Most will miss this

As we speak BLK makes 8% of my equities. Let me unpack why I think BLK is going to win over the next decade.

BlackRock is the largest asset manager in the world, and the least understood. Its Founder/Chairman Larry Fink is arguably the most powerful person on Wall Street. Everyone has heard of BlackRock, but surprisingly few – even professionals who work in asset management – understand it.

Let’s unpack:
1) Why BLK is unique and poised to win
2) How it creates exceptional value for it’s clients
3) Why even competitors use it

While BlackRock started as a fixed income house, today more than half of AUM comes from equities, fueled by the growth of equities ETF (BlackRock iShares).

But make no mistake - BlackRock is not just an ETF house. Actively managed strategies accounts for almost a third of AUM, and contributes to half of the firm’s total revenue. Importantly, BlackRock’s performance in active strategies have been good (especially 3 and 5-year returns).

Revenue breakdown roughly mirrors that of AUM breakdown. Alternatives clearly punches above its weight contributing to 11% of revenue (13% if performance fees included) with only 3% of AUM.

Not included in the breakdown above is a separate ‘Technological Services’ segment which generated revenue of $1.4bn (7.6% of firm total). This includes external revenue from Aladdin, BlackRock’s portfolio and risk management software built in-house. But the importance of Aladdin to BlackRock is much higher than its revenue contributions suggests, and in fact so important that it deserves to be the centerpiece of this report.

The Beginnings

“At 31 I became the youngest managing director at First Boston, and at 34 I became an asshole” – Larry Fink

As prominent as Larry Fink is now, perhaps lesser known is his early career. Fink had a meteoric rise as a star fixed-income trader at First Boston, becoming the company’s youngest managing director at the age of 31. Having ‘made it’ at a young age, Fink became emboldened by his success. His desk was the most profitable trading desk at First Boston. That is, until 1986, when he made a failed bet on interest rates which blew up and ended costing his desk $100 million in a few days. In Fink’s own words:

His career at First Boston never recovered. He ended up leaving the firm two years later, in 1988.

Fink attributed his failure to a lack of risk management. After leaving, he partnered with seven other co-founders and started a new asset management firm. This time around, Fink vowed to emphasize risk management at the heart of the company. So BlackRock was born.

While most of the AUM was in fixed income at the time, BlackRock also began to expand into equities. Notably, BlackRock grew by a series of successful M&As. Successful M&As are a rarity, but especially in asset management where it’s more about people and culture. In 2004 BlackRock acquired State Street Research & Management for $375mn, which bolstered the firm’s equities business. In 2006 it acquired the distressed assets of Merrill Lynch Investment Management. But Larry Fink’s biggest bet would be in 2009, when BlackRock acquired Barclays Global Investors – including the iShares ETF unit which was its crown jewel - in a $13.5 billion deal.

Fink astutely took advantage of the buying opportunity created after the Global Financial Crisis. iShares was the crown jewel of Barclays, but Barclays had been pressured to sell it in order to avoid a UK government bailout. This was a bold move by Fink. It was unconventional at the time to bring active and ETF businesses under the same roof - these two were different businesses with very different cultures. Fink’s foray into ETF demonstrated his long-term vision, but perhaps more impressive was his willingness to essentially disrupt itself to ensure BlackRock’s success.  

1) Why BLK is unique and poised to win

BlackRock doesn’t call itself this, and nor do investors, but the truth is that it’s more of a fintech than most of the companies that investors consider “fintechs” out there in the market today.

BlackRock is a first-rate investment organization, but its stock picking (or bond picking) prowess alone didn’t make it into what it is today. BlackRock’s senior management considers technology their right-to-win in the industry. This is interesting as most asset managers are bad with technology!

As an analogy, if asset management is a factory, then Blackrock operates the largest, most data-driven and sophisticated factory. It’s a factory that produces not physical goods, but risk management insights. By opening up the Aladdin platform to other large asset owners like insurance companies and pension funds, BlackRock has accumulated the largest dataset in the industry. With risk models that have been crisis-tested and refined for over three decades, Aladdin is the industry leading risk-management platform.

So what’s the significance of this for an asset manager? Consider the fact that BlackRock works closely with the C-suite and the boards of the largest pension funds and endowments in the world. These key decision makers are most concerned with risk management above all - answers to questions like: “What’s going to happen to my portfolio if X happens in the world?” or “How to quantify the risk that I can’t meet my future liabilities?”. Leveraging its technology platform, BlackRock is able to provide answers and solutions to these kinds of questions. Whatever BlackRock proposes, it’s able to back them up with data. The result is that BlackRock has earned a reputation as a risk consultant to the largest asset owners globally. With technology, BlackRock has built a ‘right-to-win’ platform in asset management.

Source: BlackRock

As we discussed, Larry Fink made it very clear from day one that risk management should lie at the heart of BlackRock. Aladdin started as BlackRock’s in-house risk management tool for fixed income. As BlackRock’s investment operations grew in scale and expanded into other asset classes, so did Aladdin. Risk management still lies at the heart of Aladdin, but it’s now hardly just a risk management software. It handles everything from pre-trade to post-trade, covering back, middle, and front office.

2) How it creates exceptional value for it’s clients

Aladdin came out of solving BlackRock’s internal risk management needs. For about ten years it was used exclusively internally. Then in 1999, BlackRock made the big decision to open it up, and started selling subscription to external clients which were mostly other big money managers and asset owners like insurance companies and pension funds. Sounds familiar? This is much like Amazon with AWS.

So Aladdin is valuable to BlackRock as both an internal tool (with BlackRock itself as the largest and most sophisticated user of Aladdin) and an external revenue-generating SaaS business. And these two are closely related. For example, BlackRock, as the largest and most sophisticated asset manager, is the main driver of innovations and new features on Aladdin.

Let’s talk about why Aladdin is appealing to external customers. Aladdin’s key value proposition is to streamline a company’s data into one data set. It’s a single database where all of the applications run off of the same data sets. Most people understimate how powerful this proposition is to clients.

Most financial services firms juggle software from multiple vendors. The alternative to Aladdin would be to use different software for different parts of the business – for example Charles River for trading, Geneva for portfolio accounting, another one for regulatory reporting, and yet another one perhaps for portfolio construction. Some may be internally developed as well. The problem is that all of these software work off of different datasets and are not designed to talk to one another. Firms have tried to stitch up products from different vendors, but the more integration work involved, the more process risk that’s created. Siloed risk management can turn into disasters for organizations, not to mention the cost and burden on the IT department for having to manage multiple vendors. Aladdin provides an all-in-one seamless solution.

Source: BlackRock

3) Why even competitors use it

The power of Aladdin is evident. But if it’s so good, why does BlackRock not keep Aladdin proprietary?

Now this is where it gets even more interesting. Risk models benefits from having more data. And one way BlackRock can obtain the most complete dataset in the industry is by allowing others, including even its competitors, to use its software.

Current Assets on Aladdin

Aladdin's influence extends beyond just asset management:

Bigger datasets mean better visibility into systemic risks, allowing it to create better models. This is a moat that’s growing over time as Aladdin reaches more users, and as risk models get tested through market crisis and are continuously refined and improved upon. If Aladdin is the dominant risk management platform today, I would wager that in ten years there will be even less competition.  

The fact that BlackRock’s competitors are even using Aladdin tells us the value and importance of the software and the software’s lead over other competing solutions. For example, Vanguard, BlackRock’s biggest competitor in the ETF space, is an Aladdin user. Importantly, it also shows the kind of reputation and trust that BlackRock has built in the industry.

A quick look at our usual 3 metrics:

It passes the 3 metrics, and made it into our portfolio.

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Simon (@simonseverino) & The Sprinters

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