Great Days at BlackRock

Just how much is $3.4 trillion? It is more than the gross domestic product of most nations, including France, the U.K. and Brazil. It is more than twice the size of the largest U.S. budget deficit on record (the one for the fiscal year that ended September 30, 2009). It dwarfs the sum of assets held by the U.S. Federal Reserve. And it is the amount managed by BlackRock.

If you think the name sounds only vaguely familiar, you're not alone. Less than a decade ago, BlackRock was a fairly obscure, mid-tier money manager with a wonky specialty: closed-end bond funds. But a few years and several gargantuan acquisitions later -- including its 2009 purchase of Barclays Global Investors, sponsor of the iShares line of exchange-traded funds -- BlackRock has become the world's largest money manager. The firm, based in New York City, runs more than 100 mutual funds, more than 200 ETFs, the federal government's retirement plan, several nations' sovereign-wealth funds and far, far too much else to list here.

Founded in 1988, BlackRock (then known as Blackstone) set up shop in a one-room Manhattan office with a team of eight Wall Street veterans unified by their desire to get away from the "sell first, ask questions later" mentality of Wall Street. "Wall Street is a velocity business," says chief executive Larry Fink. And as early as the 1980s he was starting to notice that the brokerage industry's focus on pushing products into customers' portfolios left many investors exposed to risks they didn't understand. So Fink and his partners set up a bond shop with a goal of always understanding the risks of their holdings.

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At BlackRock's first big meeting -- with Greenwich Associates, a consulting firm -- Greenwich's founder, Charles Ellis, turned the group away. "Just what the world needs," he said, "another bond manager. You should all go back to your old jobs."

Evolution of a giant

But BlackRock persevered. Its first closed-end fund, BlackRock Income (symbol BKT), posted 11% annualized returns over its first five years of existence. And a gig helping General Electric unload a portfolio of shaky mortgages in 1994 burnished the firm's reputation. By 2004, BlackRock had gathered $342 billion in assets through its homegrown products, but still focused on managing bonds for a mostly institutional client base.

And then the buying spree began. BlackRock's purchase in 2005 of State Street Research & Management, sponsor of the State Street Research funds, gave it a name in stocks. Its 2006 acquisition of Merrill Lynch Investment Management, Merrill's asset-management arm, brought in dozens of mutual funds. It bought Quellos Group in 2007 and R3 Capital Partners in 2009, expanding BlackRock's presence in hedge funds.

But none of BlackRock's previous deals came close in significance or in size to the one that brought Barclays Global Investors into the fold. "We never dreamed that a firm like BGI would become available," Fink says. "It was a firm that I'd always coveted." In fact, before BGI, the largest provider of ETFs, was put up for sale in the spring of 2009, BlackRock had decided to forgo the booming ETF segment. "We didn't think we could get involved in ETFs without an acquisition," Fink says. The ETF industry has always been dominated by the first two firms to get into the business: iShares and State Street Global Advisors (no relation to State Street Research), which together account for 73% of the market. "All the new entrants to the ETF industry are not making much of a dent" in their dominance, he says. Acquiring BGI added nearly $2 trillion to BlackRock's assets under management.

BlackRock is known for a tear-off-the-Band-Aid approach to mergers. The firm reasons that change -- particularly when it entails firing people -- is painful, so you might as well get it over with as speedily as possible. Thus, the day that BlackRock completed the BGI acquisition, BGI employees at the division's San Francisco headquarters arrived to discover that the Barclays sign and Eagle logo had come down overnight and a new BlackRock sign adorned the building.

Let 'em be

Signs and logos are one thing, but BlackRock refrains from meddling in the investment processes of the firms it acquires. "Nothing has changed in the investment practices of Merrill Lynch Investment Managers or of State Street Research or of BGI because of their acquisitions," says Rob Fairbairn, a BlackRock vice-chairman who previously served at Merrill Lynch's money-management unit.

That makes the firm's choice of motto, "One BlackRock," more than a little ironic. "The investment teams carry their heritages with them," Morningstar analyst Kevin McDevitt says of BlackRock's acquisitions. Ask BlackRock executives about the firm's investment philosophy and you'll first have to qualify which part of the business you're talking about -- for example, the part that tracks indexes, the part that follows computer models or the part that trusts human judgment to pick investments.

Among BlackRock funds that rely on brainpower and active management, the firm's goal, generally, is to beat a given index by a small margin without relying on big bets. Its bond mutual funds, for instance, "try to generate a large share of returns through individual security selection," says Peter Fisher, head of BlackRock's fixed-income department. So teams of specialists -- one devoted to, say, mortgages, another to corporate bonds and so on -- pore over market data looking for a bond here or a mortgage there that is mispriced relative to peers, trying, as Fisher puts it, "to find the pennies on the highway."

At the same time, managers will tilt their funds toward parts of the market they think offer the best value -- to mortgages rather than Treasuries, for example, or to bonds maturing later rather than bonds maturing sooner. These sorts of bets, however, are supposed to be small so that no single mistake can derail a fund's returns. "We don't make two or three macroeconomic bets and see how they play out," Fisher says.

It is a conservative strategy that harkens back to BlackRock's focus on risk. It's also a "career safe" approach, says Morningstar's McDevitt. Managing a fund so that it never strays too far from its index means never having to say you're sorry to your clients, he says. After all, you'll only do poorly when everyone does poorly.

BlackRock's record when it does go out on a limb to make a big-picture bet has been mixed. Although the firm turned cautious on subprime mortgages earlier than many, and successfully steered around much of the related carnage in 2007, it turned bullish far too early. Over 2008, several of its bond funds made untimely moves into commercial mortgage-backed securities in a bet that the worst of the financial crisis was over. That year, 63% of BlackRock's bond funds lagged their benchmarks or their peers.

More recently, BlackRock made a particularly smart call. Curtis Arledge, the firm's chief fixed-income officer, had been saying for months that investors' fears of rising interest rates in the near-term were overblown. So when the yield on the benchmark ten-year Treasury note hit 4% in early April (its highest level since October 2008), Arledge was more than happy to load up, despite warnings from many market seers that yields were headed still higher (bond yields and prices move in opposite directions). "We were very comfortable" buying at those rates, he says. By mid July, the ten-year bond's yield had tumbled to 3.1% as investors sought cover amid worries over high debt levels in Europe and deflationary pressures in the U.S.

Larger than life

Of course, when you're as enormous as BlackRock, it makes sense to emphasize consistency by discouraging managers from making big bets rather than shooting for home runs. Every year, in its annual report, the firm tallies up the portion of its funds that beat their benchmarks over the previous year, seeking to highlight a majority of winners rather than the magnitude of the winnings (63% of its actively managed funds beat their benchmarks or peers in 2009). Not to mention that when you're that big it becomes impractical, if not impossible, to make a huge bet with your assets.

One downside of being the biggest is that when disaster strikes somewhere in the market, chances are you're there. That's become obvious in the wake of BP's disastrous oil spill in the Gulf of Mexico. Since April 20, the day of the rig explosion, BP's share price has plunged by 43%. BlackRock is BP's single largest shareholder, with a roughly 6% stake, so customers of many BlackRock stock funds have felt the sting. Regulatory filings show that BlackRock owns at least 5% of the outstanding shares of more than 1,800 companies.

But size, everyone at BlackRock insists, is a plus for clients. "It's expensive to have all these analysts, and you need scale to afford the best people," Arledge says. Fink says the firm is looking into novel ways of using its scale to minimize or eliminate certain transaction costs for its clients.

So what drives BlackRock's seemingly insatiable appetite for assets? Its vision seems to be to acquire such an array of products and competencies that it can say to any investor, of any size, with any goal, "Do business with us -- we've got what you need." In that sense, BlackRock's bigger-is-better approach has undoubtedly succeeded.