Here’s One Profitable Shadow Bank Hiding in Plain Sight
January 29, 2021
I’ll get straight to the point today.
Rather than invest in the popular exchange-traded funds (ETF) or index funds today, wouldn’t it be better to simply invest in the company who makes them?
BlackRock (NYSE: BLK) is the world’s largest asset manager, with US$7 trillion in assets under management (AUM). This makes it even bigger than the world’s largest bank, Industrial and Commercial Bank of China (ICBC) which holds a total asset of US$4 trillion.
What many people might not know about BlackRock is this. At its heart, BlackRock is a passive investor.
I’ll explain it.
You see, BlackRock, like any other traditional asset managers, hires an investment team of fund managers and analysts to generate returns to try and beat the overall stock market performance. This investment team would “actively” pick stocks, bonds, commodities and other types of asset classes for the funds BlackRock manages. So far, BlackRock’s actively managed fund is close to US$2 trillion in AUM.
But what is more interesting here is this.
BlackRock manages its remaining US$5 trillion all without an investment team.
BlackRock is Quietly Growing its AUM Through Passive Funds
What BlackRock does is it automates the entire investment process.
It does this by simply creating a set of mathematical rules, to tell its funds what stocks and bonds to buy from an index a fund tracks.
Some of these funds track the S&P 500 Index, which consists of the 500 largest listed companies in the US. Some of these funds track the Hang Seng Index.
And BlackRock manages this entire process through its iShares platform. Today, the company manages one of the largest passively-managed funds in the world, which consists of exchange-traded funds (ETFs) and index funds.
Now, BlackRock’s business model is simple. The more assets it manages, the more fees it earns from it. In its latest third-quarter financial results, BlackRock earned around US$4 trillion in fees alone, which is 16.5% higher compared to last year. These include investment advisory, admin, performance and distribution fees it collects from clients and retail customers.
Over the past ten years, BlackRock grew its total revenues from US$8.6 trillion in 2010 to US$14.5 trillion in 2019, all through earning fees from a massive growth in AUM.
While the investment industry is getting more competitive due to higher operating and compliance costs, BlackRock is able to maintain its profitability. In fact, over the past ten years, BlackRock’s net profit margin has averaged 28%, which is typically higher than many large listed companies.
Technology is the Bedrock of BlackRock’s Business
The beauty of BlackRock, unlike many traditional asset managers, is it focuses heavily on technology. It makes sure it invests and develops the latest technology, manages its investment risks and finds the best possible returns for its funds.
One such technology BlackRock has developed is its leading risk management and portfolio software called Aladdin. This software is not only used within the company, but BlackRock sells them to other asset managers who may lack the technology capabilities in their own business. And because risk management and portfolio construction are a critical piece in any asset management business, this makes BlackRock’s Aladdin software very “sticky” to the end-users.
As a result of BlackRock’s technology innovation and scale, it gushes free cash flow (FCF). Its FCF is around US$2.7 billion on average each year since 2010. And because it has a capital-efficient business, it doesn’t need to reinvest too much of what it earns back into the business.
Its return on equity (ROE) is around 11% on average over the past 10 years.
And because it gets to keep most of its earnings, BlackRock has rewarded its shareholders well. So far, it has been paying out dividends since 2003, and its dividends grew from US$0.40 per share in 2003 to US$14.52 per share as of 2020. If you’d bought the shares 10 years ago, your dividend yield on cost would be roughly 7.6% today.
One big risk I have for a business, like BlackRock is if it faces a severe market correction. That is, people are no longer interested in investing in stocks and bonds anymore. This could force a huge withdrawal of investors’ money from BlackRock’s funds.
But so far, since its founding in 1988, BlackRock has weathered through multiple economic cycles, including the major global financial crisis. Even during the COVID-19 pandemic, BlackRock still held its steady performance.
Its co-founder, Larry Fink, still runs the company as chairman and CEO. You can say Larry Fink played an instrumental role in growing BlackRock to where it is today, again focusing on technological disruption within the asset management industry.
Its share price performance has been resilient during the COVID-19 outbreak this year. In fact, its year-to-date performance is up 40%, and it quickly recovered from the initial market correction in March earlier this year.
Source: Yahoo! Finance
BlackRock is truly a leader in the asset management space. It differentiates itself from most traditional asset managers by focusing on technology. And it’s looking to disrupt its industry by focusing on growing its iShares platform, which creates multiple passive funds.
In my opinion, ETFs and index funds are getting more popular amongst retail investors.
Of course, there’s a risk that BlackRock would face a drop in AUM if the company experiences a major market correction. But so far, BlackRock has weathered through the various economic crises and still manages to organically grow its assets through the years.
Willie Keng, CFA is the Founder of Dividend Titan (www.dividendtitan.com) -- a financial research publication for investors looking to grow their wealth for retirement. A former research analyst for top private banks, Willie also runs his own consulting firm. He advises investment companies on their businesses. Some of his clients include asset managers and family offices. Willie has a deep passion for helping everyday investors take control of their financial future. And has spent over 10,000 hours researching, analyzing and recommending investment ideas.