to -- led clients to seek the tools to move quickly back into equities and generated overall positive business momentum. We had $22 billion of inflows into BlackRock equity products.

The preference for equities represents a major shift in sentiment from the fixed-income bias we were seeing across the platform in prior quarters. We saw strong interest in equities across our iShares franchise as well as in our institutional business. Retail investors, however, still favored fixed income, where we generated over $6 billion in net inflows into Retail fixed-income products, again reflecting our ability to use the diversity of our platform to meet client needs across asset classes and styles. Larry is going to discuss how our focus on revenue and profitability led to an outflow of $74 billion of fixed-income index assets with very minimal revenue consequences.

We continued our discipline of returning cash to shareholders by repurchasing 960,000 shares in the quarter for about $170 million. Year-to-date, we bought back 8.2 million shares, which we repurchased for $1.3 billion. We've paid out $800 million in dividends this year. That's already returning in aggregate over $2 billion of cash to shareholders supported by strong operating cash flow. And to put the 8.2 million share repurchase into perspective, this year, we granted 2.5 million new shares for compensation, and our outstanding share base eligible for repurchase about 172 million shares.

I'm going to move to the earnings supplement, which you can find on our website. I'm going to skip a number of slides and just hit the highlights. As usual, I'll be discussing primarily as-adjusted results . So I'm going to move us right ahead and actually begin on Slide 8.

We produced a 23% increase in earnings per share compared to third quarter 2011. Operating EPS benefited from revenue growth, expense discipline and share repurchases. Nonoperating results reflected an increase in market value of the co-investment portfolio, particularly in private equity and in distressed credits, offset partially by higher interest expense. The year-to-date as-adjusted tax rate was 30.8%. 31% continues to be a good modeling level for the full year based on what we know as of today. The compensation-to-revenue ratio was 35.2%, and this is right in line with our long-term trends.

Operating income of $876 million was up $27 million from a year ago, supported by strong revenue growth, as shown on Slide 10. Third quarter revenues were $2.3 billion. That's up $95 million or 4% from a year ago. Strong performance on single-strategy hedge funds with September 30 blocks drove a year-over-year increase in performance fees. BlackRock Solutions and advisory revenues of $128 million were up 9%, driven by an 18% increase in our core line revenues, which more than offset the decline of revenues associated with the runoff in our disposition assets. Those dispositions have successfully returned money to our clients sooner than originally expected, including assets managed on behalf of the U.S. taxpayers. That appetite among clients for BRS remains exceptionally strong, allowing us to continue active dialogue across the globe regarding both Aladdin opportunities and advisory opportunities. Base fees, as seen on Slide 11, were up $75 million.

Driven by asset inflows and market improvements, we saw growth across all asset classes with the exception of alternatives and active equities. We've offered the products to meet clients' preferences for income, indexing, liquid ETFs and multi-asset class products. Our active fixed-income revenues have benefited from our strong performance, and Larry is going to touch on that some more. Active equity revenues were negatively affected by outflows from scientific products. And by the way, these products now have excellent performance. 93% of these products are now above benchmark on a 3-year basis. So we do expect an eventual reversal to inflows. Flows were also affected by retail clients' continued preference for fixed income over equities. Larry's going to talk about focus on performance and positive recent trends where some of our active equity product performance has lagged.

With respect to alternatives, returns of capital on distressed credit products and outflows in one of our largest macro hedge funds, and really, that's partially because of volatility of the fund and partially because it's been just a source of liquidity for certain clients, offset many areas of success, including we've had $600 million of new funds raised year-to-date with retail investors in alternatives. And that was really from nothing. We've got U.S. Retail now investing in alternatives. At the same time, European retail investors were pulling out of some of the alternative products. Alternatives do remain an important long-term growth area.

Now turning to Slide 12. Expense increases in the quarter included $25 million associated with the launch of our $1.6 billion closed-end municipal bond fund. When you exclude this cost, expenses were up 3% compared to a 4% increase in revenues, primarily driven by revenue-related factors. G&A was down as we reduced occupancy costs associated with double rents in 2011 that was associated with both our Princeton and London moves. Marketing was stable because we actually paused our brand advertising in the summer months. We will see marketing expense step back up in the fourth quarter. Given the positive client reaction to the campaign so far, we remain highly confident that this is a critical long-term investment in the business. So we will be continuing this and, as you saw, we started with the iShares brand.

On Slide 14, moving on to sequential quarter results, EPS was up 12%, or $0.37, supported by both operating and nonoperating improvements. $44 million of sequential improvements in operating income were driven by revenue, as seen on Slide 16. Performance fees improved by $62 million, driven by the third quarter locks and the strong hedge fund performance that I mentioned earlier.

The fourth quarter is our peak performance measurement period. As we've suggested before, it's difficult to forecast performance fees. Returns on some of our larger hedge funds move up or down multiple percentage points in just a few days, leaving it uncertain exactly where the funds will be relative to high watermarks on the lock date. The situation at this point is not dissimilar to a year ago. So it looks comparable by -- really, in a good scenario, could have upside.

Base fees were up $34 million. That's despite a $28 million seasonal decline in sec lending revenue. The decline in BRS revenues is attributed to the runoff I talked about earlier, and again, not indicative of where we are with clients. When you exclude the seasonal sec lending effects I mentioned a minute ago, base fees improved across almost all asset classes due to positive market movements and net asset inflows.

Sequential expense increases were driven primarily by our closed-end launch and revenue-related factors. These were partially offset by a $33 million decrease in marketing due to that summer pause in advertising.

I've already mentioned nonoperating. So a wrap-up on Slide 21. We delivered a healthy margin, generated strong operating cash flow and continued our share repurchases. We saw our focus areas resonating with clients, translating into organic AUM and revenue growth.

Looking ahead, we're exceptionally well positioned to meet our clients' needs for liquidity in products, such as ETFs, for income, risk management, multi-asset class solutions and long-term active returns. With that, I'll turn it over to Larry.

Laurence Douglas Fink

Thank you, Ann Marie. Good morning, everyone, and thanks for joining the call today. I want to leave more time for Q&A today. At the last meeting, I think we had to abbreviate a lot of the questions and truncate them. So we're going to leave more time for them. So I'm going to try to incorporate by market views in my business commentary. Of course, if anyone has any questions related to our views or what we see going on, we're happy to answer that during the Q&A.

Our third quarter demonstrated the benefits of our efforts over the past few years to position the firm to meet the needs of our clients in this rapidly changing environment. We built a platform with a strong belief that clients need solutions. We needed this platform with the idea that we're going to have extreme market volatility for the coming years. That doesn't mean we're going to be down. It may mean we're going to be substantially up with some down periods. But I do believe we're going to still be in an era of uncertainty, of volatility, and we're going to be in an era where politics will intersect with economics. And this is a very large change that we've witnessed in many other markets, and I think this is going to be a part of our markets in the coming years.

So with that, our clients are looking for more solutions, our clients are looking for more answers. And I do believe how we position BlackRock, a diversified platform that combines both alpha and beta, is going to be allowing us to have a more complete, more robust dialogue with our clients.

We are also a partner for our clients in terms of understanding the issues around risk and solutions. And we're helping them solve problems and achieving objectives, not just selling products. I do believe the role of asset managers worldwide is about solution providing, not about selling products. And this is one thing that we have attempted to reposition ourselves to be more thoughtful and to be more responsive to our clients' issues around this volatility, around this uncertainty, around the interchange between politics and economics.

We also need to provide our clients with liquidity tools, which allow investors to respond on a cost-effective basis and quickly allowing them to rapidly deploy different pools of money in different parts of the region in these changing markets, and it's obviously the changing world.

I believe most platforms in the asset management business cannot provide this unique -- this -- and this is one of the big reasons why we spent these last few years in repositioning the organization and moving this organization in a very aggressive manner to be into this position. Thanks to the work that we've done in the past few years, we are better positioned than any time in our history. This is -- I'm as constructive about our future as I've ever been in our history, and we believe that our model can deliver strong results for our shareholders, as evidenced by our record earnings for this quarter with diluted EPS around $3.47, up, as Ann Marie suggested, 23% year-over-year, with margins over 40%, which we've described over the last few quarters as a core objective for us to have rising margins.

Let me talk about investment performance. We've made a number of investments to enhance our portfolio management teams to improve performance and add capabilities. I believe we've made as many changes in some of our portfolio management teams as any organization, as we promised our investors, "We are not going to let you down, we're going to continue to try to build. And if we have -- if we're not successful, we're going to attempt to rebuild."

So on our fixed-income franchise, where we were particularly focused last year, we are now seeing really outstanding results. 76% and 78% of our active, taxable, fixed-income AUM exceeds this benchmark of peer medians for the 1- and 3-year periods, respectively. This is driving net new business in our retail fixed-income area, and we expect it to continue to drive more solution-based relationships. Remember, this is an area where I acknowledged that we had shortcomings, and I promised that we are going to focus on it and fix it. And we have done that.

Let me turn to alternatives, which has also been an area where we described over the last few years we're going to put investments in there and we're going to continue to be -- build great momentum.

And our performance throughout the alternative area speaks very loudly of what we have accomplished. We have delivered solid performance in many of our single-strategy hedge funds. Our market-neutral equity hedge fund has returned 20% over a 3-year annual return. Our model-driven, fixed-income hedge fund has a 12% 5-year annual return, outperforming its -- all its benchmarks. And more importantly, for those who are looking for more stability, we've had 15, I want to underscore 15, consecutive quarters of positive absolute performance. Our fundamental fixed-income diversified hedge fund is up over 13%. And despite its volatility, it is considered one of the real leaders in the hedge fund business.

Overall, our net new business in the hedge fund this quarter was muted, though, by some of the outflows of our largest macro hedge fund due, as Ann Marie described, the volatility and partly because it was a source of liquidity for certain events. These outflows are overshadowing some incredibly strong momentum. We are seeing more growth and interest in many of our strategies than we've ever seen before. In fact, in the third quarter, we had over 30 new U.S. institutional assignment in our alternative space. So the breadth of our platform is changing. Importantly, our clients are starting to look at BlackRock not just in a barbell strategy, not just for beta types of strategy, but now beta and alpha strategies, especially in the alternative space. We expect this momentum to continue in the next few quarters as we are seeing more and more opportunities in our hedge fund space.

In the third quarter, we also returned $690 million of money because we were successful in an opportunistic fund. The results were positive and, unfortunately, does show an outflow in our external reporting. We are also happy to announce in the third quarter that we've closed on the acquisition of Swiss Re Private Equity fund of funds, adding $6.2 billion of AUM to our existing platform. And we'd like to welcome all our new partners in that business. And importantly, we look forward to expanding our alternative presence in Europe and in Asia.

Let me turn to the scientific active equity performance and to turn to the top tier results with 89% and 93% of its AUM benchmarks for the 1- and 3-year period. With performance back in our side, we are in a position to compete for the quant flows again. People are asking questions, now that for the last 1.5 years when we got back up to the higher watermarks and some clients did leave, that's why we have witnessed some persistent outflows. But we are beginning to see some real dialogue together in the United States and in Europe with our SAE performance. But I want to particularly highlight our Asian SAE, where we're seeing a strong flows because we've had an incredibly long and strong track record, which is significantly outperforming our benchmarks across-the-board.

Our fundamental equity, I spoke about that in the last few quarters, and it has been a disappointment. I just want to be a little bit more specific now. We are focusing intently on performance and our teams. Our performance issues are concentrated in a handful of teams, mostly in the United States. Our European platform is doing quite well. However, we're just not seeing the equity flows in alpha products in Europe as we are seeing it in the beta flows in equities. But I want to just emphasize we made some very large changes in our teams. And over the last quarter, where we have made changes in our teams, such as our large-cap teams, the early results have been very positive. Our performance in the last quarter has been in the top quartile. So we are -- obviously, a quarter is not something we want to constantly talk about because it's not significant enough to start reversing flows and starting to see real inflows. But what it does tell us, we are selecting the right teams. We're bringing on more teams who can provide the excellent performance that we want, and we're integrating them. But so far, we have been very pleased with the change in performance over the last quarter. And so far this quarter, our performance in those -- with our new teams continues to be very good, obviously, in the first 16 days of the month.

Despite the headwinds around these teams, we delivered exceptional performance in our largest fundamental equity products. Our Equity Dividend product, which added $4.7 billion in net new business this year, has done quite well. In addition, our European equity fund has had top decile performance. So when Europe re-risk, and I'm sure it will, we should be in a very good position.

We're also very well positioned in Asia, where we made a large investment in our Asian equity teams. And we're -- we expect to have more and more dialogue there. What I'm trying to translate to you as we are making these investments, these investments are worldwide. We want to be in a real position when the markets do re-risk, that we're in a position not just in the U.S., but we're in a position in equities in Asia and Europe.

In the multi-asset area, we've had a mixed year. 75% of our funds were above our benchmarks over the first year but only 33% in the last 3 years. And so obviously, we've had an improvement this year, but that's just not enough. We're aggressively in the market telling our story about the consistency of our multi-asset products, particularly our Global Allocation product, which has delivered 11% annual return over the last 10 years.

Let me turn to our clients' needs and responding to the markets and our view in the markets in the future. This requires us to constantly look at ourselves and innovate and change and respond. We cannot stand still as to how we are positioned with our clients because our clients' issues are changing. And so this requires quite a bit of attention, making sure we're delivering all the types of ideas, that we're capable of doing it.

So in today's investment environment, clients want a variety of tools to meet their investment objectives, not just passive product, but they want to see all forms of products. They want to see what we can provide in institutional index or ETFs, which is a growing part of our toolkit, which most firms cannot provide that balance of active and passive.

This is why we did the BGI merger. We believe that there is a need for a firm to provide that completeness in product and a completeness in products worldwide. BlackRock, we believe, is -- has built the largest and most comprehensive suite of solutions in the industry. And we're combining this capability with the thought leadership that BlackRock is known for.

Let me give you a few examples of that. Our variable annuity wrap product combined active products with ETFs and annuities to create the target date retirement products that mirror the benefits of a defined benefit plan. Our model portfolio for financial advisers allow us for asset allocation using both alpha and beta strategies in combination with BlackRock's technology and risk infrastructure, bringing really great tools to the financial adviser's toolkit.

In one of our pension clients, we used our technology and our iShares ETFs to convert over 1,500 illiquid fixed-income securities into 4 ETF products to provide liquidity and transparency. This also reduced our clients' operational risk and operational fees that they're paying to custodians by eliminating 1,500 securities and going into 4 ETF products. I believe this is going to be a new trend in the fixed-income arena, and we believe this will have a much broader component of our business in the future.

These new issues are what I'm talking about, client solutions. These are not cookie cutters. They require thoughtful analysis. It requires understanding of our clients' needs. And this is not driven by product pushing. This is the power of providing both active and beta strategies, along with our risk management capabilities.

Let me talk about iShares. We had an incredibly good quarter, the best since we acquired the business in 2009. iShares has positioned itself for growth by developing the right products to meet client needs. As a result, we generated $25.2 billion of net new business this quarter. iShares was the industry leader in the third quarter and year-to-date market share of flows, capturing 31% of global flows for the third quarter and 26% flows for the year. iShares' third quarter 2012 flows were more than double our third quarter 2011 flows, and we captured the #1 of flows in all 3 months. In the third quarter, iShares' flows were up more than 300% from the second quarter of 2012, driven by a substantial increase in equity funds, which were up over $20 billion in the quarter.

Earlier in the year, iShares saw strong growth in its fixed-income products. But as market momentum shifted this quarter from fixed income to higher-fee domestic and international equities, iShares was as well positioned as any ETF provider to benefit from that, again highlighting the benefits of a broad platform that thinks about solutions for our clients.

In the third quarter, 82% of our $20.5 billion flow into equity ETFs, the remainder went into fixed-income and alternative strategies. U.S. and Canada iShares generated $19.7 billion of that net new flows with inflows across the entire equity suite, including U.S. large, mid, small cap, Pan-European and equity income flows. International iShares saw net flows of $5.5 billion, with money back off the sidelines as greater confidence returned to the European financial markets, truly great quarter from iShares.

In retail, another key area of focus, we saw good progress through investors, though investors remained quite cautious. And fixed income remains the same.

We generated net new business of $4.6 billion in our Retail business, of which $6.2 billion was in the fixed income flows. U.S. Retail, we have about $3.5 billion of long-term flows. In addition, we launched the largest closed-end fund in BlackRock's history, the BlackRock Municipal Target Term Trust, raising $1.6 billion in assets, which as Ann Marie discussed, we paid -- this was an expense in this quarter. However, obviously, this is a very good piece of business for BlackRock in terms of revenues in the coming years.

With investors focusing on income, we delivered great results in our high-yield bond products with net flows over $1.4 billion and our multi-asset income fund with flows over $250 million. This fund now is approaching $1 billion. Our initiative towards building a leading retail alternative platform is gaining traction. In the quarter, we raised another $200 million into our alternative mutual funds.

In our international retail, we had $1.1 billion of long-term net inflows gaining momentum in Europe. In Europe, these flows were dominated by $1.5 billion fixed income flow. We still are still seeing some outflows in equities in Europe as Europe is still under some stress as to how this sovereign credit issue is going to be resolved.

A key enabler to our future and a key enabler in reaching and communicating with our Retail clients has been our investment in our brand. At the end of the quarter, we launched the next phase of our brand campaign. A message has caught the attention of our clients, our partners, some opinion leaders and certainly, our competitors because some of our competitors are already trying to emulate some of our theme messages. In building our reputation among individual investors, it is strengthening our relationships with our advisers, our distributing partners and sparking new conversations. We had more demand than ever before from our financial advisers for our material. We also are seeing increased traffic on our website, up 55% since the launching of our campaign earlier this year. And the campaign has opened doors for relationships BlackRock has never had before. All of this is our ultimate goal, to build a stronger presence in retail and a stronger presence in our ETF platform products. The firm is also better positioned than ever before with our larger institutional clients.

I just returned from the IMF meetings in Tokyo and was struck by how our reputation in the marketplace has been transformed over the past few years. Investors, large and small, increasingly are turning up -- turning to us for advice, and I believe that BlackRock is now as -- is in a unique position to be a thought-leader for our clients. Just to give you a relative understanding, in the last year's IMF meetings, we had 42 -- 43 client meetings. This year, we had 110 meetings. And we had to turn down many meetings so we did not have enough time. So this was a very gratifying way for me to see these meetings, to be part of these dialogues and to be part of solutions that our clients are seeking.

Today, after the -- after this phone call, I'll be heading over to our U.S. institutional client conference, where we have over 200 institutional clients representing over $5 trillion at our institutional client conference today. So the quality of the dialogue with these clients have never been better, and they increasingly appreciate our platform. I would say what has transformed our positioning institutionally is really remarkable. When we did the BGI transaction, we talked about the benefits of scale. Unfortunately, many of our clients were frightened of that scale. Unfortunately, many of our client were dubious, "Can you do alpha and beta?" I can say very soundly today, clients are looking out -- looking to us to provide them with more information. They see the reasons why we did the merger. They understand the benefits of the alpha and beta, and they certainly understand the benefits of having us -- having a global footprint and our dominance in risk management. So the dialogue with our institutional clients is entirely different than it was just 2 years ago. And so, it may have taken longer than I personally thought it would be to convince clients of our platform, of our opportunities we have in front of us, but I could tell you right now, the dialogue is totally about how we can help our clients and not just defending who and what we are. A huge difference than it was a few years ago.

So the excitement is beginning to manifest in RFPs, in dialogue and inflows. However, when you look at the flows for the quarter, it's important to recognize that there was a single outflow on a very low fee piece of fixed income index business, totaling $74.2 billion, a mouthful of -- a lot of money. However, it was one of our lowest fee products that we provided. And in fact, this assignment was passed on to other index providers at a fee that, I would tell you, if there was 1 minor trading error, those investment managers are going to lose money. I would also tell you, as I've said in the past, I am not going to chase business for window dressing of my AUM as some of our competitors are certainly doing because it does not make economic sense in this case as to what these investors did.

So I will promise you, in the future, we're not going to chase unattractive business simply to bolster AUM. As I said, over the last 2 years, we're focusing on building revenues, building growth and building more complex relationships. And if we have to sacrifice more of this type of business that looks big, that feels big but in terms of revenues, it's -- they're quite small, we will continue to do that. So excluding this decision, hopefully, we attracted $1.5 billion of long-term net business. The trend to path of products in institutional business was evident this quarter. And EMEA led the quarter for institutional business, generating about $8.5 billion of net inflows, as I said, largely an index equity products.

In the Americas, clients looked out for index and multi-asset strategy solutions. This resulted in about $3 billion in index equity and about $4 billion in our multi-asset class products. Our DC business continues to be very strong, and our DC clients generated $9.2 billion into our Life Path multi-asset offering. As I said earlier, this is one of the innovations of having wrappers of annuities using passive and alpha strategies. These are solution-based relationships that allow us to have this type of inflows. We did, however, see outflows in some other active products such as $4.1 billion leaving the active equities. A lot of that was in Europe, as I said earlier, and about $2.5 billion in some of our active fixed-income strategies.

In the Asia-Pacific region, for institutional business, we experienced some challenges with about $5 billion in net outflows. These outflows were entirely from an index product, masking the momentum that we've had in fundamental fixed income with clients interested in investing in high-grade and in high-yield income products.

While we feel very good about the positioning of the firm today, BlackRock's history has been one of constantly adapting to meet the future needs of our clients. With that in mind, in August, we did an internal reorganization of the firm to ensure that we are constantly focused on; one, our clients' needs particularly as they look to us with more and more advice and solutions rather than just a single product focus; two, we focused on strong investment performance within every invest style we manage. Specifically, we organized the client side in our business into 2 groups: one compromising -- comprising of retail and iShares and one comprising institutional and BlackRock Solutions.

The separation of the client business in these 2 groups does a couple of things. First, it creates more focus on the unique needs of our client segments. And second of all, it gives us the ability to create internal leverage such as combining our Retail and iShares sales force and the alignment of our FMA sales force with our institutional calling effort for greater efficiencies and with a much more focused and direct dialogue with our clients.

And we split our investment functions into 5 distinct categories and strategies: alpha, beta, multi-asset, alternatives and trading and liquidity. Again, we believe the separation both benefits the firm and our clients in a couple of ways. It creates enhanced focus on performance in that each of these investments styles are very unique and organized groups around the style to ensure that we have a culture focused on performance and focused of -- focused in the style that they're managing. And second of all, it allows us to be more efficient in product development process.

In summary, we structured ourselves to be aligned with our clients and to capitalize on the broader industry trends impacting our clients, such as the use of alpha and beta to create holistic solutions, changing dynamics in the retail distribution space and the mega trends of our industry, which are retirement, income and the growth of alternatives. BlackRock Solutions is core to the organizational realignment, which was designed to be more closely coupled with our institutional client business and our analytics and advisory capabilities.

In the third quarter, we did sell down our Maiden Lane portfolios. Once again, this brought down our assets, but I'm very proud to say we delivered to the American taxpayers the full amount of money that was invested by the American government plus a very handsome profit. And this was a lot of hard work by the BlackRock team in delivering this for our taxpayers and for our clients in the New York Federal Reserve Bank.

Another great trend why I'm so constructive on our BRS business and our Aladdin business is, worldwide, clients are looking for more and more solutions. Worldwide, we have more dialogue for clients putting on our Aladdin product. In the third quarter, we added 1 more Aladdin assignment. But what we're working on right now in our pipeline, we have 3 new Aladdin clients that we're working on right now. And we're working on with 3 existing Aladdin clients on adding equities to their fixed income component. So we have never had this type of pipeline with our Aladdin platform. I would also say, as I said many times over the last few years, we have to manage this very carefully because at the moment, again, there is more demand than we have people responding to the needs. And we are aggressively trying to realign. This is one of the reasons why we've merged the FMA group to our institutional effort, and this is all under Rob Goldstein. But this is very important for us to really work towards this and to be better aligned.

Our pipeline remains steady at $45 billion, which I'm very pleased about, including about $10 billion of mandates that funded this quarter-end and about $35 billion of awards to be funded. The added -- the unfunded portion of our pipeline reflects only our institutional business and is heavily weighted towards passive mandates. Over 1/2 of these mandates on our active pipeline are in the fundamental fixed income, where we've had great success in turning around our performance, and we're seeing a corresponding increase in flows through those products suites. Against this backdrop of a very strong quarter, which included great demand for our iShares product, we've announced on Monday several key initiatives to build on our momentum in our ETF business.

I want to pass it on to Rob Kapito, our President, for more information on these initiatives.

Robert Steven Kapito

So thank you, Larry. Good morning, everyone. As you may recall and as Larry indicated again this morning, when we acquired BGI in 2009, we believed that indexing and ETFs were going to be increasingly important tools for investors, particularly, as they pursued barbell strategies, and we wanted to be able to offer our clients the full range of products they need.

Today, I'm pleased to report that as clients continue expanding the ways they're using ETFs, our iShares business is firing on all cylinders, having one of its best quarters since 2009. iShares is the market leader, managing a 39% share of all global ETF assets and captured 27% of net new business so far this year.

Even in the U.S., our most competitive market, we attracted more flows, $18 billion, than any other firm in the third quarter, and we have a 25% market share inflows year-to-date. Our goal is to continue to be the leading ETF provider in every region around the world. But being the global leader requires that we constantly adapt to the changing client needs and to expand into new client segments. That's why to build on the momentum in iShares business, we announced a number of initiatives this week to enhance our competitive position in the U.S. as part of our broader globalized shares growth strategy. As you saw on Monday, these initiatives include creating the iShares Core Series, a new family of 10 ETFs in the U.S. that provide the essential building blocks for buy-and-hold investors to use in constructing the core of their portfolio, launching a major multi-pronged brand campaign to support the new Core Series and build on our strong brand position in the U.S. and globally. And finally, combining the iShares and BlackRock U.S. Retail sales teams, creating the largest retail field force in the asset management industry and one that is unmatched in its ability to offer a full range of active and index products to our clients.

So let me first talk about our new Core Series. When we look at investors, we categorize them by how they use ETFs for their investment strategies. And in the U.S., we consider 3 distinct types of investors. First, our active capital markets participants who need deep liquidity and derivative capabilities. Second are those who look to ETFs for precise, specialized exposure. And third are those who are buy-and-hold investors in broad core exposures. We have a very strong position with clients in the first 2 segments. But as Larry discussed last quarter, we are facing increased competition in the third segment of clients, buy-and-hold investors.

So we've created a new suite of products, targeted directly at this market segment. Now to be clear, it's important to understand that by buy-and-hold, we don't mean retail. We mean investors of all stripes, large and small, that invest for the long time horizon. They could be insurance companies, endowments or people saving for retirement, anyone investing over the long term. Our experience and research shows us that clients and distribution partners consider many factors when investing in ETFs. They look at innovation, performance, quality, liquidity, brand, pricing and distribution. And some of the things that clients value most about iShares include that iShares has a 10-year track record of providing tax-efficient EPS, that we use leading indexes like MSCI that iShares is backed by BlackRock's industry-leading risk and analytic capabilities, that many of our ETFs are among the most liquid, that we provide strong transparency through daily disclosure of fund holdings, and we provide the ETFs most trusted by professional investors. Among professional investors that use ETFs, 9 out of 10 use iShares. But different investors value the weight of these factors differently depending upon their utilization and time horizons. So to be clear, ETFs are not one-size-fits-all. So to be the leader in all investment segments, we need to tailor products and services to different clients' needs.

Because investors that seek core portfolio products to buy and hold for the long-term value price over other attributes, we have created a suite of products tailored just for them. The iShares Core Series includes 4 new ETFs, 3 of which are international equity funds that track indices from MSCI and 1 which is a short-term U.S. fixed income product, plus 6 existing iShare ETFs that we are adapting to make more attractive for buy-and-hold investors by reducing the management fees to align them with the rest of the series.

This new iShares Core Series enables us to better serve and capture market share in this important, highly competitive and price-conscious segment of the buy-and-hold investor. BlackRock share of net new business in the buy-and-hold investor base, which is in the core, is relatively small. And that's why we're implementing the strategy we have outlined. With an attractive product set targeted directly at this segment of the market, we believe we can increase the overall growth rate in iShares. Over a multi-year horizon, we believe we can grow our market share in the U.S. to generate sustainable double-digit organic growth for iShares. So this is good for iShares, and this is certainly good for BlackRock.

Now of course, there are a wide range of iShares products on our platform that offer different value propositions to other investment segments. Many investors, particularly some of the larger institutional clients, are focused on executing more dynamic strategies. They value superior liquidity, capital markets depth, tight spreads and products using premiere index providers. Now for investors who want products for executing these more dynamic strategies, they frequently turn to iShare ETFs to execute specific investment trades. EEM, which you're familiar with, is a perfect example of that. It has 2.5x the average trading value of its major competitor and open interest in the EEM exchange traded options market is almost 69x that of its major competitor. So EEM's deep liquidity and tight spreads resulted in the best available execution even during volatile periods. EEM is now also the only highly liquid emerging markets product pegged to MSCI, which many institutional clients use as a benchmark for emerging markets and consider the gold standard for indices in this market. So we do not expect significant migration out of EEM. The fact is the market is already naturally segmented because the investors that had put price above liquidity and tight spreads already have migrated to other products. There have been lower cost products available for years, but EEM continues to provide the strong value proposition to investors and in fact, has attracted $6 billion in new flows over the past 12 months. So we are not planning to make changes in the structure or prices of those products that investors value using dynamic strategies.

The bottom line, we are focused on providing clients with the best products for their particular needs while preserving revenue and long-term growth.

Using September 30 data, we estimate the revenue impact of our repricing of existing funds that focus on the buy-and-hold investors, assuming no growth, to be $35 million to $40 million annually. However, we expect to see incremental flows that will over time more than offset potential revenue impacts. In addition, we see a big benefit from the Core Series for our business be on the flows directly into these 2 products since being part of the core portfolio for buy-and-hold investors creates opportunities for discussions with them about other products from iShares' broad range of asset allocation choices. And we also will be able to capture flows into asset allocation models using these core products.

Now to support this core offering and the entire iShares brand, we're also making a multi-year commitment to revitalize the iShares brand, especially in the United States. As the ETF market continues to grow, we want to build on the strength of the iShares brand and further differentiate ourselves in the marketplace.

iShares has consistently offered clients 3 key attributes: Professional quality, individual choice and responsible innovation. So our new campaign is going to bring these attributes to life in a compelling way with ads that you may have already begun to see on television. If you watched the Yankee game last night or in the newspapers, this new campaign also nicely aligns with the themes of the BlackRock brand campaign and brings the brands closer together, so each brand can fully lever -- leverage the power of the other.

As we announced on Monday, we are committing substantial resources to our iShares branding campaign. Our fourth quarter marketing expense for the entire firm will be slightly higher than what you saw in the second quarter this year. And going into 2013, we will balance the marketing spend appropriately as BlackRock always does to make sure that dollars are well spent.

Finally, we are creating the largest retail field force in the asset management industry by integrating our iShares and U.S. Retail mutual fund teams. This integration is critical because it will enable us to present a single face to clients while retaining an ETF specialty team. A combined sales force will enhance the way we deliver our U.S. offerings to the market and allow us to more effectively offer financial advisers and distribution partners a fully integrated suite of index and active solutions for today's investors. We are not integrating our sales force to simply save some expenses. We are integrating our sales force to be more effective and deliver our firm to our clients. The sales force integration follows a similar path to our institutional sales coverage, where we implemented the changes last year to bring the iShares and BlackRock institutional teams closer together, a change that continues to be essential in creating tailored solutions for our clients. There is also an unmet need in the market for a firm to help retail clients and advisers construct overall portfolios, combining active and indexed strategies. This newly combined sales force will be able to fill that gap. So this includes offering model portfolios, which combines both index and active products, to deliver optimal asset allocations achieved through specific outcomes, such as target income, hedge risk income and strategic and tactical equity models. And this ability to offer both active and index products together is a major strategic advantage for BlackRock.

As Larry mentioned, delivery of innovation and client-centric solutions is what differentiates BlackRock. Our ability to use ETFs in combination with active products in those solutions, as highlighted in some of those specific examples Larry described, are a key area of growth and differentiation for BlackRock. No other firm can offer these solutions to clients. So as I mentioned, these initiatives in the U.S. are just part of a broader global strategy to drive growth at iShares as more and more investors embrace ETFs in their portfolios and as regulatory change and the evolution of capital markets open up more geographies and client segments. Two other key legs of our global growth strategy are focused on new application for ETFs and market expansion. Fixed income is a great example of how we can innovate to grow the ETF market. There is a huge runway for growth in fixed income ETFs.

Today, they account for only 0.3% of the $37 trillion U.S. bond market compared to equity ETFs, which represent 2.2% of the U.S. equity market. We are the leader in building ETF usage in the fixed income segment with 59% of global assets and 45% of year-to-date flows in fixed income ETFs. We believe fixed income ETFs could grow from $300 billion today to over $2 trillion over the next decade, and we intend to be at the forefront of driving this growth. That commitment to being a leader in fixed income is one of the reasons why we cut the price of AGJ. The other key growth theme globally is market expansion. Outside the U.S., we are growing into new client segments and accelerating the development of the ETF category as we continue to diversify our geographic sources of revenue and assets.

In Europe, we are deepening our penetration of retail client segments. For example, by taking advantage of regulatory changes such as already are in the U.K. and by partnering closely with key distributors. In Canada, we are building on our successful integration of the Claymore business, which gave us broader reach into the advisory market. In Latin America and Asia-Pacific, we are capitalizing on the ongoing evolution of capital markets and the regulatory environment to drive greater local ETF penetration. Our growth rate outside the U.S. today is in the mid teens, and we expect to sustain this growth by capitalizing on these major trends.

So in summary, we are very excited about the significant growth opportunities for iShares over the coming years, both in the U.S. and globally. iShares is the clear global leader in ETFs, and we intend to build on that position by continuing to innovate and respond to the evolving needs of our clients and by maximizing the quality, reliability and total performance of our global product range. Of course, iShares is only one important piece of BlackRock's growth strategy.

So with that, let me turn it back over to Larry to wrap up our overall results.

Laurence Douglas Fink

Thanks, Rob. I guess the only question I have for you, why didn't the Yankees win with an iShares ad? It certainly didn't help. Let me just wrap it up and open it up for questions. Let me just give a few takeaways from the quarter.

We generated top line revenue growth of 4% and over 23% over a year-to-year basis, increasing our EPS. We strengthened our operating margin to 40.7%. We delivered strong investment performance across our platform. We're rebuilding our equity team in the U.S. We experienced the best quarter in ETFs since 2009. And lastly, as I try to say pretty loudly, our messages are resonating with our investors. And our strategic growth areas, income retirement, ETFs and solutions are fueling our growth. Our brand is getting stronger, and I expect the momentum to continue in the coming quarters and the coming years.

With that, we're happy to answer any of your questions.

Question-and-Answer Session


[Operator Instructions] And your first question comes from the line of Matt Kelley with Morgan Stanley.

Matthew Kelley - Morgan Stanley, Research Division

So I was hoping you could first talk a little bit more about the integration of the iShares and BlackRock retail sales teams. Your commentary is very helpful. But how do you think this gives you an edge in approaching retail and the other client bases you just mentioned? And how big of -- what's the approach to them and how big of an impact do you think it could be?

Laurence Douglas Fink

I'm going to have Rob answer that.

Robert Steven Kapito

So as you know, we have a lot of products on our platform. And what we're finding is that the dialogue that we're having with the financial advisers is more wholesome. They use both mutual funds. They buy stocks, bonds and use ETFs. And what they want to have is a more wholesome conversation about how to use both in their asset allocation. So we think by sending someone there and combining that group to have those more wholesome conversations, that we're able to expand the type of business that they're doing with BlackRock, because they're looking for stewardship, advice and solutions and not just someone that's coming in with one particular product. We also think by combining this, we'll have a greater outreach because it takes more time to have those wholesome dialogue. And in order to expand our reach, we want to have more people in the field having those direct conversations.

Matthew Kelley - Morgan Stanley, Research Division

Okay. That's helpful. And then just following up on the ETFs again, you mentioned your thoughts on the future fixed income ETFs potentially being a $2 trillion market. I'd be curious to get your thoughts on the future of both active ETFs, obviously, a small component of the market currently, and then whether there's a potential to have a stronger presence for multi-asset in the ETF space.

Robert Steven Kapito

So we are continuing to explore the active ETF market. Currently, we really don't have enough evidence to show that, that is going to expand as dramatically as putting fixed income ETFs in more of an asset allocation model. That's where we're focused right now using fixed income. But we do believe that, that is going to continue to grow. It gives clients a more liquid way to be in the fixed income market. As far as the multi-asset, we think that is a huge growth opportunity, one that we are particularly set up to do because people are looking for, a, the asset allocation and, in fact, a way to enter more high-yielding instruments like alternatives. And we think that there will be many, many more opportunities to iShare various vehicles that are in the marketplace. So we look at that as growth opportunities for us as well.

Laurence Douglas Fink

Matt, this is consistent with what we've been saying. We're not suggesting there's not room for active ETFs. We just don't believe as the overall industry is going to be driving that much of the growth, and the real key will be using ETFs as a tactical allocation product. As evidence of what we did with this institutional pension fund, by allowing them to simplify their huge fixed income positions and having 4 different dynamic fixed income ETFs allows them to move around the allocation from emerging markets to credit, to low duration and back and forth. And we believe you can earn alpha through that mechanistic way of moving around your weightings by those categories using ETF. This is what we believe is going to be a lot more dynamic. So allowing the investor to do more of that asset allocation within fixed income institutionally will lead more and more institutions that can be driving this. This is one of the big reasons why we believe it could be a $2-plus trillion market


Your next question comes from the line of Jeff Hopson with Stifel.

J. Jeffrey Hopson - Stifel, Nicolaus & Co., Inc., Research Division

So 2 questions. One, most of these pricing changes are pretty immediate, and one of your competitors has some transition issues. So the question is, what's the timeframe to see some effect potentially on flows and our market share? And then secondarily, we've never really talked about ETF margins, not that I'm asking for the number, so to speak. But as you think about margins over time, assuming this change doesn't affect the overall revenue yield, I guess, can you talk about the benefits of scale, a more effective sales force? What's happening with the direct cost? It looks like those are coming down a little bit. And then where does new product development cost fit in there, et cetera?

Robert Steven Kapito

So initially, we don't expect to see any savings from our combination of the sales force. We want to see how this is going to work. We want to size it properly. We want to make sure that they're having the appropriate dialogue. And we think we'll see increased sales. But we're not expecting that right out of the box to have any incremental savings on that. So that's really the first part of it. As far as the margin goes, we don't break down the individual products in that way. But we can certainly say that iShares contributes to the healthy 40% operating margin that we currently have, and we expect that to continue. And the other part of your question is that, how soon do we expect to see growth in the new products? We have the pedal to the metal here. We're going out in advertising. The sales force is ready. It takes a little time to go out and talk to everyone, but we're working hard on ramping these products up as quickly as possible. Those are the foreign new products. And as you know the 6 existing ones that we have changed the price, we are already seeing flows into those particular products. So those are already outstanding and ready to be ramped up in new products. We're going to have everyone out discussing it and hope to do it as soon as possible.

J. Jeffrey Hopson - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And if I could follow up just on the margin issue again, I mean, obviously, scale is of benefit, but are the other inputs stable increasing, decreasing? Any thoughts on that?

Laurence Douglas Fink

On the overall margins?

J. Jeffrey Hopson - Stifel, Nicolaus & Co., Inc., Research Division

On the ETF side, I'm sorry.

Laurence Douglas Fink

Oh. There's always going to be more and more competitive pressure. But we're not here to tell you that there's not issues like that. But it really depends on the mix of the products. I mean, some of our margins increased in our ETF products because of the mix of business. So it is a mix issue more than anything else. It is the mix business -- much more dominant than competitive issues and things like that. So if you could describe to me where the mix is going to be, I could describe to you what the direction of the margin is going to be. But we're very comfortable with where we are today in our margins. We don't think the margin is going to dramatically change over the future. And if the mix changes to much more -- like it did this quarter. With more equities, the margins improved. If the mix goes more back into fixed income, the margins will be reduced. I'd say I don't think there's any mystery there. Let me just touch on one thing because you asked the question kind of vague related to the changes in one of our competitors. We aren't seeing flows into our existing products because of the changes of index providers with our competitor. But I'm not getting into any more detail than that?


Your next question comes from the line of Chris Harris with Wells Fargo.

Christopher Harris - Wells Fargo Securities, LLC, Research Division

Just curious about the strategic decision here to initially roll out 10 ETFs. Obviously, you guys have the capability to do a much larger number than that for the new buy-and-hold investor that you're targeting. Any thoughts there as to maybe you might see this expand a little bit or do you feel like this is a good initial launch?

Robert Steven Kapito

No, we've done a lot of work on this, and we've been working on this for the last 6 months, trying to really identify the major core products that this buy-and-hold sector is interested in. And we want to have the large and very liquid products that they're looking for. And this is the group that we identified. We will start here, as our clients need change. Then we'll look to -- if we need to make as much change, we'll change. But this is a lot of research over the last 6 months to make these changes.

Christopher Harris - Wells Fargo Securities, LLC, Research Division

Okay. And then as a follow-up, I guess, have you had any thought as to how Vanguard might react to this? I'm just wondering maybe if you guys could comment what you might be prepared to do, if Vanguard turns around and reduces fees further on their end? Did you feel like you're fairly well positioned at this point? Or might that result in another reaction?

Laurence Douglas Fink

Vanguard is an excellent company. They have a great market position. They have a great brand. I'm not here to talk about my competitors. They are actually a big client of BlackRock, too. So I'm not here to discuss what Vanguard may or may not do. I believe we're in a very good position. I think we responded to some elements. But let me just say overall, this is not a price war. This is all about working with our clients. I think you guys, and I'm kind of -- I mean, including the press, have created this myth about a price war stuff. There's nothing related to a price war. We did not think about this as a price war. We thought about this as a means to be much more comprehensive to our clients to provide, as Rob said, core products that will fit our clients needs, who have different dimensional needs than some of our other clients. And so we've got to move on from this myth about a price war. As this -- we had our healthiest quarter. We are very optimistic about where we are. We're well positioned in product engineering and product design. That's what's -- that's the greatest dynamic that's going to fuel ETFs. It is not about pricing and all that. It's responding to clients to provide products that fit the needs of clients as they expand in product, as they expand geographically. And I think we are as well positioned as any firm in the world, in the ETF world to be responsive to our clients in products, in geographic mix and in design and then linking these products into a solution-based relationship.


Your next question comes from the line of Luke Montgomery with Sanford Bernstein.

Luke Montgomery - Sanford C. Bernstein & Co., LLC., Research Division

Look, I'm sorry to beat the dead horse on the ETF pricing issue. But I did have another one. I could see why matching or not matching, rather, fees on the emerging market product to Vanguard's VWO is sensible. I guess you'd have to assume pretty drastic decay rates on your products, that sort of the management for that to be an economic decision. But I'm wondering still if some fee cut in that product might have been prudent as it relates to institutional traders. And specifically, do you have an idea of how much of your market share lost to Vanguard over the last 3 years was from leakage from an institutional trader segment? And might you be overestimating the importance of a secondary market liquidity in maintaining that segment's loyalty?

Laurence Douglas Fink

The secondary market liquidity is tantamount. I think we have 3x more liquidity in that product than any Vanguard product. So it is an institutional choice and we continue to do that. The one thing that people are failing to look at, too, is institutions, by and large want to use the MSCI Index and so that's a big change, too, going forward. But the one thing that no one is focusing on, if you're an institution, you're much more attuned to tracking error. You're much more attuned to liquidity bid-ask spreads. And if you add up liquidity, you'll add up the most recent tracking error differentials. The spread that you're suggesting is far smaller than what it really is. And institutions understand that. It's a harder thing to understand if you're retail. But institutional, and this is why we are continuing to see $6 billion of growth, this is why we continue to believe what we're doing is the right one. And you know what, we'll find out in a year or 2 if we're wrong.

Luke Montgomery - Sanford C. Bernstein & Co., LLC., Research Division

Okay. And then just on the new emerging market product, hundreds of ETFs that have been launched over the years that never really gained traction. So what gives you confidence that this product will succeed given that it's arguably not first to market in the buy-and-hold segment? And in your research on the segmentation of these markets, how important did you determine that the first market advantage is to customer segments exhibit greater price elasticity?

Laurence Douglas Fink

No question. First to market is a huge advantage. That has not changed. That has been our position, and we've discussed this over many years. And obviously, we are aware of first market issues. On the other hand, we do believe the brand of BlackRock and the brand of iShares is quite compelling. Most ETF platforms are just not growing enough. They're not going to achieve scale or velocity. And I do believe we have an advantage with our platform. Our platform that we have in retail, our platform that we have globally and institutionally, allows us to have more connections with retail clients, and more importantly, with institutional clients globally. So there's no question, first market mover is a very compelling, strong foundational issue. We know we can't change that dimension because we fully believe that is a very compelling dimension in terms of looking at growth of ETF product. But we do believe just like -- with our brand, with our brand advertising backing this, we believe we have a large opportunity in hand in building our market share in that product.


Your next question comes from the line of Bill Katz with Citigroup.

William R. Katz - Citigroup Inc, Research Division

Just going back to ETFs -- I'm sorry also to beat the dead horse. As you look out a company, let's say, you are successful in building out this buy-and-hold strategy, the pricing differential between the maybe your institutional liquidity-driven investor, it's pretty sizable. So is there a risk of any kind of sort of adverse arbitrage even without incremental pricing back and forth between you and Vanguard, Schwab, what have you. But just internally, just in terms of that adverse shift, have you thought about that in the sort of...

Laurence Douglas Fink

There's no question if our core products can build more rapidly than you think, there's no question you could see a slow burn from the large product -- from the existing product to the smaller one. I'm not here to suggest otherwise. In addition, first of all, our fees are not our decision. There are mutual fund, and in this case, our iShares board's decision. So, I don't want anyone -- it's pretty hard for me to discuss this. I don't even -- I'm not on the board, Rob is. But it is a board decision related to fees and it is the board's decision to determine how should fees be looked upon versus various products.

William R. Katz - Citigroup Inc, Research Division

Okay. And then just maybe a 2-part second question. When you mentioned before the world going to a more of a service solutions based business between sort of the beta and some of the alpha strategies, what's the outlook for active equity mandates generally? And then the second part of the question is, if you're successful in getting to $2 trillion of fixed income passive inflows in fixed income, where does that come from and the implication for the fixed income businesses at large?

Laurence Douglas Fink

Let me address the fixed income side first and we go on to passive and active, and I'll let Rob discuss that, too. On the fixed income side, I think Basel III has a huge implication and the Volcker Rule related to capital positions for banks and security firms. They're going to have to have higher capital balances. And therefore, they're going to have to charge more for their balance sheet. This is totally -- this is totally in the same direction how we think about our building and trading platform if we need to create more liquidity. So unquestionably, investors in fixed income are feeling the issue around liquidity and fixed income. And if more and more institutions who are actively investing in fixed income are being punished by the bid-ask spreads, which erode active returns, which is a real threat, we believe more and more institutions are going to put a large component of their fixed income in this type of strategy by owning 4, 5, 6 core active fixed income ETFs and move around that dynamic. And we're seeing that. We have more and more dialogue. We're in a dialogue with one other large institution right now in doing that. So I believe that trend is going to be a major component. Now if miraculously we see some very tight bid-ask spreads and we see less pain in trading actively fixed income, maybe the outlook on fixed income will be lessened. I mean, we are responding to the market and trying to be solutions-based relationships with our clients. And this using ETFs as a solution is a very good way of minimizing that trading reduction. It certainly reduces operational risk for clients who are sitting with huge pools of fixed income. And so we are obviously very involved in various dialogues on this. But importantly, we're seeing more and more clients who are tactically allocating using fixed income ETFs, and we believe this will continue. So Bill, if you believe that Dodd-Frank Volcker Rule, Basel III is going to have a permanent impact in the way of balance sheet treatment for security firms and banks in terms of making markets, which means wider bid-ask spreads, then the usage of ETF fixed income is going to grow. If you don't agree in that outcome and you think we will get more normalized again than we have it in this past year, then you may not see as much growth. But let me -- before Rob turns over, let me just say we'd done something very fundamental about fixed income and equity. This is really a beta-alpha issue related to the alpha part of equities. If fundamental equities outperformed consistently the indexes, you are going to see then more flows back into alpha products. That's -- so you're going to see the ebb and flow from index into alpha and back and forth. One of the big reasons why we are aggressively building our -- and you may say this is wrong, but we are aggressively building our alpha fundamental equity teams because we believe there will be a time where active managers outperform with consistency. Hopefully, those teams are at BlackRock, and we're going to get the flows then. And we're seeing that already. Albeit small, we are the -- we have a -- our European equity team is the top decile team over the last 5 years. We are actually winning about 50% of the flows in European equities in Europe. Now 50% of the flows only represents $400 million, $500 million this year. And so if you have performance, you are going to get those flows. And I do believe that -- if the equity industry has a more consistent out-performance after fees, by the way, then you're going to see a mix change between beta and alpha. But Rob, do you want to respond to that?

Robert Steven Kapito

I'd say Larry has said it directly. The field is narrowing based upon performance. If you have the performance, there are flows to get. So I would not rule out active equity, and we're going to build that area because there will be another cycle where active managers outperform their benchmark significantly enough for that money to move. And we want to be there to capture that money.

Laurence Douglas Fink

The key is -- the real key is, if you look -- talk about bar-belling for a second, Bill, there's just so much money flooding into alternatives. And so we see that unabated. But the reality is a lot of hedge funds are certainly underperforming the equity markets now for a couple of years. And it looks like this year is going to be another year where most hedge funds are underperforming. The real question will be, is there a pivot point whereby investors start saying, "Gosh, I maybe not as interested in hedge funds strategies or as much and maybe I will use some of that allocation to go back into fundamental equities." So don't just think it's active-passive. It is also a balance between investing in alternatives and fundamental equities.


Your next question comes from the line of Eric Berg with RBC Capital Markets.

Eric N. Berg - RBC Capital Markets, LLC, Research Division

So I certainly hear your point. It's coming through loudly and clearly that the ETF market is segmenting and that there has been historically a group of capital markets participants who value the liquidity type bid-ask spread and so forth. But I'm hoping you can build on your earlier answer or your answer to an earlier question by answering the following: To the extent that the history of finance has basically seen lots of deep pressure in the institutional side of the business as well, with brokerage commissions coming down, bid-ask spreads narrowing on the institutional side of the business, why shouldn't we think that the same price pressure or price consciousness on the part of customers in the buy-and-hold segment will over time manifest itself in the other segments that you say is currently not all that price-sensitive?

Laurence Douglas Fink

Well, what we're saying also, that segment is also looking at the bid-ask spread as a component of cost, and they're looking at tracking error. So from that segment, they're looking at all 3 and the totality of those 3. And what I think there's a failure of people recognizing the 2 other costs. So I'm not suggesting they're not thoughtful about costs. But keep in mind for a lot of the trading-oriented organizations, if they're tactically allocating, they're looking at much more -- they want to make sure that they get as close to the index as possible, that's their tracking areas. They want to make sure that they have the liquidity. And so unquestionably in our conversations and dialogues with those institutions, fees are less important. I am not suggesting, though, that fees and the trends in fees across all of our businesses are under review continually. If you provide the right solutions, though, fees become less dominant. And so this is an industry that in my mind has those types of dominant pressures. As I said, we saw that evident in our loss of our $70-odd billion fixed income product, where some -- our competitor are willing to do it almost at cost. So that's another evidence of -- you could call it fee pressure, we would call that kind of stupidity. But -- so I don't want to leave anyone with the notion that we're not constantly reviewing our products. We're not constantly reviewing how those products are performing. And obviously, it's undeniable, lower fees are better than higher fees for our clients. Rob, do you want comment on?

Robert Steven Kapito

Let me just say, look, it's a very generalist question. Over time, it will depend upon what the competition is, what the value proposition is and then what the innovations are that we're able to establish to want people to come to our products and they're willing to pay for those innovations. So we have to be on the cutting edge, and we have to earn the fees from them. And that's what our strategy has been for the last 20-odd years. But what you're talking about is that everything always reverts to price. And remember, we have vendors, too. So we understand that from our perspective as well.

Eric N. Berg - RBC Capital Markets, LLC, Research Division

One quick -- one second question, my final one regarding your advertising. It's curious to me that you're doing this mass market with the Yankees and so forth. In the sense that -- are you trying to create an outcome in which customers come into -- let's talk about the retail segment -- customers come into retail brokerage firm and ask for iShares or rather...

Laurence Douglas Fink

Yes. Yes, yes, yes. We have been told by our distribution partners we need -- if we're going to be the #1 or 2 largest providers of products, largest providers of solutions in both iShares and in our mutual funds, we needed to have more brand awareness. And -- that is -- and so we've been told by our distribution partners, it is necessary for us to have more branding, more brand recognition to support their effort in selling our products. So we are responding to our clients, and they were loud and clear to us a year ago, in that we needed to build brand awareness. That is truly our objective. And in a very short period of time, we are achieving some of that. And it's a long story, and it's going to take time. And time, if you have the message over time, that message becomes very strong. And the great brands have strong brand messages that are resilient over time. That is my #1 priority related to this brand, branding effort. So we can have a long-standing brand effort that has a connection with the retail client. So our distribution partners can find it much easier to talk about BlackRock or BlackRock iShares products.


Ladies and gentlemen, we have reached the allotted time for questions. Mr. Fink, do you have any closing remarks?

Laurence Douglas Fink

No. It's -- we have a lot to look forward to, a lot of volatility. We have a presidential election. We have a fiscal cliff. We have -- and we also have European uncertainty in front of us. Setting that aside, though, BlackRock is as well positioned to respond to all those issues to our clients, to help our clients in terms of understanding how to deal those uncertainties. And as we said in our branding initiative, BlackRock was built for these times to be responsive to our clients, to helping our clients overcome the uncertainty around all of these big macro issues. And lastly, I just want to thank all of the employees of BlackRock for a great quarter.

Ann Marie Petach

Thank you.

Laurence Douglas Fink

Thank you, everyone.


And this concludes today's teleconference. You may now disconnect.

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