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BlackRock's gamble on quant trading could pressure smaller fund managers

A push by BlackRock Inc. to sharpen its focus on quantitative-driven strategies could have sweeping ramifications, potentially leading to lower fee structures and reduced headcount across the asset management industry.

As part of BlackRock's latest overhaul of its active equity platform, the world's largest asset manager identified four segments aimed at tailoring products to clients seeking a diversified range of investment opportunities. Within BlackRock's core alpha series, the company expects to narrow its concentration on a set of nine mutual funds that rely on algorithms to spot trading patterns and predict stock movements. While the shift is widely viewed by industry experts as a low-risk play with little downside, the re-engineering of BlackRock's platform could be detrimental for a number of competitors, specifically smaller industry players, said Kyle Sanders, an analyst at Edward Jones.

By moving about $30 billion of assets into the quantitative strategies, BlackRock is delivering a warning shot to the rest of the industry that they are willing to gamble on evolving robo-investment platforms, which have largely underperformed over the last decade, Sanders said. If the approach takes off, other asset managers could be beset by continual pricing pressures. But if BlackRock's pivot ends up being unsuccessful, Sanders said the move will be viewed as more of just an "experiment," considering the company had more than $5 trillion in AUM as of Dec. 31, 2016.

"For them, it's kind of like playing with house money," Sanders said in an interview. "This is a baby step, it's a very small piece to the overall pie."

Craig Siegenthaler, an analyst at Credit Suisse, said in a March 29 research note that the changes at BlackRock could reflect many of the difficulties human fund managers have encountered when investing in large-cap U.S. stocks. Blackrock's revamped strategy, Siegenthaler noted, may also compel other U.S. active equity funds with management fees in the range of 50 basis points to 80 basis points to reduce costs even further in order to compete with exchange-traded funds and other low-cost passive options in the retail channel. For BlackRock in particular, Siegenthaler does not expect the company to lower management fees below the 30 basis point range.

Other asset managers are feeling the effects of the industrywide headwinds. Legg Mason Inc. recently announced plans to eliminating about 30 jobs, or 3% of its administrative staff, citing disruptions across the industry. The company examined its overall business model to address the pressures, while looking at ways to deploy capital toward investments in technology, products and distribution, according to a spokesperson.

"As such, we further reduced operating costs, which includes a reduction in headcount," a Legg Mason spokesperson said in a statement.

In many respects, the substitution of technology for labor in the finance industry should be viewed as a logical move, said Terrence Hendershott, a professor at the University of California Berkeley's Haas School of Business. When it comes to some of the less-complex strategies fund managers can employ in order to drive growth, Hendershott believes automation should be favored.

Hendershott likened the transformation in the asset management space to what happened to the brokerage community when high-frequency trading took off about a decade ago. Although a strategy that relies on sophisticated algorithms to trade high volumes of securities at a rapid pace wound up being very profitable at the time, increased competition has pushed returns down more recently, he said.

"If the same happens with algorithmic longer-term investments, it could be a good outcome for investors, although perhaps not so much for asset managers," Hendershott wrote in an email.

While Edward Jones' Sanders noted that quant-driven strategies have been common among institutional investors over the last decade, BlackRock is now exploring whether such products could garner interest on the retail side. Since cost-conscious retail clients are more responsive to lower fees than their institutional counterparts, the quant-focused funds may be appealing for long-term, buy-and-hold investors, Sanders said.

BlackRock's restructuring efforts conclude a six month review by Mark Wiseman, who was appointed as head of the company's global active equities division in May 2016.

"The active equity industry needs to change," Wiseman said in a statement. "Asset managers who simply use the same techniques and tools from the past will limit their ability to generate alpha and deliver on client expectations."