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BlackRock kicks off earnings for fund management industry in tumult



BlackRock will this week kick off third-quarter earnings season for a fund management industry where the widening gap between its winners and losers has unleashed a wave of consolidation.

Asset manager Eaton Vance was last week sold to Morgan Stanley in a $7bn deal, underlining how midsized fund managers are scrambling to be absorbed by larger groups or combining with peers in an effort to secure the scale required to compete with the likes of BlackRock and Vanguard.

The relentless pressure on fees across the industry from the popularity of cheaper passive investment products has crushed margins and accelerated consolidation efforts.

BlackRock, the world’s largest fund manager with $7.3tn in assets, has benefited and exploited these industry trends, particularly during the pandemic. Its shares have risen 20.4 per cent this year as the eight-member S&P Asset Management index has dropped 3.4 per cent. Shares in Baltimore-based T Rowe Price, another of the larger asset managers, are up 15.4 per cent.

“Two things drive the share price performance of asset managers, organic growth and strong margins. BlackRock and T Rowe have that,” said Greggory Warren, sector strategist at Morningstar. “People are willing to pay up for it,” he added. 

BlackRock’s Aladdin risk management system, unrivalled by competitors, has also helped diversify its revenues with attractive subscription-based fees. In March, BlackRock was controversially awarded a contract from the Federal Reserve to buy bonds, including its own fixed income exchange traded funds.

Line chart of Rebased showing BlackRock and T Rowe Price outpace rival listed asset managers

Mr Warren expects third-quarter results, which begin with BlackRock on Tuesday, will lay bare the severity of the challenges confronting the mid-tier and smaller asset managers. Those pressures risk being compounded this quarter should financial markets pull back as the US economy faces more disruption from the pandemic.

Analysts at KBW expect investors will focus “on expense trends, each manager’s ability to combat a still challenged flow and revenue outlook, and managements’ view of strategic M&A”. 

The coronavirus crisis has deepened the plight of midsized asset managers already struggling to distinguish themselves both from bigger rivals that benefit from scale as well as smaller niche players, said Michael Spellacy, global head of capital markets for consultancy Accenture.

“There is a continued divergence between the winners and those barely surviving,” he said. “You’re seeing the middle being acquired or shrinking.”

The industry was already animated by the prospect of more consolidation even before Morgan Stanley’s swoop on Eaton Vance. At the start of October, Trian, the activist fund run by Nelson Peltz, disclosed stakes of almost 10 per cent in both Janus Henderson and Invesco. Asset manager Legg Mason, another of Trian’s investments, was acquired by Franklin Templeton earlier in the year. 

“We are in the early innings of a consolidative phase,” said Mr Warren, pointing out this was unfolding both through M&A but also within groups as fund managers combine products.

Analysts note that Morgan Stanley’s acquisition of Eaton Vance stands out for its high valuation, which may not be repeated in future deals.

KBW estimates Morgan Stanley paid in the region of 17.2 times their 2020 EPS estimate of $3.29 for Eaton Vance and 13.4 times its forecast for ebitda of $560m. 

Robert Lee at KBW said the high valuation for Eaton Vance reflected its “unique product mix, competitive positioning, and long-term record of positive organic revenue growth.” He expected “normal” deal multiples for a traditional manager without Eaton Vance’s attributes may be closer to 8 to 9 times a target’s ebitda.

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Financial bubbles also lead to golden ages of productive growth




Sir Alastair Morton had a volcanic temper. I know this because a story I wrote in the early 1990s questioning whether Eurotunnel’s shares were worth anything triggered an eruption from the company’s then boss. Calls were made, voices raised, resignations demanded. 

Thankfully, I kept my job. Eurotunnel’s equity was also soon crushed under a mountain of debt. Nevertheless, the company was refinanced and the project completed. I raised a glass to Morton’s ferocious determination on a Eurostar train to Paris a decade later.

With hindsight, Eurotunnel was a classic example of a productive bubble in miniature. Amid great euphoria about the wonders of sub-Channel travel, capital was sucked into financing a great enterprise of unknown worth.

Sadly, Eurotunnel’s earliest backers were not among its financial beneficiaries. But the infrastructure was built and, pandemics aside, it provides a wonderful service and makes a return. It was a lesson on how markets habitually guess the right direction of travel, even if they misjudge the speed and scale of value creation.

That is worth thinking about as we worry whether our overinflated markets are about to burst. Will something productive emerge from this bubble? Or will it just be a question of apportioning losses? “All productive bubbles generate a lot of waste. The question is what they leave behind,” says Bill Janeway, the veteran investor.

Fuelled by cheap money and fevered imaginations, funds have been pouring into exotic investments typical of a late-stage bull market. Many commentators have drawn comparisons between the tech bubble of 2000 and the environmental, social and governance frenzy of today. Some $347bn flowed into ESG investment funds last year and a record $490bn of ESG bonds were issued. 

Last month, Nicolai Tangen, the head of Norway’s $1.3tn sovereign wealth fund, said that investors had been right to back tech companies in the late 1990s — even if valuations went too high — just as they were right to back ESG stocks today. “What is happening in the green shift is extremely important and real,” Tangen said. “But to what extent stock prices reflect it correctly is another question.”

If the past is any guide to the future, we can hope that this proves to be a productive bubble, whatever short-term financial carnage may ensue.

In her book Technological Revolutions and Financial Capital, the economist Carlota Perez argues that financial excesses and productivity explosions are “interrelated and interdependent”. In fact, past market bubbles were often the mechanisms by which unproven technologies were funded and diffused — even if “brilliant successes and innovations” shared the stage with “great manias and outrageous swindles”.

In Perez’s reckoning, this cycle has occurred five times in the past 250 years: during the Industrial Revolution beginning in the 1770s, the steam and railway revolution in the 1820s, the electricity revolution in the 1870s, the oil, car and mass production revolution in the 1900s and the information technology revolution in the 1970s. 

Each of these revolutions was accompanied by bursts of wild financial speculation and followed by a golden age of productivity increases: the Victorian boom in Britain, the Roaring Twenties in the US, les trente glorieuses in postwar France, for example.

When I spoke with Perez, she guessed we were about halfway through our latest technological revolution, moving from a phase of narrow installation of new technologies such as artificial intelligence, electric vehicles, 3D printing and vertical farms to one of mass deployment.

Whether we will subsequently enter a golden age of productivity, however, will depend on creating new institutions to manage this technological transformation and green transition, and pursuing the right economic policies.

To achieve “smart, green, fair and global” economic growth, Perez argues the top priority should be to transform our taxation system, cutting the burden on labour and long-term investment returns, and further shifting it on to materials, transport and dirty energy.

“We need economic growth but we need to change the nature of economic growth,” she says. “We have to radically change relative cost structures to make it more expensive to do the wrong thing and cheaper to do the right thing.”

Albeit with excessive enthusiasm, financial markets have bet on a greener future and begun funding the technologies needed to bring it to life. But, just as in previous technological revolutions, politicians must now play their part in shaping a productive result.

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US tech stocks fall as government bond sell-off resumes




A sell-off in US government bonds intensified on Wednesday, sending technology stocks sharply lower for a second straight day.

The yield on the 10-year US Treasury bond, which acts as a benchmark for global borrowing costs, climbed to nearly 1.5 per cent at one point. It later settled around 1.47 per cent, up nearly 0.08 percentage points on the day.

Treasury trading has been particularly volatile for a week now — 10-year yields briefly eclipsed 1.6 per cent last Thursday — but the rise in yields has been picking up pace since the start of the year and the moves have begun weighing heavily on US stocks.

This has been especially true for high-growth technology companies whose valuations have been underpinned by low rates. The tech-focused Nasdaq Composite index was down 2.7 per cent on Wednesday, on top of a 1.7 per cent drop the day before.

The broader S&P 500 fell by 1.3 per cent.

The US Senate has begun considering President Joe Biden’s $1.9tn stimulus package, with analysts predicting that the enormous amount of fiscal spending will boost not only economic growth but also consumer prices. The five-year break-even rate — a measure of investors’ medium-term inflation expectations — hit 2.5 per cent on Wednesday for the first time since 2008.

Inflation makes bonds less attractive by eroding the value of their income payments.

“I would expect US Treasuries to continue selling off,” said Didier Borowski, head of global views at fund manager Amundi. “There is clearly a big stimulus package coming and I expect a further US infrastructure plan to pass Congress by the end of the year.”

Mark Holman, chief executive of TwentyFour Asset Management, said he could see 10-year yields eventually trading around 1.75 per cent as the economic recovery gains traction later this year.

“It will be a very strong second half,” he said.

Line chart of Five-year break-even rate (%) showing US medium-term inflation expectations hit 13-year high

Elsewhere, the yield on 10-year UK gilts rose more than 0.09 percentage points to 0.78 per cent, propelled by expectations of a rise in government borrowing and spending following the UK Budget.

Sovereign bonds also sold off across the eurozone, with the yield on Germany’s equivalent benchmark note rising more than 0.06 percentage points to minus 0.29 per cent. This was an example of “contagion” that was not justified “by the economic fundamentals of the eurozone”, Borowski said, where the rollout of coronavirus vaccines in the eurozone has been slower than in the US and UK.

The tumult in global government bond markets partly reflects bets by some traders that the US Federal Reserve will be pushed into tightening monetary policy sooner than expected, influencing the costs of doing business for companies worldwide, although the world’s most powerful central bank has been vocal that it has no immediate plans to do so.

Lael Brainard, a Fed governor, said on Tuesday evening that the ructions in US government bond markets had “caught my eye”. In comments reported by Bloomberg she said it would take “some time” for the central bank to wind down the $120bn-plus of monthly asset purchases it has carried out since last March.

After a series of record highs for global equities as recently as last month, stocks were “priced for perfection” and “very sensitive” to interest rate expectations that determine how investors value companies’ future cash flows, said Tancredi Cordero, chief executive of investment strategy boutique Kuros Associates.

Europe’s Stoxx 600 equity index closed down 0.1 per cent, after early gains evaporated. The UK’s FTSE 100 rose 0.9 per cent, boosted by economic support measures in the Budget speech.

The mid-cap FTSE 250 index, which is more skewed towards the UK economy than the internationally focused FTSE 100, ended the session 1.2 per cent higher.

Brent crude oil prices gained 2 per cent at $64.04 a barrel.

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UK listings/Spacs: the crown duals




City-boosting proposals are not enough to offset lack of EU financial services trade deal

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