Where eagles dare

On the 12th June, Blackrock announced that it would buy Barclays’ asset management arm, Barclays Global Investors (BGI) for a total of $13.5bn. The deal makes the new entity, BlackRock Global Investors, the largest asset manager in the world by assets, with around $2.8bn of client assets under management. The market reaction was initially negative: Barclays shares closed down 4.1 percent on the day and BlackRock closed down 3.3 percent. The poor market reaction suggests that the deal was not beneficial to either party, but this was within the context of broader market indices declining 2% on the day.

BlackRock Inc., founded by its current CEO, Larry Fink, in 1988, rapidly grew to become a leader in asset management, known particularly for their actively managed funds and expertise in fixed income. BGI was formed after Barclays bought San-Francisco based Wells Fargo Nikko Asset Management, and merged it with their own asset manager, BZW Asset Management. Since its purchase, Barclays has built the asset manager into one of the leading passive asset managers and the largest manager of exchange-traded funds by assets.

Asset management businesses take custody of funds deposited with them by clients, and manage them in order to maximise return. This can be achieved by active strategies, which involve selecting a portfolio of investments in which to place the funds, to be re-balanced as market conditions change, or by passive and indexed strategies, in which a manager attempts to invest the funds to match the returns of an index as closely as possible. BGI’s specialty, exchange traded funds (commonly known as ETFs), are a type of passive investment, which allow investors to buy shares of an exchange traded fund on stock markets, and then receive returns matching the index that the fund tracks.

Barclays had agreed a sale of the ETF division of BGI, iShares, to a London-based private equity firm, in April for $4.4bn, but a clause in the deal allowed Barclays to renege on the deal by paying a small cancellation fee if it found a better price for iShares or all of BGI elsewhere. Following the April announcement, analysts valued Barclays Global Investors at $10bn. CVC Capital Partners are not expected to compete with BlackRock by issuing a new bid for the business.

Many have attributed Barclays’ success during the recent market volatility to avoiding state aid, allowing them to continue engaging in more risky and more profitable business. After significant writedowns announced in their 1st quarter results and a low capital ratio, there was speculation that Barclays would need to raise capital. The sale of BGI does provide much-needed funds, but it also removes one of the safer and more dependable business areas.

The universal bank model, which was adopted by almost every major bank before the market volatility of 2007, included an asset management division. It was believed that the benefits from co-operation with research and markets divisions outweighed the costs incurred by the need for regulatory separation of some roles. BGI was a top performer in the asset management space and among Barclays’ divisions. Given that Barclays has not given an indication that it is abandoning the universal bank model, you might agree that ‘it does feel like a company selling the family silver’, as Chris White of Threadneedle Asset Management, a competitor, said.

In a joint television interview with Larry Fink, Bob Diamond, the Barclays CEO, addressed this concern arguing that regulation was preventing Barclays Capital, the investment banking and markets division of Barclays, from doing mutually profitable business with BGI and that by taking a long term stake in BlackRock Global Investors (Barclays will hold 19.9 percent of the equity and have a 4.9 percent voting interest) Barclays would realise greater profit from its businesses.

The more worrying part of this deal for Barclays shareholders is the shift in company policy. A low-risk, successful division has been spun off leaving Barclays’ retail operations, which are very susceptible to shifts in the economic cycle, and Barclays Capital which, though it has high margins and significant profits, is also susceptible to significant writedowns on assets and trading losses. The shareholders should worry about taking on more risk while the crisis is not yet over.