“The reason why ETFs are a phenomenal success is that they solved a lot of problems clients faced with mutual funds, namely surrounding transparency, liquidity, costs and tax-efficiency. Remember, we have been working on developing the ETFs for 15 years before it finally caught on and became popular. This alignment of securities features with client needs was achieved after an extended period of product incubation and testing stage.”
As a well respected Harvard Business School alum who has done extremely well for himself and his shareholders at BlackRock, a leading global financial institution based in New York with $32 billion in market capitalization and $3.4 trillion assets under management, Robert Kapito, President of BlackRock, is also a great conversationalist. One minute he could be convincingly painting a broad-stroked picture of the strategy and competitiveness of a global franchise; the next he could be well in the weeds explaining the differences between various financial products and portfolio strategies.
In a recent interview for The Harbus, Rob openly shared with me his thoughts on the benefits and risks of financial innovation, predictions for the asset management business, views on BlackRock’s incredibly successful ETF strategy, and general advice for students looking to make their mark on today’s world of business.
According to Barron’s magazine, BlackRock currently ranks as the world’s largest money manager post its $15.2 billion acquisition of Barclays Global Investors, a transaction that strategically combined an active asset manager with one that oversees passive investments late last year. With $3.4 trillion AUM, the firm is twice as large as its closest competitor, State Street Global Advisors. In an interview with Bloomberg that took place in April, Rob stated that given BlackRock’s leading distribution capability, he believed the firm could reasonably achieve a growth rate of 5-6% in assets. “We expect to see growth in the passive and the iShares business – those two are getting a lion’s share of the money – and the alternative business.”
Last week, BlackRock posted Q3 earnings of $551 million, an increase of 74% from a year ago. AUM grew by $296 billion or 9% during the quarter and 140% year-over-year. Net new business in equities was $21.6 billion, of which $25.9 billion came from net inflows in index products, including $6.4 billion in iShares, and $4.3 billion of outflows from actively managed portfolios, as retail investors worldwide retrenched. The net positive growth reflected a business model that successfully combined both active and passive investment strategies in an integrated solution that satisfied the varying asset allocation needs of investors.
Rob, the President and a Director of BlackRock, is also a member of the Global Executive Committee, Chairman of the Global Operating Committee, and Chairman of the Americas Executive Committee at BlackRock. He is responsible for the day-to-day oversight of all BlackRock’s key operating units including Portfolio Management, Alternative Investment, Global Client Group, Risk & Quantitative Analysis and BlackRock Solutions. Rob also serves as Director of iShares Inc. Last Monday, he came to Professor Lauren Cohen’s class and offered his insider’s perspective on the HBS case “Barclays Global Investors and Exchange Traded Funds (208033)” authored by Professor Luis M. Viceira and Alison Berkley Wagonfeld, Executive Director of the HBS California Research Center.
Entering the Buyside Profession and Co-Founding BlackRock
After spending many years in the sales and trading business on Wall Street with an investment bank, Rob was ready to take on greater responsibility for investors’ money and work closely with clients to build a better financial future with the asset management service model.
In 1988, he founded BlackRock on the premise that there existed very few buyside firms that helped investors objectively evaluate the risk characteristics of various securities invented by Wall Street. His vision for BlackRock was therefore to provide the tools and expertise to allow clients to manage their money, and put in place the infrastructure and platform necessary to closely monitor and manage risks. When asked why he thought other market participants failed to see such opportunity, Rob reasoned that most of Wall Street didn’t understand the risk characteristics of various securities and product innovation. BlackRock, on the other hand, has maintained a focused strategy and stayed on a very narrow path of providing only investment advice, thereby demonstrating real differentiation as the ultimate fiduciary for clients, independent of and free from any potential conflict of interest that may arise from the banking model which often includes a proprietary trading component.
Incorporating Product Development into Business Strategy
According to Rob, ideas are developed in a laboratory setting at BlackRock in response to the ongoing and rapidly changing needs of the market. Consequently, the process for product development is institutionalized into the day-to-day operations at BlackRock, based on the guiding principles of stewardship, advice, and solution.
BlackRock’s iShares unit is the largest seller of ETFs, with $578 billion in assets as of September 30th – that’s more than 50% of total market share. “The reason why ETFs are a phenomenal success is that they solved a lot of problems clients faced with mutual funds, namely surrounding transparency, liquidity, costs and tax-efficiency. Remember, we have been working on developing the ETFs for 15 years before it finally caught on and became popular. This alignment of securities features with client needs was achieved after an extended period of product incubation and testing stage. As markets change, financial innovations allow investors to adjust their strategies accordingly and achieve the return and risk profiles they wanted for their portfolios,” explained Rob.
The firm is also benefiting from increased investor interest in “barbelling”, a strategy which basically involves the separation of alpha and beta components of a balanced portfolio. More specifically, the strategy entails putting a portion of the money into low risk, low beta passive investments that mimic indexes, such as ETFs, and the rest into alternative assets, such as hedge funds, designed to generate alpha, or higher returns than market benchmarks.
“At BlackRock, we work together as a team. We call it ‘One BlackRock’. The portfolio managers and client relationship managers work very closely together to provide clients with the best solutions that address their needs”.
When asked whether there had been any product development failures at the firm, Rob said no and pointed out that since each new product is seeded with the firm’s own capital, his team is committed to making them work, even if it meant that numerous iterations are needed during the testing stage. “We are committed to getting our products to deliver the returns and results to meet expectations, but at times, the performance of some products have been disappointing”.
Finally, Rob believes that training is a big part of the equation for continued success with product development. “For example, I run a daily meeting with all portfolio managers at the firm to discuss what is happening in the markets,” says Rob. This not only allows the open exchange of ideas between fund managers, but also provides a forum for new ideas to be generated. “At BlackRock, given our industry leading sales and distribution force, we have lots of training programs to constantly update and education our employees on products that satisfy investors’ various needs and strategies. Additionally, it’s hard to be versed in everything. But given our unparalleled scale and human capital, we have experts in every field to differentiate our product and services.”
When asked how his team manages to co-brand active and passive investing business, two inherently very different strategies, Rob responds with the following: “I don’t know why I get this question a lot. Our clients don’t ask this question because there is a role for various instruments depending on their objectives, which change from time to time. When one strategy underperforms, money moves to the other. It’s a very dynamic and cyclical business, and there’s competitive advantage in offering a plate of products that allow for asset allocation within the same company”.
On whether he thinks ETFs would eventually displace mutual funds, Rob provides the view that ETFs are set to take a significant amount of assets from mutual funds in the coming years. “However, there is room for both products to co-exist. The liquidity and access features favor ETFs while mutual funds still have the professionally managed aspect to it.”
Managing Risks with Financial Innovation
Someone in the industry once said that “the financial technologies we develop, just like computer technologies, often overstep our ability to use the innovation responsibly.” Rob seems to agree with this view.
Although financial innovation generally benefits society and is welcomed, Rob believes that given the increased number of new entrants in the ETF space, competitors may begin to offer highly levered portfolios that have not been stress-tested under different interest rates and market cycle scenarios. “We at BlackRock, as the early innovator and developer of ETFs, are adamant about protecting investors and staying away from leverage. We achieve leverage in returns through other means and stay committed to a more conservative approach to our iShares business”.
Last but not the least, I asked Rob for any parting advice for both students at large and those who plan on entering the investment management profession. Rob gladly offered the following thoughts: “It’s going to be a long journey ahead. First, make sure you find a job that nicely matches your personality so you can shine. Find your passion and do something you would feel proud of. Secondly, act in the highest ethical stands. As HBS graduates, you will have a lot of influence on how business is conducted, so never forget that integrity is the coin of realm. I can’t emphasize enough that you should always operate businesses in a highly ethical manner. HBS opens the door to many opportunities and most people, such as my classmates, go on to be very successful in their careers. Finally, the asset management business is a great profession to be in. Unlike in a sales role, you get to act as a fiduciary to your clients. Our business is about performance and each area of the firm is dedicated to delivering the best results. Then there is a good balance of both the investment and client-interfacing aspects to our business. You are constantly in touch with the markets, talking to clients and managing a very dynamic global business”.
Besides his conviction to the business and clients at BlackRock, Rob also finds time to give back to society as a member of the Board of Trustees of the University of Pennsylvania, as the Chairman of the Hopes and Heroes Children’s Cancer Fund and President of the Board of Directors for Periwinkle Theatre for Youth, a national non-profit arts-in-education organization. Among his other professional and personal achievements, Rob is the recipient of the 2009 Joseph Wharton Leadership Award, the Marine Corps-Law Enforcement Foundation’s 2010 Semper Fidelis Award.
Nina Yang writes for the HARBUS on financial matters. She has worked in Toronto, Hong Kong and New York in financial advisory. Her hobbies include playing tennis, reading biographies and travelling.