STT State Street Corporation

By Justin Baer 

The surging popularity of low-cost investment funds has dialed up the pressure on most asset managers -- including some of the firms most responsible for the industry's transformation.

Investing giants State Street Corp. and BlackRock Inc. on Friday reported lower earnings in the second quarter, a period in which the Dow Jones Industrial Average ascended to a new record high and both firms posted inflows.

A rallying stock market is usually a boon for the profits of investment firms, which collect fees on the assets they manage for clients. When asset prices rise, the managers' fee revenue goes up. But investors' money is increasingly finding its way to cheaper mutual and exchange-traded funds -- and rotating out of higher-fee investments.

"In some cases, you've got firms losing both assets and revenue," Ron O'Hanley, State Street's chief executive, said in an interview. "There's a shift from active to passive, and they're just not participating."

"For us and BlackRock, you're seeing growth but also a movement into lower-cost products," he added.

BlackRock and State Street are top sellers of ETFs, the product that helped accelerate investors' shift to index-tracking funds.

BlackRock, the world's biggest money manager, said Friday that second-quarter investment and administrative fees fell by 1.4% from a year earlier even as the assets the firm manages jumped by more than $500 billion, to $6.84 trillion. State Street's investment-management division followed suit with a revenue drop from a year earlier. In that same period, assets under management rose to $2.9 trillion from $2.7 trillion.

State Street's shares rose $3.79, or 6.7%, to $60.08 on Friday. BlackRock fell $1.90, or 0.4%, to $473.24.

Friday's results may set the tone for others in an industry still wrestling with the changes wrought by investors' embrace of passive investing. Some of the biggest active managers, including T. Rowe Price Group Inc., Franklin Resources Inc. and Legg Mason Inc., are slated to report their results in the coming weeks.

"BlackRock is doing much better from an earnings standpoint than other asset managers," Morgan Stanley analyst Michael Cyprys said. "Peers are going to be down significantly more."

The results at State Street's core asset-servicing businesses, which perform key back-office functions to some 90% of the biggest investment firms, underlined the tough terrain facing asset managers.

Servicing fees fell 9.3% to $1.25 billion from a year earlier, the custody bank said Friday.

"Nobody feels good about this industry -- at all," said Brennan Hawken, an analyst with UBS AG. "That's not new. But it has really come home to roost in the past three to four years."

On a conference call with analysts, State Street Chief Financial Officer Eric Aboaf said custody banks have historically lowered their fees on bookkeeping and other services by 1.5% to 2% a year. But as many asset-management clients struggled to lower fees, they pushed their custodians to cut theirs, too. Last year, servicing fees fell on average by 4% and appear headed for a similar drop in 2019, Mr. Aboaf said.

"This industry is under pressure," said Mr. O'Hanley. "But the reality is that even taking their custody fees to zero is not going to solve those pressures. What this industry needs is a fundamental restructuring of its operating model."

State Street announced plans in January to slash $350 million in annual expenses this year as it trims jobs and automates tasks once directed by human hands. On Friday, the custody bank upped its 2019 savings target to $400 million.

State Street's willingness to detail its cost-cutting plan may signal it has a better handle on how low servicing fees may go before they stabilize, Mr. Hawken said. "It's a sign they are getting their hands around the pricing pressure," he said.

Indeed, Mr. Aboaf said Friday that declines in servicing fees have moderated as the year progressed.

Dawn Lim contributed to this article.

Write to Justin Baer at justin.baer@wsj.com

(END) Dow Jones Newswires

July 20, 2019 05:44 ET (09:44 GMT)

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