Robots Are Crushing Humans: Passive Funds Control A Record 44% Of The US Stock Market

When it comes to the battle between robots and humans for control of the market, the robots are winning so much, they're getting sick and tired of winning.

According to the latest data from Bank of America, in the first half of 2018, there was a continued increase in the share of passively managed funds/ETFs. Between year-end 2017 and June 30, 2018, the passive share continued to grow, hitting 44.2% from 43.6% for US equities... 

... to 24.4% from 23.5% for US fixed income...

...  to 29.7% from 29.4% for high grade...

... and to 13.6% from 13.5% for high yield.

Extrapolating the current growth rate, passive funds will have a majority stake of the market as soon as 3-4 years from now.

And while traditional passive funds will be the big winners even as carbon-based human investors are relegated to the "2 and 20" (or more realistically 1 and 10 if not lower) scrap heap, one company will be the biggest winner.

BlackRock, the world’s largest money manager, may never have grown as far and as fast as it did without the unprecedented changes brought about by the recession. The business now towers over its competitors; its $6.3 trillion in assets under management exceeds the size of Germany’s economy.

And, as a detailed Bloomberg article profiling Blackrock's history notes, the story of how BlackRock reached its current position is also the story of the financial industry over the past 10 years. The rise of exchange-traded and index funds and low-fee investing; lower risk tolerance on consumers’ part and higher anxiety within institutions; the government’s scramble to understand this crash and prevent future ones—all of these played to BlackRock’s benefit.

Readers may recall that in the immediate aftermath of the financial crisis, Barclays, which had just acquired the bankrupt Lehman estate, was looking to boost its capital reserves after rejecting U.K. government bailout money. The bank put up one of its crown jewels for sale: the iShares ETF unit, part of the fast-growing, San Francisco-based fund management subsidiary Barclays Global Investors Ltd. (BGI).

And when iShares came up for sale, BlackRock seized the opportunity in a big way, sweeping in with a $13.5 billion cash and stock offer—not just for the ETF unit, but for all of BGI.

“They were in a position to play offense while everyone else was scrambling,” says Kyle Sanders, an analyst at Edward Jones & Co.

The 2009 deal doubled BlackRock’s assets under management overnight, and has proven to be one of the best investments in recent history: riding a wave of investment in passive products, iShares had $1.8 trillion in assets as of the end of June. That - according to Bloomberg - gives BlackRock a commanding lead on its closest competitors, Vanguard and State Street, which had about $936 billion and $639 billion in ETF assets, respectively. Some more details from Bloomberg:

IShares accounted for 28% of BlackRock’s assets under management at the end of 2017, according to the company’s yearend report. Plenty of growth potential remains: ETFs are still nascent outside the U.S. The company predicts the global market for the funds will more than double by the end of 2023, to $12 trillion, driven by continued downward pressure on financial advisory fees and investors’ rising willingness to use bond ETFs for easy exposure to fixed-income markets.

There are other aspects to Blackrock's post-crisis success, including its financial risk software, known as Aladdin (called an "X-ray machine for financial portfolios by the company's COO), and which currently watches over $18 trillion in assets; then there is Blackrock's close relationship with the NY Fed, which turned to BlackRock to manage Bear Stearns' portfolio of toxic assets (in one 18-month period from 2011 to 2012, he was in contact with Fink more than any other corporate executive, according to a Financial Times analysis of his publicly available diary.), not to mention CEO Larry Fink's increasing political prominence and clout when it comes to policy issues: when Fink wrote CEOs a letter earlier this year warning that they should be able to explain how their companies contribute to society, it made international headlines.

In any case, BlackRock’s success over the past decade might be easy to overlook, especially as it’s competing with government-reconstituted giants like JPMorgan, while private equity firms have vastly increased the scope of their investments in the last decade—particularly Blackstone which was spun out of BlackRock—and tech companies such as Google and Inc. have begun flirting with asset management.

Yet as Bloomberg notes, despite the fierce competition, BlackRock’s growth is among the starkest examples of how a financial company can build itself into an empire, even as the system is upended.

And there is one thing that has been more instrumental to BlackRock's success more than anything else: the company's early bet that computers and other "passive investors" would eventually price humans out of the asset management market. So far, with no recession ten years later, the longest bull market in history, and nothing but smooth sailing for the robots, the victory of the ETFs has made Fink and Company one of the biggest winners on Wall Street in the past decade.