How The SEC’s Examination Of Alternative Funds Affects BlackRock

The Securities and Exchange Commission (SEC) is reportedly examining alternative mutual funds launched by some of the country’s largest asset managers, in order to improve regulatory oversight for the segment which is fast gaining popularity among retail investors. ^[1] These risky investment products have seen a significant inflow of funds over the last 18 months from retail investors looking for higher returns in the current low interest rate environment. The financial regulator aims to examine alternative fund offerings of 30 firms by next April – including BlackRock (NYSE:BLK), AQR Capital Management, Goldman Sachs (NYSE:GS), BNY Mellon (NYSE:BK), Blackstone and PIMCO – to ensure that retail investors are given a clear understanding of the risks involved in these investments by the asset managers as well as by financial advisers.

The move by the SEC was expected considering the fact that alternative mutual funds have swelled nearly tenfold in size from just over $30 billion in 2008 to $283 billion at the end of 2013, largely due to their unregulated nature. Last year, the Financial Industry Regulatory Authority (FINRA) released a cautionary note aimed at educating investors about the risks involved in these offerings, and it was only a matter of time before the SEC stepped in with guidelines governing the manner in which they are marketed and sold to retail investors. While alternative funds are expected to continue to grow in demand in the future, tighter regulation will most likely prevent the asset managers from maintaining the sharp growth figures they have seen over recent months. In this article, we highlight how changes in asset size for BlackRock’s alternative mutual funds affects the share value of the world’s largest asset manager.

We maintain a price estimate of $355 for BlackRock’s stock, which is around the current market price.

See our full analysis for BlackRock

While there is no doubt that the condition of the global debt and equity markets has improved considerably since the economic downturn of 2008, investment options have shrunk due to stagnant interest rates in the U.S. and the continuing slowdown in Europe. The situation drove demand for high-yield investment options among investors – something the world’s largest financial institutions have only been too happy to fulfill through their alternative mutual fund offerings. Alternative mutual funds focus on non-traditional investments like real estate, commodities, leveraged loans as well as unlisted securities, and also make use of  complex trading strategies including the use of derivatives and short-selling to boost profits – making them comparable to hedge funds in terms of their risk profile.

Asset managers have a lot to gain from investments in alternative mutual funds because of the higher revenue potential in terms of fund expense ratios as well as performance-based fees. To put things in perspective, BlackRock earns operating fees which are roughly 0.6% of the total assets managed by its alternative mutual funds in comparison to fees of under 0.2% for actively-managed fixed-income funds and a substantially lower 0.05% for passive fixed-income funds. More importantly, performance-related fees for alternative mutual funds are as high as 0.4% (as shown in the chart above) compared to 0.03% for “lucrative” actively-managed equity funds.

We currently estimate that BlackRock’s alternative mutual funds will see 5-6% annual growth in assets over the coming years. But a slower growth rate stemming from restrictions imposed by SEC in the future will have a negative impact on our estimate share value for the company – something you can understand by making changes to the chart below.

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1. SEC Launches Examination of Alternative Mutual Funds, The Wall Street Journal, Aug 12 2014 [↩]