BlackRock's audacious Microsoft hook-up reveals fee-compression busting pivot to annuities sales and software distribution, as eMoney and Envestnet deals increasingly make sense, but analysts warn of existential RIA risk if Vanguard et al. join the fray

BlackRock has finally showed its hand and revealed the hidden in plain sight strategy that's seen the firm buy and invest in a slew of software firms -- it's going to sell annuities.

The $6.4 trillion New York asset manager announced last week that it had teamed up with software giant Microsoft, after a secret meeting between the two firms' CEOs.

Behind the PR spin of Laurence Fink of BlackRock and Satya Nadella of Microsoft having a pow-wow over "how to tackle pressures on society", attributed to sources in the Wall Street Journal, the upshot is the two giants want to sell annuities.

Both firms are on a heady precipice, with rapid growth and a grinding crunch real possibilities, and by wrapping up Microsoft's deep tentacles in the workplace and BlackRock's vast scale as an asset manager -- it manages $1.2 trillion more than its nearest rival, the Vanguard Group -- Nadella and Fink plan to get the jump on rivals with annuities 2.0.

For BlackRock, long under pressure in a punishing price war, the deal represents a move to counter the ever downward impetus on its fees, as rivals like Fidelity Investments press on in the race to zero.

Annuities are yet to bear the full brunt of the technology-driven price wars hitting asset managers, and lucrative margins of 18% are not unheard of.

For Redmond, Wash.-based Microsoft, part of the benefit is that it gets to gazump Amazon, which is gearing up its own moves into finance, after Amazon made the early running in the cloud business with Amazon Web Services. This fact is not lost on Nadella as his company fights to gain ground on its rival with its own cloud system, Azure.

Recently, Microsoft has reclaimed its crown as the world's most valuable traded company, a position it lost to both Amazon and Apple, and one it has not held since 2002. The firm's renewed relevance can be traced, at least in part, to its decision to prioritize the cloud, according to analysts.

Making a move into wealth management ahead of Amazon may, therefore, be part of a strategy to ensure it stays relevant.

Naming spades

If the two firms can pull it off, it's going to be a real coup, says David Stone, CEO of Louisville, Ky.-based RIA insurance vendor, RetireOne, via email.

“Annuities are the one segment of financial services for which technology has not been able to lower costs … but the benefit (income guarantee) remains unique.”

The BlackRock and Microsoft press release, however, obfuscates the fact that the world’s largest asset manager and one of the world’s largest software firms are jumping into bed together to repackage and sell a product with a 1950’s heyday that’s often surrounded by a cloud of distrust.

Instead, the release describes the budding alliance as a “cutting-edge” new platform that will sell “guaranteed income” products not found “in 401(k) and other retirement plans”. These products will be “similar to target date-funds, [in] a blend of investments that get more conservative as investors head into retirement," the release states.

But the Wall Street Journal, which broke the news on Dec. 13, albeit as a software story, promptly called a spade a spade, and refers repeatedly to BlackRock's mooted new quiverful of asset-management and guaranteed income products, by the name that fits: annuities.

That said, neither Microsoft nor BlackRock, which currently oversees about $1 trillion in defined contribution assets, hid the fact that the chief deliverable was selling guaranteed income direct to employees in bundles front-loaded with BlackRock products.

"BlackRock intends to offer the platform in connection with next-generation investment products that it will design and manage," the release states. "The new products from BlackRock will seek to provide a lifetime of income in retirement."

These workplace-only products are likely to bundle up iShares ETFs and annuities, but sources, including one close to BlackRock, state that the RIA market will ultimately prove too lucrative to ignore, at least for now.

Taking control

Yet, for all that, the fact remains that profit-munching BlackRock's belated reveal as to why it's been snapping up software firms, like FutureAdvisor in 2015, and investing in others, like Envestnet in Nov., has culminated in the disclosure that although it plans to put annuities at the vanguard of its strategy, it has yet to figure out precisely how to do it.

"BlackRock will be in talks with insurance firms that create products similar to annuities," a person "familiar with the matter" told the Wall Street Journal.

"As well as other parties involved in handling worker accounts such as record-keepers that hold data on customers and custodians that house assets on whether they will be willing to be tied to the platform in 2019," the Wall Street Journal's coverage states.

In fact, neither BlackRock nor Microsoft has explained just how the deal will work in practice, whether BlackRock will underwrite income guarantees, or if the application will come pre-loaded with Microsoft's enterprise software.

Both firms declined to comment, beyond the release.

Nevertheless, it is clear that both firms see value in pairing up Microsoft's business reach -- read the huge number of employees using Microsoft enterprise services -- and BlackRock's asset management, by creating a distribution platform that sidesteps advisors, with annuities in a leading role.

Until now, BlackRock has had no direct-to-retail distribution system.

Plumb this

BlackRock "wants to shape the technology plumbing that connects it to different parts of the financial ecosystem handling workers’ retirement money", according to the Wall Street Journal.

"The funds BlackRock wants to roll out will also increase their concentration in financial instruments like annuities that provide regular payouts as participants get older."

Whether this means workflow-style alerts to employees using Microsoft products is unclear, however Mark McCombe, BlackRock's head of the Americas, certainly seems to suggest this.

“We are trying to nudge people a little bit towards a more active relationship with retirement,” McCombe, who is apparently taking a key role in the partnership with Microsoft, told the Wall Street Journal. The technology could “prompt you through daily life and show there are ways to reach financial goals in retirement,” he said.

The partnership remains, however, very much in the early stages, with software prototypes still on the table for the jointly designed financial planning software that will serve as a marketplace for employees, rather than a finalized product.

End of the ridiculous era

Another benefit for Blackrock is that since the core ingredient of annuities is guaranteed income, as long as it meets its obligations, the asset manager can load its new funds with its own iShares ETFs, says Michael Kitces, founder of the Bozeman, Mont.-based XY Planning Network, and writer of the popular Nerd's Eye View Blog, via email.

"At worst, BlackRock can still sell a helluva lot of iShares into retiree portfolios," he says.

But by outsourcing the job of providing the annuities component to its upcoming guaranteed income funds, BlackRock leaves itself open to questions of how dedicated they are, its long list of ‘plumbing’ investments notwithstanding.

Indeed, it is unclear if BlackRock will ultimately guarantee the retirement income they propose.

That said, BlackRock and Microsoft's link-up does come as the green shoots of an annuity 2.0 era begin to take root.

Old-line insurers realize they can sell their products on a non-commission basis, according to a number of sources, and thereby revitalize an often "ridiculed" sales model that nonetheless puts retirement income in a rare safe refuge. See: Decades-old stench of annuity sales and deception hangs heavy, but very 2018 efforts by DPL, Nationwide, Allianz and others offer whiff of hope of cracking the RIA market.

The shape of things to come

For BlackRock, whose multi-year investment and acquisition binge in software companies seemed scattergun and without a single coherent monetizable strategy, the release offers clues as to how the firm intends to fight back against ferocious margin compression in its core asset management business.

Where Fidelity's strategy has been to embrace the cross-selling opportunities garnered by a mutual fund give-away, BlackRock chose a different tack. See: Vanguard's asset machine wobbles under Abby Johnson's withering pricing assault, but Fidelity's new cost-cutting front aimed at advisors is proving more lethal for BlackRock.

First signposted by its purchase of the robo-advisor FutureAdvisor, the asset manager's move to solve the problem of diminishing returns is to make all roads lead to BlackRock.

The bet is that, if it owns enough financial infrastructure, it can stack the odds in its favour by turning software into a delivery system stuffed with its own products.

It's all about getting to the client first, says David Lau, CEO of RIA insurance supermarket DPL Financial Partners, via email.

"The competition with asset managers will be around embedding your technology at client entry points, such as the workplace, as asset management and products are commoditized," he says. "Controlling the technology will be the dominant way to distribute products."

It's the shape of things to come, says Francois Gadenne, co-founder and head of Boston consultancy The Curve, Triangle, & Rectangle Institute, via email.

“[It’s] similar to Edelman's deal with Financial Engines, and Envestnet's deal with Yodlee. [These are] deals to pair a monetization engine with client-data.”

It’s a “brilliant long-term strategy”, says Lau.

“Foreseeing the increasing commoditization and subsequent price compression of asset management, BlackRock are wisely moving to own technology, which will increasingly drive and control product selection, and provide product solutions, like guaranteed income, that can keep assets and clients under their control," he says.

Pivoting BlackRock

Indeed, although BlackRock's annuities move is part of a wider trend that's breathing some life into old-line insurers, on a higher level, its partnership with Microsoft evinces a pivot to using technology as a means to distribute and generate revenue, says Kitces.

“This isn’t just about ramping up plumbing, per se. This is a wholesale shift to viewing technology as a distribution channel, which is an entirely new phenomenon," he explains.

"[With FutureAdvisor] Blackrock was initiating a major shift in its distribution strategy."

Indeed, at a presentation to Goldman Sachs’ US Financial Services Conference on Dec. 5, BlackRock's chief financial officer, Gary Shedlin, was emphatic about the centrality of technology to BlackRock's future.

"Our overall goal is to position ourselves for long-term leadership and to accelerate existing tech-enabled and direct technology revenue opportunities," he said. "Technology enhances all aspects of our business."

Direct technology revenues remain just a small part of BlackRock’s overall income, standing at just six percent -- although 18% year-over-year growth in the third quarter explains the firm’s double-digit technology growth forecasts -- but it is indirect revenues that form the basis of BlackRock’s new strategy, whereby users of planning or research software like Aladdin are cross-sold BlackRock’s asset management.

Financial technology products like Aladdin, or FutureAdvisor are the future of BlackRock, says Shedlin.

"[They] touch all aspects of our business, generating sustainable alpha in our investment process, leveraging our distribution capabilities, and scaling our operations. Bottom line it's core to absolutely everything."

Approximately 25% of BlackRock’s 14,000 strong employee-base work in technology roles, putting it narrowly behind Fidelity, in percentage terms, where the figure stands at 30%.

Additionally, since it acquired FutureAdvisor, BlackRock has taken a number of minority stakes in financial software firms, including iCapital, Acorns, and Scalable Capital.

Its $1 billion per year technology budget, however, remains paltry when compared with industry big-spenders. JP Morgan spends approximately $10.8 billion, Citigroup around $8 billion, Morgan Stanley, $4 billion, and Fidelity roughly $2.5 billion.

This month, as well as its deal with Microsoft, BlackRock hooked its retirement income calculator, iRetire, directly into Boston, Mass.-based Fidelity Investment's eMoney, putting BlackRock's software, and presumably its investment products, in front of the 50,000 advisors who use it.

In late Nov., the asset manager also took a minority stake in Chicago, Il.-based software vendor and outsourcer Envestnet that embeds BlackRock software like iRetire, Advisor Center and FutureAdvisor into Envestnet's open architecture network, which serves 2,500 companies and 55,000 financial advisors managing some $2 trillion in assets.

A shot in the arm

For all that BlackRock is turning its software into a kind of automated sales force, the slow resurgance of insurance products like annuities, which guarantee a small annual return for the policyholder with no risk of loss, is itself noteworthy.

In recent years, the insurance industry has been blighted by an image at once utterly bland and wholly spivvy.

This is because of a sales model riven with conflicts, from captive agents paid on commission, to the paradox of firms selling one product as a panacea, says Mark Forman, senior managing director for marketing and PR at RetireOne, via email.

"That [old] system can organically breed the kind of sketchy sales tactics that have given all annuities such a bad rap."

But as old-line insurers like Minneapolis, Minn.-based Allianz Life, and RIA up-starts like Louisville, Ky.-based duo DPL and RetireOne start preaching the fee-based gospel, there are signs that this rap could change, just as BlackRock is stomping into the game.

BlackRock’s involvement is a much needed shot in the arm for the annuity industry, says Stone. “The traditional commission annuity world has been shrinking and is subject to much ridicule in the financial press. To be relevant, the annuity industry needs to partner with firms like BlackRock.”

Income, fixed?

Precisely how BlackRock intends to wrap-up annuities into its asset management products remains unclear, as previously stated.

At present it seems the firm will white-label other vendors' products, rather than build its own. Presumably this is because of the huge regulatory and financial obligations that a wholesale move into producing insurance products would entail.

The firm is, therefore, on the market for partnerships with insurers, as well as record-keepers that monitor retirement assets, according to the Wall Street Journal.

BlackRock seems to think technology can wrap annuities into asset management products and solve the problem that they're complex and tricky to sell, says Stone.

"They probably see the outcome for clients as being a BlackRock-built income guarantee as underwritten by an insurer," he explains.

There's also little risk for BlackRock in its distribution and annuities strategy, but it will need to choose its dance partners carefully, says Joel Bruckenstein, founder of the T3 conferences, via email.

“The execution and commitment on the part of the partners will be key," he adds.

Major or minor?

It’s wrong though to see annuities as the key part of BlackRock’s strategic shift, says Kitces.

“[BlackRock's] entering a new distribution channel, technology as distribution, and [it's] simply trying to put [in] as much product variety as [it] can, to see what works and what sticks," he says.

But if Nadella's statement in the release is anything to go by, his firm sees the pairing up of new retirement products and software as a major deal. "Together with BlackRock we will apply the power of the cloud and AI to introduce new solutions that address this important challenge and reimagine retirement planning," Nadella says in the release.

Put simply, BlackRock wouldn’t be partnering with Microsoft if “guaranteed income” wasn’t a significant play, says Lau.

“BlackRock is trying to position itself as a cradle to grave solution … [and] retirees have an enormous need and desire for guaranteed income," he explains.

"Now BlackRock can control those assets rather than have them leave to an insurance carrier.”

Still, Kitces is right to say that there’s a throw it at the wall and see what sticks aspect to BlackRock’s strategy, says Gadenne.

“In their shoes, I would multiply many combinations of distribution channels [with] many types of products … in order to see what works and what what doesn’t. This is evolution in action."

What Gadenne, Kitces, and Lau do all agree on is the fact that other asset managers will follow BlackRock's lead in adding annuities and in using technology as a means of distribution.

Who’s next, asks Gadenne. “Who, in the financial industry, will do the matching deals with Facebook, Apple, Netflix, Google, etc.?”

Seeding Acorns

One element that may yet come into play, although, given neither Microsoft nor BlackRock were willing to comment on this article, this remains purely speculative, is BlackRock's partnership with Irvine, Calif.-based Acorns.

On May 9. 2018, Blackrock invested in Acorns, and signed a partnership agreement, becoming "an anchor investor".

Acorns automatically rounds up consumer purchases and then invests the spare change into ETF portfolios, like BlackRock's iShares.

Owing to the technology-forward strategy BlackRock just revealed, it is not beyond the realms of possibility that Acorns Later, Acorns' automated retirement round-up software, might well become a target market for BlackRock annuities.

Risky Business

After hearing of the deal, some analysts issued a stark warning: RIAs face a survival risk if moves like this prove a riproaring success, and other asset managers join the fray.

This potentially represents an existential threat to RIAs, says Lau.

"For consumers, [asset managers] are replacing advisors," he says. "Advisors falsely believe they don’t lose clients to them, but the reality is they are probably never getting the opportunity to win the client [in the first place]."

Indeed, if every action has an equal and opposite reaction, and every business decision has winners and losers, this will necessarily be the case when it comes to BlackRock’s retirement and technology play, but although its direct competitors are firms like Fidelity, Schwab, and Vanguard, RIAs could find themselves made irrelevant by changing technology, according to Lau.

“[As these] large asset managers begin providing planning in addition to robo investing, it’s a threat to the advisor community … No longer are these solutions for “play money” for consumers, they are replacing advisors,” Lau explains.

"This is a threat for RIAs as BlackRock continues to take steps to grab clients as they enter the workplace, through the Microsoft deal, and never let them go, with their technology and guaranteed income solutions."

Lau cites the fact that over the past five years, discount and online brokers have recorded tremendous growth, with the value of their assets under management surging from $6 trillion in 2013 to $8.3 trillion in 2018.

In 2017 alone, these firms added $1 trillion to their total assets under management, a sum that amounts to nearly half the size of the RIA market.

Put simply, there’s not much that makes RIAs different anymore, everyone is fee-based; “fiduciary” and “best interest” sound similar to clients; and if the asset managers that buy and sell for RIAs start providing planning, it will be tempting to just go straight to the source, says Lau.

“Asset managers have been moving into asset allocation through robos for a number of years and now they are moving into planning," he explains. "Soon the plan will be commoditized ... [so] RIAs need to evolve to compete.”