BlackRock's US$32b hedge-fund business has a little problem
[BOSTON] Yes, he runs the biggest asset management firm the world has ever seen. But right now, Laurence D Fink has a little hedge-fund problem.
Mr Fink's BlackRock Inc, the US$4.5 trillion behemoth known for its mutual funds and ETFs, threw in the towel on its lacklustre macro hedge fund last month - a humbling capitulation that stunned the investing world.
While hedge funds represent only a tiny fraction of BlackRock's total assets under management, the setback nonetheless underscores the upheaval convulsing the broader hedge-fund industry, as well as the particular challenges facing BlackRock as Mr Fink tries to attract hedge-fund money - and the hefty fees that come with it.
The turbulence threatens to hold back BlackRock's ambitious push into hedge funds, which form a key part of the alternatives business that Fink, the firm's chief executive officer, rapidly built up through a series of acquisitions.
And while BlackRock said the macro fund closure will have a minimal impact on its business, such missteps do little to change a long-standing perception that traditional "long-only" shops lack the wherewithal to compete with their more glamorous counterparts - regardless of overall performance.
"In terms of its ability to grow the business, it's something you would have liked to see prosper," said Rory Callagy, a senior credit officer at Moody's Investors Service.
More broadly, "poor performance by hedge funds this year, in a market environment in which they were designed to shine, may lead to a slowdown in flows into funds and challenge growth across the industry."
GIANT STEPS
BlackRock, which now oversees US$32 billion in hedge-fund assets, quietly became a big player in the industry after acquiring Barclays Global Investors in late 2009. The deal, which made BlackRock the dominant provider of exchange-traded funds, also helped to boost its hedge-fund assets by US$13.8 billion, more than doubling its business at the time.
The New York-based firm currently has about 30 hedge-fund strategies and says it's committed to adding more offerings to give clients the broadest array of options - even after the macro fund's failure. While BlackRock's size makes it one of the industry giants alongside the likes of Viking Global Investors and Baupost Group, it's still a relative small fry when it comes to the individual offerings in its long and varied hedge-fund lineup.
Of the 17 strategies listed in an investor document obtained by Bloomberg, a dozen of its funds still managed less than US$1 billion as of October.
One example is BlackRock's long-short credit pool. When it started in 2013, the fund set out to gather as much as US$3 billion. It managed about US$554 million after declining 3.6 per cent through October.
Mark McCombe, who was named to co-lead BlackRock's alternatives arm in June, said the firm can still do more to attract clients.
ASSET FLOW
"We definitely noticed as a firm we were very broad, we had some exceptionally good product, but it wasn't necessarily where we were seeing most of the asset flow," he said in an interview. Mr McCombe said he's developed a dedicated sales team for alternative investments and has put more emphasis on targeting consultants that specialize in the business.
BlackRock's own figures suggest it has kept pace with the broader hedge-fund industry in attracting client assets in recent years. Some of its strategies have also been standouts. But bringing in more money may be a challenge with the industry itself bracing for more redemptions.
Unexpected market shocks this year, such as the devaluation of the Chinese yuan in August, has led to steep declines for some macro fund managers and caused investors to lose patience even with funds run by marquee funds like Fortress Investment Group LLC and Bain Capital. A sudden turnabout in the junk bond market has only added to jitters in the past two weeks.
BlackRock's own macro fund was upended by the turmoil.
Before it was shut down, the Global Ascent fund was on course for its worst ever year, tumbling 9.4 per cent. The fund, which had US$4.6 billion in assets just two years ago, has shrunk to less than US$1 billion, a person familiar with the matter said in November.
Mr McCombe, who said the macro fund was a "huge disappointment," declined to specify how BlackRock would fill that gap in its multi-strategy lineup.
Many investors and bankers now say the industry could see outflows this quarter after the weakest third-quarter inflows in six years.
THINKING BIG
Mr Fink, 63, has argued that there's a big opportunity in alternative investments as traditional long-only clients look for different ways to bolster returns.
"This is one of the big reasons why we are building out our infrastructure platform, continue to build out our hedge fund platform, our real estate platform," Mr Fink said during a third- quarter earnings call in October.
The push isn't solely about client demand. BlackRock's US$114 billion alternatives business, which also includes private equity, infrastructure and funds of hedge funds, is among its most lucrative. Fees of 1 to 2 per cent on assets and up to 20 per cent for performance - standard for most hedge funds - far outstrip average expense ratios of about 1.1 per cent and 0.35 per cent for its open-end mutual funds and iShares exchange- traded funds, according to data compiled by fund research firm Morningstar Inc.
As a whole, alternative funds contribute a disproportionate amount to BlackRock's fee income. They account for 8 per cent of revenue and make up just 3 per cent of assets.
That part of the business "contributes to profitability at a much higher level," said Macrae Sykes, an analyst at Gabelli & Co.
BUSINESS RATIONALE
In the previous two decades, BlackRock's hedge-fund model was based in part on allowing its long-only managers to start alternative strategies. After Carl Eifler was named the head of its direct hedge-fund business in 2013, BlackRock has focused on creating bigger funds. It has also filled gaps by adding event- driven and credit strategies.
Some have been top performers. The US$1.8 billion European hedge fund has gained 27.2 per cent through October, the investor document showed. That's more than quadruple the return for HFRI Western/Pan Europe Index.
The US$2.1 billion flagship global fixed-income fund, called Obsidian, has outpaced a comparable HFRI benchmark in four of the past five years.
"BlackRock is one of the few long-only firms that has succeeded" in building a hedge-fund business, said Don Steinbrugge, managing partner of Agecroft Partners.
Despite those successes, traditional asset managers like BlackRock may still face an uphill battle winning over skeptical hedge-fund investors.
UPHILL BATTLE
Long-only shops have traditionally struggled to win over clients because of nagging worries that they don't have the expertise to consistently win by shorting, a common practice used to betting against securities, according to Jason Kephart, an alternative funds analyst at Morningstar Inc.
And even if performance holds up, there's the risk they won't be able to reward those who run in-house hedge-fund strategies enough to keep them from being poached or setting out on their own.
Generally, "what really trips up long-only managers that try to get into it is the shorting," Mr Kephart said.
BLOOMBERG
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