Black Rock's ETFs

Black Rock's acquisition of IShares has implications for the investment management industry. With this purchase, BLK's AUM mix shifts to about 50/50 active/passive. Given that trading is a diseconomy of scale in the investment management business, this mix allows BLK's growth to continue with a smaller impact from this impediment. Cynically, it might be argued that as a firm grows, there's a risk its results become more average, and that passive management will earn better returns for the firm and its clients. But I won't make that argument. BLK clearly expects that ETFs will be used more broadly in the implementation of investment strategies. I was involved in the design of the first ETF at State Street two decades ago. At the time we thought ETFs were an improvement on many aspects of mutual funds. We also thought the wrap account business would offer benefits to retail investors. Finally, the ETF business has developed enough diversity and complexity where there is probably room for an expansion management activity far beyond strategic asset allocation. IShares has been pushing on the 401(k) market, but there is really little penetration of the large end of the market by ETFs. There has always been this fear that too much passive management will affect the price discovery mechanism for stocks. For any given stock, active managers over time should be the marginal pricers, but as more of the stock is tied up in passive portfolios one would expect more market impact from the trading of a position of a given size. This might cause more valuation discrepancies for active managers to take advantage of. Finally, this acquisition may have an effect on the AUM mix of Merrill brokers, with BLK's ETFs possibly gaining share at the expense of other players.