BlackRock, Inc.
Q3 2011 Earnings Call Transcript

Published: 19 Oct 2011

[Operator:]

Good morning. My name is Sarah, and I'll be your conference facilitator today. At this time, I would like to welcome everyone to the BlackRock, Inc. Third Quarter 2011 Earnings Teleconference. Our hosts for today's call will be Chairman and Chief Executive Officer, Laurence D. Fink; Chief Financial Officer, Ann Marie Petach; Vice Chairman, Susan L. Wagner; and General Counsel, Robert P. Connolly. [Operator Instructions] Thank you. Mr. Connolly, you may begin your conference.

[Robert Peter Connolly:]

Good morning, everyone. Before Larry, Ann Marie and Sue make their remarks, I want to point out that during the course of this conference call, we may make a number of forward-looking statements. We call to your attention the fact that BlackRock's actual results may differ from these statements. And 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. Finally, BlackRock assumes no duty to and does not undertake to update any forward-looking statements. And with that, I'll turn it over to Ann Marie, our Chief Financial Officer.

[Ann Marie Petach:]

Thanks, Bob. Good morning, everyone. We're pleased to report that really despite an adverse and volatile market in recent months, BlackRock delivered strong results in the quarter. It's a confusing environment out there. Clients, more than ever, are looking for advice and solutions in the face of uncertainty, and BlackRock's diverse mix of business leaves us well-positioned to meet their needs. BlackRock was able to provide pooled end products that were especially important to investors in this environment. We experienced large index flows in both our institutional ETF products, though liquidity of these products allowed clients to react rapidly to the environment and more efficiently move into or out of asset classes. We generated inflows into multi-asset class products across each of our channels. BlackRock is uniquely suited to meet the growing demand for these products. We also saw clients getting into income-oriented products in the face of the sustained low interest rate environment. Of course, we're not immune to the effects of negative markets on AUM, flows, revenues. And while revenue was down from the second quarter, the diversity of our product set and clients allowed us to lessen the impact of the negative flow environment, such that our flows were relatively flat in the quarter. The nature of our cost space meant we were able to maintain strong margins as we balance beta-driven revenue effects with expense management. In combination, this resulted in cash flow generation of $1.7 billion year-to-date and allowed us to return a large amount of cash to shareholders. Larry is going to be talking a lot more about the environment, the flows we're seeing across our business and what we believe it means for our clients and for BlackRock. But first, I'm just going to focus on the results themselves. As I said, it's a good story. And these, for me, key takeaway is that our performance in the face of really tough global headwinds illustrates the strength of BlackRock's business model

[Laurence Douglas Fink:]

Thanks, Ann Marie. Welcome, everybody. I'm sitting here at The Plaza Hotel in New York City. We are, at this time, having a conference with over 250 of our clients. Our clients are confused. Our clients are really asking quite a bit of questions right now. This is a 2-day affair, and it's going quite well. But it's obviously very clear to all of us that the global markets have been very challenging, and it's producing some real stress with many of our clients. You're witnessing a record low yield, which changes the value of their liabilities. We are seeing declining equity markets and their gap between their assets and liability. In some cases, may be irretrievable, they may not be able to ever achieve their objectives. In most cases, I think that investors will do that, and they'll find ways to make it. But they're looking for solutions. It's going to be solutions that are heavily based on advice by BlackRock, and I do believe we are probably the best positioned to provide that advice because we are agnostic-related to our clients if they are looking for passive strategies, alongside alpha strategies, global strategies, domestic strategies with an overlay of risk management. There's no firm in the world that could provide that, and the information content that we're able to provide because of our footprint has been very helpful to our clients. So as we reflect on the third quarter, as we help our clients digest all this, the third quarter was obviously very challenging. It's exasperated by governmental policies worldwide, not just here in the United States. Politics and government are playing a major role in market performance and market volatility. Long-term investing have become more difficult as a result of this. When government focus on short-termism, when government focuses on blogs, when government is not focusing on how to best prepare an economy over a long cycle, it becomes really difficult for investors to focus on long-term investing, too. And this is one of the greatest issues that we are trying to confront with our clients. How do you manage these short-term issues, the extreme volatility, this enormous uncertainty but focus on long-term investing? This is not an easy answer because some clients, who may have 10-, 15-, 20-year liabilities, they may be judged by their shareholders or by their Board or by their pension fund committee by quarterly results. They may be judged by annual VAR if you are an insurance company, and that's how your regulators look at you. And so there's an incredible mismatch, and it's at, in my mind, severe preportions right now how accounting is forcing unbelievable short-termism. So we have the problems of accounting and governmental policy that, in my mind, is causing this great disruption in our pension funds and great disruptions in our marketplace, as fewer and fewer people are able to cope with the long-termism. So with governments not focusing on our long term and with governments, in many cases, just doing the wrong thing, we have many clients worldwide who are confused, frozen and looking for answers. But the markets are testing governments, and that we see that -- we saw that all throughout the third quarter, other [ph] market has tested the European situation continually. It's the incrementalism of the Europeans that really have tested the market, and the markets have resoundingly been pretty negative with this incrementalism of trying to fix the problems in Europe. Hopefully, this weekend, we will see something more than short-termism, hopefully more than incrementalism but a grand solution. A good example of what I would call government's failure is the European stress test, where just 10 weeks ago, the governments indicated in their stress test results that a bank like Dexia, a client of BlackRock's, has capital of 10%. They're on capital at 10%, only to have that bank nationalized a few weeks ago. And it's that sort of information and problems is really unsettling to the marketplace. I don't need to tell you that, but to me, this is just a glaring example of how government has really unsettled the marketplace. We just can't understand how they could have an institution that's cited in the top 10 most capitalized banks in Europe, then weeks later, nationalize it. It just doesn't feel right, and as a result, people are de-risking. And if you look at our flows, the most amount of de-risking and flows that we've seen in our high-fee business has been in our European mutual funds, which I'll talk about, where we saw the greatest amount of outflows because of fear in Europe, because of things like that have been the most severe. So worldwide, clients are de-risking. But I need to remind clients and I need to tell everyone, this is not 2008 and 2009. This is a confidence crisis, not a liquidity crisis. There's trillions and trillions of dollars sitting in the sideline, as we know, that's why we have such low rates. And if we can have a sensible, longer-term view beyond the next blog, we can have a sensible long-term positioning in fixing these problems, these structural problems in Europe. And our budget deficit and growth issues and job issues of the United States, I do believe investors would rush right back into the marketplaces, and we would have a very strong markets, which would then, in my mind, would propel the economy to higher growth rates. During the third quarter, we had substantial declines in the global equity markets, as Ann Marie discussed. S&P was down 14%. The European blue-chip index, the stocks was down 23%. The MSCI emerging market index was down 23%. The Hang Seng was down 21%. So if you think about that, investors who diversify their portfolio, thinking that was the right thing, it produced even worse returns, than those who stayed totally in the United States. As a result of market instability and this lack of confidence, clients worldwide have de-risked. They are delaying investment decisions, and that is what drove the negative flows across the industry and across the globe. Clients are now asking questions about how should they be reviewing their liabilities in light of these large declines, and we expect renewed activity very shortly. And -- but we're not going to have what I would call normalized flows until we have -- our clients have better understanding of their liabilities, and that will then determine how they then manage their assets and their duration. Let me talk about BlackRock. Ann Marie really did a great job in talking about our earnings and the texture of our earnings. As a report noted that we did have negative flows, much of it was related to -- totally unrelated to our merger. We don't have any merger-related outflows. One, in our pipeline, a significant change was related to a client who in-sourced $30-odd billion of index business, basically. And so -- but what I think the quarter really showed, and which really gave the leadership team of BlackRock great encouragement is our business model has proven to be an incredible differentiator. We have growth businesses that we have not seen in a long time. The diversity of our business model has really produced what I would call very good revenue flows and, importantly, a very good operating income ratios. So in these periods of uncertainty and volatility, we are really well-positioned today to serve our clients. And I think this is one of the great feelings we have yesterday and today with our clients here, and we're seeing that repeatedly worldwide, as we are working with more and more clients related to what we can bring to them. And we are seeing, as the information showed in our third quarter, we're seeing a huge increase in request for BlackRock Solutions products, as clients are trying to truly understand how to navigate their risk on a global basis. But what impressed me related to our quarter, and what we're really pleased with is that diversified business model. We had growth in BlackRock Solutions, a growth in SEC lending, in transition management, which is becoming a bigger business as clients are trying to reassert how they should position their portfolio. There's much more transitioning being done. And our BlackRock multi-asset class strategies, where clients are looking for much more comprehensive solution-based assignments. And so this is what's driving this 9% year-over-year increase in base fees. Even with these really difficult market headwinds, we saw continued organic growth across global iShares. We saw actually growth at our U.S. retail channel. We had growth in our defined contribution channel and, as I said, in our multi-asset class offerings. In multi-class offerings, we had over $3 billion of inflows across almost every channel. We are expanding the product range now into our retail products, not just institutional products. And they came across in almost every category, from alternatives, equities, fixed income. And clients are increasingly looking for strategies that rely on indexing or ETF products, as bar belling and multi-asset class strategies are what clients are looking for. And as I said earlier, no firm has that product mix. No one has the research in terms of how we can best position our clients for these complex, multi-asset class strategies. So the other thing about the third quarter, we needed to make sure -- we needed to find ways of continuing the growth, as we see some great growth opportunities. But we needed to make sure that we are pretty disciplined. As we did in terms of the market setbacks of '08 and '09, we were very disciplined and ahead of the curve in terms of what we had to do. We remain to be very vigilant in terms of making sure where we spend our money, we spent it well. The areas that we continue to invest, even with our margins above 40%, we were investing in our retirement solutions, we invested more in alternatives, we invested more in ETFs and currently [ph] , we have been able to invest in some very high-caliber professionals, who will help fuel our future growth. A good example is Mark McCombe, who is the new Head of Asia PAC, who will be joining us at the end of the fourth quarter. Another great example of our investing to making it our better platform, as Ann Marie discussed, our opening of our London new office. Since our merger, we were operating in 2 different offices, and we did move people around. But it was certainly not the best of circumstances to really grow one BlackRock. Everybody is in one common building today in London, and now our London office happens to be our largest city location in the world, bigger than our corporate headquarters in New York. And so things like this are, obviously, a cost, but we expect these costs will really generate more continuity, hopefully better performance as our portfolio managers are all together, but importantly, a better dialogue amongst our teams, which will produce better dialogues with our clients, that which would produce more opportunities for our business. As Ann Marie suggested, we continue to generate a lot of cash flow, $1.8 billion year-to-date. We have a long history of returning capital to our shareholders, and this year, we already increased our dividends. I need to remind everybody at 37.5%, we've repurchased $2.5 billion of shares as recently as June. And I could tell everyone today, we will continue to take appropriate steps to be well-positioned to capture opportunities. I am here to tell you, I don't know many opportunities at this moment, so I'm not here to suggest and I'm not trying to forewarn that I know of anything going on. But we will be well-positioned if there are opportunities to do things and, obviously, when it is not until the first quarter of the new year where the Board of Directors would look at our dividend policy. So let me go over some of the businesses in the texture of the industry and in BlackRock. Let me start off with retail. Our U.S. retail business had positive flows, which was unusual in our business. And while Europe and Asia saw de-risking, for a reference point, U.S. mutual funds, x ETS had $48 billion as an industry in outflows in the third quarter. BlackRock had $1.8 billion of inflows globally, but we had long-term flows of $3.5 billion. Our U.S. retail saw positive long-term flows in the third quarter of about $2.6 billion, really concentrating at some of our unique products

[Operator:]

[Operator Instructions] Your first question comes from Glenn Schorr with Nomura.

[Glenn Schorr:]

So, obviously, a brutal quarter for the markets, and I can understand the outflows. Now the markets have bounced here in October so far. Have the clients settled down, as you said? Has the outflows calmed down? Or is that just an ongoing process that takes a few quarters to run through?

[Laurence Douglas Fink:]

It really depends on the situation. In some of our inflows and some of our pipeline, we had a very large international client that actually, in spring, took $12 billion out of the marketplace, and most recently added, I think -- I know $2.6 billion is in our pipeline. But they're starting to reinvest back into the marketplace. And so we are seeing -- we had another big fund that did the same thing in spring, that put $5 billion. That's in our number. So it really depends on the client, so as more of the international ones. But I would say, the pension funds, the insurance companies, I don't think they're paying attention to the 1-week, 2-week market movement there. They're going to committees right now. They're asking us to help. We actually have a lot of presentations with our institutional clients for the next month or so to try to help them come up with a strategy, working alongside their consultants. So it really depends on the situation. As I said, if some of those clients who really got out of the marketplace in spring or late spring, early summer, we are seeing those clients coming right back in right now. So it really depends on the situation.

[Glenn Schorr:]

Got you. And then maybe I want to get your thoughts on Volcker. I know it's a long process ahead of us, but, in general, the way I see it is most of the implications actually have a direct impact on you and your clients just by potentially removing liquidity from the system and increasing the cost for euro interact on behalf of your clients. I'm just curious on

[Laurence Douglas Fink:]

Oh, we love our regulators. A, there's no question. It's not just a Volcker Rule. The Basel III, as banks are going to be required to have much more capital, the utilization of their balance sheet is going to affect everybody. Bid-ask spreads are going to be widening because these institutions are going to need to make some form of profit for putting their balance sheet in front of you. This is one of the reasons why we have been very rigorous in spending a lot of money, building the trading platform, to cross trades for our clients. This is one of the actions that we are doing, and we continue to do that. And we're continuing to build it. And so what we are trying to use that scale of ours to differentiate us with our clients and hopefully to reduce that friction cost that we're going to see in the marketplace, and so this is something that we are quite sensitive on. In terms of our interaction with our regulators, well, we are actually having some very good dialogues with our regulators. We are trying to be above the line with them and really working with them in terms of trying to help them understand the difference between asset management and organizations that work on their own balance sheet. We are trying to make sure that in our conversations related to ETFs, they understand the difference between ETFs and ETNs. We have been very rigorous in terms of -- and an outlier in the industry in the money market fund industry suggesting that capital should be put in place to offer NAV declines. And we do believe regulators are going to begin to focus on the money market fund industry, because I do believe from every regulator I speak to, they believe money market funds do present risk in the system. And there's going to have to be some ways of protecting the system. And so we are trying to work with regulators in terms of understanding the type of risk that's presented and how best to effectuate and minimize that risk. In terms of everyday business, until we really get more dialogue and in terms of -- and more certainty of how they're going to implement some of these strategies, it's hard for us to say how that will further impact BlackRock or how we work with our clients. But it's a moving dialogue, and I could promise you, we are involved in the dialogues with the regulators. When they want to hear our opinions, we are offering them as loud as possible. We have -- I think as you know, we do have an office now in Washington, working alongside with our regulators. It happens to be one of our biggest businesses now working in Washington. It's a core competency that we have to work with our regulators and working with our politicians to help our investors. So one thing I said to our investors at our conference, we are one of the lone sheep working with Washington in trying to protect investors' interests and investor rights.

[Operator:]

Your next question comes from the line of Craig Siegenthaler with Crédit Suisse.

[Craig Siegenthaler:]

First, just to start on the margin. I'm wondering, was there any impact from performance fees, and helping the margin in the third quarter may be hurting it? And then as we walk forward into the fourth quarter, if we see flattish market returns kind of through December 31, what should be our expectation for the margin going forward?

[Ann Marie Petach:]

Okay. Craig, on the first one of those, whenever we have a quarter with performance fees, we usually get a little bit of margin boost from that, because other than the payout, the revenue shares, really, there's not incremental expense associated with generating those revenues. As far as the fourth quarter, what I said in my comments, I really said focus on the year-to-date margin when you're thinking about margin. I think every quarter of the margin can move around a bit, but I just sort of think in that range, as far as -- that's what we've achieved year-to-date. That's what's going to drive the full-year margin. And all things being equal, we should be delivering something. Now we know the margin can vary widely based on changes in market and levels of performance fees, and those are 2 big unknowns.

[Craig Siegenthaler:]

All right. And also on the pipeline for funded -- or excuse me, but one [ph] but unfunded wins, was the decline there, in your view, and it sounds like it is, more cyclically driven by investors reacting to what has just happened in the market over the last 3 or 4 months and differences between the assets you're investing and the duration of their liabilities. Or is this kind of more of a structural issue?

[Ann Marie Petach:]

No, I think this is more of an environmental issue. So as you just described it, I think this is a period of time as the pipeline and flows get affected, as people have to pause and reconsider what is the right action.

[Operator:]

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

[William R. Katz:]

Staying on the regulatory front, and, Larry, sort of in your commentary on some of the liquidity business. So what I'm hearing is that the squabbling [ph] proposal seems to be dead on arrival and sort of back to the drawing board. Can you talk a little bit -- you mentioned capital buffer in your prepared remarks. Can you talk a little bit about how you sort of see the most likely cost for reform on a go forward basis and what the impact will be in the economics of the business?

[Laurence Douglas Fink:]

Sue?

[Susan L. Wagner:]

I mean, Bill, on the money market reform, I mean, as you know, we've been sort of going back and forth around a variety of possibilities. So the squabbling [ph] proposal is one that's interesting, although I think the discussions most recently are focused on whether or not it's really practical, given that it requires subordinate capital to be raised for each fund for each issuer. So I think, at the same time, we're not really hearing the capital buffer as a favor to either. So I think regulators are still engaged in an active discussion with industry participants, and we are very much at the forefront of that. We've been helping things through different alternatives for how we might support this business. And as you know, and as Marie Shapiro [ph] testified before the Congress, an floating rate NAV is still out there as a possibility as well. And there will be -- if that comes to pass, the business will find a new level, but it will still be a valuable business for investors. So we continue to work with them. There's not a lot of clarity out there on this.

[William R. Katz:]

Okay, that's helpful. And my second question sort of comes back to ETF business. I think BlackRock filed with the SEC a few weeks ago, maybe a month or so ago, to get into sort of the active [ph] of the fundamental side of the business. It seems a little bit of a sea change relative to the cap weighted business. Maybe you can talk about maybe the philosophy and the reasoning behind that. And does that sort of pertain an embedded view about the cap weighted side of business?

[Susan L. Wagner:]

Again, Bill, I'll try to answer that. I mean, I think that we want to have the flexibility to provide investors with a wide range of products off a wide range of indices. So we also have a view that there are opportunities, both in fundamental ways and indices. And as you know from that same filing, the opportunity potentially to create our own entities to be able to offer clients products that might be more tactically used by them in asset allocation. So it's part of a broader range of possibilities. I think as you also know, the SEC, the registration processes take a long time, and so part of this is just widening out our capability to offer a range of products to the market.

[Laurence Douglas Fink:]

And I would say, Bill, I do -- we do not believe actively-managed ETFs will be anything close to the scale of the market based or index-based products. But we do believe that clients are going to be looking for lower-cost solutions, whether that is multi-product, they're looking for liquidity. And so we are going to explore and expand in those product areas. But our expectations are that it's not going to be driving massive growth, but it will be more incremental.

[Operator:]

Your next question comes from the line of Cynthia Mayer with Bank of America.

[Cynthia Mayer:]

Larry, in terms of how the institutional investors are reevaluating, going from core to credit, you mentioned, possibly or maybe to preferred, looking at new products, would any of this have any impact on the mix shift and the fee rate? Or do you see it more as a move amongst similar priced products? And, in general, do you see institutional clients still going to passive over active?

[Laurence Douglas Fink:]

It really depends. So, a, I think you're going to see -- I think you're going to see huge move into indexation of bonds, much lower fees. As I said, if you don't believe interest rates have that much further to go down over the next few years, you're only earning a few hundred basis points of return. And so we're going to start seeing other -- we're going to see clients looking to use beta as a bigger flow. You saw that in the ETF flows over the last quarter. So we continue to expect that to continue. We are seeing more and more inquiry in high yield and more and more inquiries in the higher-yielding fixed income products, whether it's in Europe or the U.S. So, once again, it's more bar belling. So indexing, obviously, is a lower fee, higher margin result, and the credit and the other types of products are going to be higher fees, in many cases, lower margin business. So I think we're going to be probably be as best positioned to handle that and take that in. I should remind everybody, indexation, even institutional indexation of fixed income, is not like indexation of the S&P. There are thousands of bonds in the Barclays index or other fixed income type of indexes. You have to have a lot more technology to replicate the movements of fixed income to get close to an index. So it's much harder for institutions to internalize fixed income indexing. So we look at that as -- even if institutions went that way, we would expect to be a huge beneficiary of that. The second thing, in terms of equities, we're going to continue to see more bar belling. As you saw the flows, people were de-risking in core type of products. They were going into more specialty type of products. They're going into more alternatives, and they are using as a baseline a foundation they're going into index. So it really depends on each client's issues, where they are with their liability, whether they are horizons and -- but I think it's very clear across the board, investors are looking for some form of advice.

[Cynthia Mayer:]

Okay. And then just briefly on expenses, a narrow one. It looks like, excluding the U.K. charge, G&A dropped or actually it was lighter than what I expected. What are the trends there? And I think you mentioned marketing. How sustainable would cost control be in G&A?

[Ann Marie Petach:]

You're right. The key driver in the decrease was marketing, and I actually think it's been great. We've had Linda Robinson coming into the firm, and what she's bringing in is really looking across everything we were doing. And, really, we were duplicating ourselves. We weren't always spending our money as efficiently to get our messages across clearly. And so we actually expect, going forward, to be able to do more with less.

[Operator:]

We have reached the allotted time for our conference. Mr. Fink, do you have any closing remarks?

[Laurence Douglas Fink:]

No. Hopefully, the markets continue to improve and stabilize in the fourth quarter. I think we are all waiting to hear what Europe has to tell us this weekend related to this new round of stabilization in Europe by the authorities and politicians in Europe. It's my hope that we find a stabilization. I have to remind everybody, if Europe does find a way to stabilize its future, they will put all the pressure on to the United States to making sure that the United States now focuses on a long-term solution. So I don't think volatility is going to be going away this quarter, but I do believe the opportunities ahead of us and ahead of BlackRock are even larger than even before. Thanks, everyone.

[Operator:]

This concludes today's conference call. You may now disconnect.