BlackRock's Robot Stock-Pickers Post Record LossesBy
Fink combined SAE with stock-picking unit to bolster returns
Firm’s U.S. active funds had their biggest withdrawals in 2016
Like so many fund titans these days, Laurence D. Fink is betting on machines to turn around BlackRock Inc.’s beleaguered stock-picking business.
Trouble is, they just might have made things worse.
BlackRock’s main quantitative hedge-fund strategies -- which use computer models to sort through vast amounts of data to pick out patterns -- were on track for losses in 2016, according to a monthly client update sent out in late December. Of the five included, four were set for their worst returns on record, data through November showed. A separate investor presentation with a broader quant lineup showed that almost two-thirds underperformed.
While quants represent just a fraction of BlackRock’s assets under management, the losses are a setback for Fink, who combined the group -- a top performer in past years -- with the stock-picking unit early last year to lift returns and lure clients to higher-fee products. Demand for low-cost exchange-traded funds helped BlackRock maintain its position as the world’s biggest asset manager, but also has led to record withdrawals from its U.S. active funds business and chipped away at revenue.
“Quant is key to salvaging BlackRock’s active business,” said Kyle Sanders, an analyst at Edward Jones. “This is one way to improve their performance and distinguish themselves from the pack. Unfortunately, they have yet to deliver.”
Spokesman Ed Sweeney said New York-based BlackRock has “one of the largest and most advanced quantitative analytics platforms” and that its quant team “will be a key component in the future of our active equity franchise.”
He also pointed to the group’s longer-term track record of outperformance. Based on BlackRock’s numbers, the strategies have beaten 93 percent of their benchmarks or peer-group median over the past five years. (The firm doesn’t disclose the peer groups or benchmarks it uses for comparison.) And of course, BlackRock’s own shares have consistently beaten those of other asset managers, returning more than 140 percent in the past five years.
Yet in many ways, BlackRock’s quant push reflects many of the broader pressures convulsing the money management industry. High costs and middling returns have caused investors to spurn active managers in favor of ETFs.
To cope, many managers have turned to computer-driven strategies to gain an edge. That even includes some of the most storied names in the hedge-fund world, like Paul Tudor Jones and Ray Dalio, who have jumped on the quant bandwagon to bolster performance -- and justify their hefty fees.
At $282 billion, BlackRock’s active equity business constitutes just a small part of the $5.1 trillion behemoth. Still, it’s an important one for BlackRock because the funds carry much higher fees than its ETFs. For example, the $21.7 billion BlackRock Equity Dividend Fund has an expense ratio of 0.69 percent, data compiled by Bloomberg show. That’s 17 times higher than its $92.1 billion iShares Core S&P 500 ETF, which has an expense ratio of just 0.04 percent.
In the first nine months of 2016, its active equity business alone accounted for 16 percent of BlackRock’s base fees, even though it made up 6 percent of AUM.
Over the years, it has also been one of Fink’s biggest headaches.
Returns for the group’s fundamental active equity funds have consistently lagged behind many of its rivals, even after improving in 2016. According to Morningstar Inc., just 6.9 percent of BlackRock’s funds were in the top quarter of respective fund categories based on performance in the past five years. That’s led to redemptions, which contributed to a record $19.3 billion of outflows from its U.S.-based active fund business last year.
The $78 billion quant team, which BlackRock dubbed Scientific Active Equity, or SAE, was supposed to help fix that. In addition to combining SAE with its stock pickers, BlackRock armed them with the team’s analytical tools.
“As people get the data and learn how to use the data, I think that there is going to be alpha generated and, therefore, will give active managers more opportunity than they’ve had in the past to actually create returns,” BlackRock President Rob Kapito said at a Barclays conference in September.
BlackRock inherited the three-decade-old quant business with its purchase of Barclays Global Investors in 2009. Initially, the group was a big success under new management, delivering outsize returns. More recently, things haven’t panned out quite as well.
According to BlackRock’s most recent publicly available figures contained in its third-quarter earnings report from October, the strategies beat 31 percent of its peers or a benchmark over a one-year period. That’s slightly worse than its traditional stock pickers, who exceeded their yardsticks half the time.
(A separate investor presentation showed 12 of 19 quant strategies trailed their benchmarks in the 12 months ended November, before management fees were deducted. Five of the seven that outperformed were part of their regional lineup. BlackRock declined to say the total number of quant strategies it runs.)
At least three of the quant strategies used by BlackRock’s global hedge fund platform have suffered losses greater than 10 percent in the year through November, according to the client update, a copy of which was seen by Bloomberg. That compares with an average return of 3.6 percent for quant funds, Hedge Fund Research Inc.’s directional quant index shows.
The biggest decline was in BlackRock’s $768 million 32 Capital fund, a global long-short equity fund run by Raffaele Savi that has seen its assets decrease by 34 percent in the one-year period ended October. The fund lost 12.2 percent through November, the worst year-to-date performance in its 15-year history.
Some of the quant group’s deepest losses came in the first few months of the year, when markets plunged before bouncing back sharply in late February. Many quant shops stumbled, but a big reason SAE missed the rebound had to do with BlackRock’s own investment policy. It instructs the team to sell when losses become sizable, regardless of what its mathematical models say, according to a person with direct knowledge of the matter.
What’s more, SAE’s managers, who have the discretion to tweak the weightings of various factors that effect performance within their models whenever they see fit, intervened on at least one occasion in a way that hurt returns, according to Morningstar’s Jason Kephart. In a July report, he described how the $645 million BlackRock Global Long/Short Equity Fund (the mutual fund version of 32 Capital) lost money in early 2016 after its managers changed how much the strategy was exposed to different types of stocks.
“They had the worst timing possible,” Kephart, who called into question BlackRock’s ability to shift factor weightings on the fly, said in an interview.
Whatever the case, performance suffered. The fund class for institutional investors fell 6.9 percent in 2016 and beat only 9 percent of funds in its category, data compiled by Bloomberg show.
To make matters worse, SAE has lost some of its top talent. The departures included Bill MacCartney, a former Google scientist that BlackRock hired in 2015 to help build out machine-learning, and Ryan LaFond, a head researcher and one of the brains behind the firm’s socially responsible funds.
Of course, SAE could rebound from its lackluster performance and plenty of bold-faced quant names had a tough time in 2016. The main computer-driven fund at Leda Braga’s Systematica Investments lost 11 percent last year. Three such funds run by Man Group Plc’s AHL division had losses through September.
And regardless of the industry’s ups and downs, few firms anywhere can match BlackRock’s wherewithal. SAE is made up of more than 90 investment professionals, including 28 Ph.D.s and numerous data scientists. In September, Mark Wiseman, the former head of the Canada Pension Plan Investment Board, was brought in to run the group.
“They are willing to invest and put money into the business to differentiate themselves,” said Edward Jones’s Sanders.
Convincing clients is an altogether different story. Even as the promise of computer-driven investing helped quant funds amass almost $16 billion in new money in the first 11 months of 2016, BlackRock was largely left out.
After getting $1.7 billion in fresh capital in 2015 (and snapping six straight years of multibillion-dollar outflows), SAE once again suffered investor withdrawals last year. Fink hasn’t been shy about his disappointment over the inability of SAE to bring in money in the past.
“The one area where we’ve done quite well is in the model-based equities and we’re still not seeing really any flows,” he said on a fourth-quarter earnings call in 2014. “I am very bullish on building this out as a component of our active equity area and I’m quite frustrated, to be frank, that we haven’t seen the momentum that I would thought we would.”
A tough 2016 figures to make the challenge that much harder this year.