BlackRock, Inc. (NYSE:BLK) 2023 Bank of America Securities Financial Services Conference February 16, 2023 8:00 AM ET

Company Participants

Rob Kapito - Co-Founder, President and Director

Conference Call Participants

Craig Siegenthaler - Bank of America

Craig Siegenthaler

So this is Craig Siegenthaler from Bank of America, and it's my pleasure to introduce Rob Kapito. Rob is Co-Founder, President and a Director of BlackRock. He is responsible for the day-to-day oversight of all key operating units including investment strategies, client businesses, technology and operations, and risk and quantitative analysis.

Rob, thank you for joining us today.

Rob Kapito

My pleasure.

Craig Siegenthaler

So quick background of BlackRock, and I know you all know it, it's the largest asset manager in the world with $9 trillion in assets under management. More importantly, it's the leader and first mover and scaled in all the major secular growth verticals. This includes iShares and ETFs, Aladdin in technology, ESG, retirement solutions and privates. Rob, let's start first with the rebalancing opportunity in fixed income.

Question-and-Answer Session

Q - Craig Siegenthaler

Yields at levels we haven't seen in 20 years. Pension plans can finally hit their liability hurdle rates without stretching, and the baby boomers can finally generate a decent income. So what is your view on the potential for large reallocations into fixed income in 2023?

Rob Kapito

Well, great. So I'm going to talk less about BlackRock today and more about these questions on the market and then let you decide who can actually prosper in a market like we're going into. So I wrote down a bunch of little statistics because Craig is one of our best coverage, and he likes numbers. So the first thing is the backdrop here. Why is there going to be repositioning? So we are coming off the highest inflation in 40 years. We're coming off of the fastest increase in interest rates in 40 years. We have the tail end of a pandemic. We have a war in Europe. We have all the geopolitical issues that you all know, and the S&P was down 19%, and all of that spells B-O-N-D-S and added bonds.

And we're going to go through a generational change in the bond market. So what does that mean? It means that the 10-year average on the one to three, which used to be called the Merrill Lynch one-to-three index. The 10-year average is about 145, the 20-year average is about two and change. And right now, the Merrill Lynch one to three, and I still call it the Merrill Lynch, is about 4.5%. That is a generational change in rates. So what do we have to do? We have to take advantage of that, and why do we have to take advantage of this because this is what I'm going to call back to the future.

So in 1995, you can have 100% of your clients' assets in bonds and get that 7% return. Now you go and that's a magic number, not only for individual clients, but for pension funds and institutions. Now you fast forward 10 years and you know what, you need bonds and you need something else, you need equities. And at that time, BlackRock was a bond manager, and we repositioned ourselves by buying one of the best institutions in equities at that time, which is Merrill Lynch Investment Management.

And now we have the equities to lead our clients. And you fast forward 10 years later, and what do you need? Bonds, equities and you need something called alternatives in order to get that 7% yield. And if I can leave you with anything today is that today, you can be 100% in bonds and get that 7% return. And in fact, you can take the least amount of credit risk and the least amount of duration of price risk and get an 8% or 9% return in the shortest part of the curve before where rates are. Not taking advantage of this is not doing a service for your clients. Now for pension plans, you asked about repositioning. Pension plans have done very similar to what everybody else has done.

They went very long equities, and they didn't have any bonds because they are yielding zero, why would you have bonds. And everyone used equity large cap dividend stocks as a surrogate for bonds, and then barbell into private equity, which you saw the growth in this. Well, the shock hit, beta goes down across the board, equities, bonds, private equity. The phone rings and everybody has to pony up to the private equity companies to draw down the money and they look what are they going to sell.

Well, you're really not going to sell the equity that went down 50%. You're going to sell something that you didn't make as much of a loss on, you sell it -- some equities, you pay the draw downs. And now you look at your portfolio and you have private equity at the max that you can have, you have a stock portfolio that's more risky because you sold the stocks, it didn't go down that much because they're more stable and you have no bonds.

So what can you do in the next several months going forward? You got to add to the bond portfolio. So you're going to see a huge flow into bonds, and this is not something to watch. This is something that you have to participate in. So we have $3.2 trillion now in the fixed income and in cash. And in 2022, we added a record $123 billion of net flows into bond ETFs and $6 billion into private credit. And just to verify what I'm saying in case you want to, I'll save you time, in the first two weeks of the year, we added $12 billion into iShare bond ETFs.

So there is a huge amount of money that's in motion and it's very, very focused on the bond market. Don't miss this. This is not something to watch because this is a lifetime change, short duration, two-year type paper, you can get 6% direct. And if you have a little bit of flavor in it, you can get to the 8% to 9% and then we can watch and see where inflation goes, where the economy goes.

And at some point in time, the yield curve will change, you'll be able to extend that out and you'll view your client and incredible service. So we think we're going to prosper from that because there's nobody that has more flavors of bonds and more ways to get into bonds and more bond EPS than anybody else, any other asset manager. And if it's one thing that we do know over the last 35 years, is how to manipulate the bond market.

Craig Siegenthaler

[Technical Difficulty] very large rebalancing into fixed income. BlackRock arguably is best positioned for that. Now within that, the last 10 years, we've seen a very strong migration in the equity side from active to passive. We really didn't see that in the fixed income side until last year. Last year, passive fixed income is in and active fixed income is out. Going forward, what percent -- or do you think passive fixed income will be a large part of the infill like we saw last year?

Rob Kapito

So, this is another important question, Craig, and this is about... [Technical Difficulty] how we look at the markets. So a lot of you have access. Let's talk about the bond market through individual bonds and through mutual funds. But during the last several years, this new product called ETFs have been created, which just are a better mousetrap, a better structure for your clients because it offers diversification, it offers transparency and it offers liquidity that individual bonds do not have and it's very important to pay attention to because you can also structure a bond portfolio that will give you themes that you can accentuate for whatever your client is looking to do.

So that's the first part of using what we would call or you would call passive, but people are being active with their passive. Where they're doing this is another... [Technical Difficulty] is that in this market structure change, we have another issue, which is facing everyone, which is model portfolios. And this is really important for all of your clients because a lot of people are looking for a portfolio that represent their objectives, their future, their age, their time when they're going to need to draw down money, and they're creating models. And I know that you all have models in your offices as well. We have models, and one of the best products to use in a model, the least expensive model and to get exposures that you want is using ETFs.

So where BlackRock is participating, in not only creating ETFs that represent a lot of the needs that your clients and also institutions have, but what they're trying -- what we're trying to do is build a larger and larger opportunity base and value proposition for the clients. Where we participate is not only in the models that we have for the client, but we participate in models that other people are building even other competitors, who are going to use ETFs in those models. And so our growth rate in ETFs will be higher than anyone else's growth rate because of the use of that.

But don't look at passive is not -- is giving up on the market. You can add a lot of alpha using ETFs and using index depending upon how you do it, and it's not going to be just passive or just active. The most sophisticated models and the returns that people are getting for their clients who use both active and passive strategies in what they're trying to do for their clients.

Craig Siegenthaler

So Rob, let's talk about one business that's been generating huge mandates recently, your outsourced CIO business. Recently, you've won a large mandate from AIG and they just really keep coming at. So maybe update us on why they've been turning to BlackRock? And what's the pipeline look like in this business?

Rob Kapito

So the business is getting more complicated as we all see. Different type of structures, different type of ways and analysis to add alpha into the portfolios, and a lot of institutions don't have the ability to buy that technology, to have the staff to do it, to have the scale and size that they need to be relevant in the marketplace and also to source assets in the marketplace. So they're turning to us and OCIO, outsourced CIO, and they're bringing very, very large blocks of assets to us to act as their portfolio management group and their technology group.

And the fact that we have the large plate of products that we have and that we have the technology to tie it all together that is up to date makes us a big advantage to them. And we have positioned ourselves very well over the last many years with all of these products. So they turn to us, and we just, this year, won a $38 billion mandate from Central States. We just won an $11 billion pound mandate from the Royal Mail. So these are the type of institutions, and you did mention AIG, which is $140 billion. There are not that many managers that can do this and provide all of those services. So when you're looking at BlackRock, they're looking at us as an institution that can operate in all these markets, operate with the technology they need to provide the reports they need, and then to create the -- all of the alpha that they're looking for.

And some of these clients are very complicated. So they need liability matching. They need accounting as well, and all of these things over the years, we have built into our technology called Aladdin, and then we can offer them this full service. So this is something where there are not many people like to do this. It's already successful, and we are seeing a pipeline of these, which should really add value to BlackRock as an entity.

Craig Siegenthaler

Great. So BlackRock has also built one of the largest alt managers. There are a series of smaller acquisitions, also some organic investments. When you look at this business today, do you see any significant product gaps in privates? And also across this business, what are your most attractive scaling opportunities?

Rob Kapito

So we don't make a splash in the paper about being an alternative manager versus many that really focus only on alternatives because I see it as just another asset class that we need to have. And I also personally think that the word alternatives is going to disappear because there's really not much that's alternative about some of these markets that deserve a much better name. So our platform is about $320 billion. So we are in the top 10, and where we are focused is on opportunities in the marketplace that we see primarily in credit, again, focused on the bond market and the long-term, long-duration product where we can get yield.

And the second one is very interesting to think about is infrastructure. Around the globe, there's a rebuilding of infrastructure. And what does the infrastructure product give you? Long-duration assets for the yield and some upside that have a social impact. So we have been investing, especially in local communities alongside of companies like we just announced Gigapower with BlackRock doing the financing for AT&T to go out and we're in a unique position because we have these relationships with corporations around the globe, who are going to be building infrastructure. And we could go alongside as a partner differently than many other institutions go.

So I wrote down a few numbers. This is a global energy and power fund. We raised $5 billion in 2020. We have done now our fourth infrastructure fund, $4.5 billion close in 2022. That will get us to our target of $7.5 billion and -- but it's part of a much bigger platform that we have. And what we're doing with these alternatives is we're adding the ability to analyze these in Aladdin. So we have a company that we book called eFront. So we will be one of the only providers that can give a client a picture of the whole portfolio, and we think this is a very large growth area for us as well. We grew 30% in Aladdin last year. We have a queue of people that want it, but we're adding more value into it.

So in the alts business, we're approaching it the same way that we approached the equity business and the bond business by building the analytics and the tools that we need to invest in it properly, and then we are also building out a sourcing area so that we can call Bank of America and go out and say, "We have financing to do for your corporate clients and others who are making different transitions, and we would like to be introduced and finance them and Bank of America is acting as a great source for us for these clients." But we're building an alternatives platform methodically in a way where we believe that we can add significant value and bring alpha to our clients for the long term.

Craig Siegenthaler

So Rob, as you scale this business over a term, there's a management fee component, but there's also a performance fee component. How much opportunity is there to grow that realized performance fee component because many of these businesses are small, mid size? They're not really at full potential yet. So there could be a nice earnings left as its performance fee scale.

Rob Kapito

So I know you're going to go there and try to figure out how this is going to impact BlackRock. So I did bring a couple of numbers for you. So the private markets, which we can call it, the -- it represented over 50% of our overall performance fee. So you can see how important alternatives are going to be for the future of BlackRock. We have already, what we'll call unrecognized deferred carry of about $1.4 billion, which has doubled since 2020. And so what does that mean to the future of the earnings of the firm? Well, we have now $34 billion in dry powder, and once I invest that money, that should add about $260 million of future annual base fees.

And I know, Craig, you like base fees once we deploy that capital, and the opportunities to deploy it are right in front of us right now. So we are today evaluating several very large opportunities. So this helps us to deploy that money. So alternatives are going to be a very important part of our future growth, and I also think it's going to really help the returns of our clients' portfolios as well.

Craig Siegenthaler

So BlackRock has a great technology solutions platform with Aladdin. It helps insurance companies, asset management competitors, trust banks, financial advisers, but I want to understand more of the strategic benefits of having Aladdin next year asset management business. How does it help the asset management business generate better flows?

Rob Kapito

So you can think of this as the ultimate fintech for asset managers, and the first thing is knowing what you own, and many asset managers are bifurcated into equities bonds, who is sitting there and really understands the entire risk of a client's portfolio. So that's why we built it to know what you own and what the risk is and then being able to act quickly to mitigate risk, but also to take advantage of opportunities in the market. But as we started using it and installing it in other organizations, the first thing it does is it actually unifies the culture of the firm because everybody is operating with the same data with the same number and speaks the same language about risk.

And as you know, many companies have been built and different areas came on and everybody has their own way of looking at things and analytics, that could cause a lot of risk. So it unifies the culture. The second thing is it increases the operational leverage. If you know where everything is, then you can be much more efficient in whether you're buying or selling or moving your risk around to a couple of different places.

It empowers the investment team because they have the information at their fingertips to make quicker and better decisions. It also unlocks the power of data. You've heard about AI. How are you going to incorporate AI into your investment process? So what we like to call Aladdin in any organization is a single source of truth for investment data. And then you look at the scalability that a firm would have in trading and other opportunities, all from Aladdin. So what we intend to do with that once an institution is on Aladdin is we're going to add in lots of value propositions. So we've now added in Aladdin for accounting, so firms that are looking for accounting. We've added in Aladdin provider.

So now you can be more efficient by sending assets directly to your custodians. So we have less potential for operational issues. So there are just so many opportunities that we're finding, and you know what's interesting. There's a whole Aladdin community now. All of the firms that use it are calling and saying, wouldn't it be nice if you do this or do this. So we have over 3,000 programmers that are sitting and modeling every security so that we can have the appropriate analytics people we need. So it's been very difficult over the last several years to invest in technology if you're an asset management company and an insurance company trying to watch your expenses. And the systems keep getting better and better and the maintenance becomes very expensive. So we turn this into a real business and it's open source so that all of the clients are not depending upon what our models are saying, they can build their models on top of this.

So central place for data, central place to unify culture to get faster, better efficiencies. All of these things have created one of the largest fintech companies within BlackRock.

Craig Siegenthaler

So Rob, inside of Aladdin right now, there's a lot of newer businesses, there's the operating system, which is kind of the legacy business. Which one or two are you most excited about for the future?

Rob Kapito

Well, I think the one that's the most exciting is the whole portfolio look. And this is really interesting because you know that clients and institutions, if you talk about retail clients, you have accounts at more than one place for maybe different types of investments you have. Don't we all want to look at our investments on one piece of paper and see what the risk is and what we have? So we've built something called Aladdin for wealth, where a client can actually see everything they own. So the whole portfolio, and the one piece that's really hard to get in any analytics package is alternatives. It's very difficult to look through and see what people own and see what the risk is in these, and as the market becomes more volatile, we have a lot of political issues and all these things, you really need to know what the client owns before it's too late.

So the one on most exciting is the whole portfolio look, and I did what other people did. We built Aladdin from scratch and we look to see how long it would take us to build in the alternatives platform, and it would take four or five years for us to do that. And rather than wait, we went out and bought a company called eFront, which already had so many of the alternatives that you all know on that platform. And what we did is we bought that company, and we're incorporating it together with Aladdin to be able to look at the whole portfolio. And I will tell you, in some of these, it's been an asset-gathering tool because once a client sees that look at the whole portfolio, if there's something that's not on Aladdin, they bring it in. So for a lot of investment advisers, it's been an asset-gathering tool to be able to see everything on one piece of paper. So that's really the most exciting part to me is seeing it. I'd like to see what I own on one piece of paper, and so I assume a lot of people want the same.

Craig Siegenthaler

So BlackRock generated really strong organic growth over the last five-plus years. Although sometimes the AUM organic growth rate and the revenue organic growth rate, they diverge, and they're driven by mix shift. And if you look at the total growth rates, things like data and currency can also sort of drive that. So as you look in the future and think about ETFs driving a lot of growth, OCIO probably driving a lot of growth. How do you think about the delta between the AUM organic growth rate and the revenue organic growth rate?

Rob Kapito

We've been able to grow consistently over the last 35 years, and we're a growth company. So we're looking for opportunities to continue to grow. So last year, when people saw outflows and everyone was panicking, what is the growth rate? We raised $300 billion of assets. That's $1 billion. And I don't think we should get lost and how important and how big those numbers are. So I wrote down for you, Craig, that we've delivered organic base fee growth rate above our 5% target in seven of the last 10 years. Last year, in the last quarter, we had a 3% growth rate. So we're going to be consistent. We're saying 5%, and I like being able to get on the phone with Craig and say we did better than that. And we're consistently building in growth tools so that we can continue to offer you products that the client needs.

So I'm going to tell you 5% and we're going to be consistent. I think we can do that, but I'm an optimistic person, and now when I see the money in motion from all this repositioning, and it's in motion and an area that we are experts and have the widest plate of products to use, I think we can do better than that. So I'm very excited for the future, and we cannot fail here as a group. Many, many of our clients, a good majority are retirees. Failure is not an option for people to live in dignity. So we have a pretty awesome responsibility here to find opportunities to get them the biggest returns, and we sit on the same side of the table on that in trying to bring good opportunities to our clients.

Craig Siegenthaler

Well, with that, we're out of questions and good luck grabbing all those bond flows this year, and congrats on a strong 2022.

And Rob, thank you very much for joining us. On behalf of all this in Bank of America, we appreciate your time.

Rob Kapito

Thank you very much.

Craig Siegenthaler

Thank you.