The shares of BlackRock Inc. (BLK - Get Report) , the world's biggest asset manager, tumbled the most in 17 months as fund fees rose less than analysts had expected, even as investors poured money into the firm's iShares exchange-traded funds at a record pace.
Net income rose by 9% from a year earlier to $857 million, or $5.22 a share, the New York-based company said in a statement Monday. Yet the earnings were below analysts' forecast for $5.40 a share, according to FactSet.
The miss shows how BlackRock's relentless sales of ETFs and "passive" index funds have shrunk profit margins, since such low-cost strategies carry lower fee rates than traditional, actively managed mutual funds. BlackRock also has cut fees to attract more customers, and CEO Larry Fink told investors on a conference call that the New York-based firm is spending $1 billion on improved technology and data to "differentiate" itself from competitors.
"We will continue to drive technology to make us different," Fink said on the call.
The stock tumbled 3.4%, leaving it up 11% on the year.
According to analysts at the brokerage firm Jefferies & Co., BlackRock's operating margin -- essentially pretax profit divided by revenue -- slipped to 43.9%, below the forecast 44.5%. And general and administrative costs were $24 million higher than expected.
The iShares ETFs drew in a record of about $73.7 billion in the second quarter, surpassing the previous quarterly high of $65 billion recorded during the first three months of the year, BlackRock said in the statement. The ETF gains helped drive BlackRock's overall inflows to about $103.6 billion for the period; by comparison, analysts at brokerage firm Jefferies estimated that the next-closest competitor, Alliance Bernstein LP (AB - Get Report) , attracted just $1 billion.
Investors are shifting away from mutual funds and hedge funds run by active stock-pickers in favor of low-fee index funds and ETFs, which simply try to match the performance of the broader stock market or certain asset classes like bonds, commodities and currencies. In the past five years, New York-based BlackRock's assets under management have surged more than 50% to at least $5.7 trillion -- bigger than the U.S. Federal Reserve.
Increasing numbers of investors have become disillusioned with stock pickers due to years of underperformance coupled with high fees. Star hedge-fund managers like Greenlight Capital's David Einhorn, Paulson & Co.'s John Paulson and Eton Park's Eric Mindich have faced redemptions this year as investors ran out of patience with their losing trading bets. Mindich decided to shut down Eton Park earlier this year.
The downside of the shift toward ETFs is that fees are lower. BlackRock's total revenue climbed 6% to $2.97 billion, though investment-advisory fees were $22 million less than Jefferies had estimated. Performance fees, which BlackRock collects when managers beat benchmarks or return hurdles, were $42 million below Jefferies' estimates.
In the past year, BlackRock has announced cuts to its ETF fees in a bid to attract more customers, while also moving to reduce costs in traditional mutual funds to keep investors from leaving. In March, the firm overhauled management of its active stock mutual funds, declaring that the move would save customers about $30 million on an annualized basis from lower fees. The move also resulted in a $25 million first-quarter charge, due to one-time costs such as severance.
On the conference call, CFO Gary Shedlin said that BlackRock is focused on absolute growth in fees rather than the profit margins. And Fink said that the higher expenses on technology and data will position the firm for future growth and continued market-share gains.
"We're trying to stay a couple steps ahead of our competitors," Fink said on the conference call.
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