Breakingviews: Blackrock Opens New Investment Passivity Front

Larry Fink is opening a new front in the passive investment war on fund management. His firm, BlackRock, will sell exchange-traded funds using its own customized fixed-income indexes – and slash fees. It’s a formula the money manager with $5.4 trillion of assets has used in equities to eat stock pickers’ lunch. For an industry with little growth, the casualties of this latest assault may be widespread.

Low cost and ample liquidity have made ETFs wildly popular for everyone from retail investors to hedge funds. Most of the action has been in equities, though. They represent nearly 80 percent of the U.S. industry’s $3 trillion of assets, compared with just under 18 percent for fixed income.

The reasons are structural. ETFs track everything from broad indexes like the S&P 500 to so-called smart beta products that follow specific sectors or style factors such as low volatility.

By contrast, the bond market is heavily fragmented. Companies like Apple and General Electric have dozens of bond issues outstanding but typically only one common share. There are a relative handful of widely followed bond indexes, like the Barclays Capital U.S. Aggregate, a broad gauge of investment-grade issues. BlackRock’s iShares subsidiary uses that index for its largest bond ETF.

Now the firm is offering two new bond ETFs that track its own customized indexes: one focusing on investment-grade bonds paying higher than average yields and another on high-yield bonds with low default risk. BlackRock is betting products like these will shake up bond investing just as they have equities. For extra measure, it’s slashing fees on its existing mortgage-backed securities ETF by two-thirds, hoping to benefit when the Federal Reserve begins to sell down its massive holdings later this year.

Fresh innovation by the world’s largest manager, with a $71 billion market value, is more bad news for rivals. Assets under management rose 6 percent in the United States last year to some $33 trillion, but that was all market appreciation, according to Boston Consulting Group. Net new flows were slightly negative. The lack of growth and competition from passive vehicles has squeezed industry revenue margins by nearly a quarter over the past decade, to less than $27 for every $10,000 of assets.

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