Q&A: Martin Small

Martin Small was asleep in a San Francisco hotel room at 4:15 a.m. late last year when he got a call from Larry Fink, his boss and the CEO of BlackRock, the world’s largest investment management firm. “It’s time for you to take on the next challenge,” Fink told Small. “We want you to lead our U.S. wealth advisory business.”

The promotion was a logical next step for the 43-year-old, who has been rising through the ranks at BlackRock ever since he joined its legal and compliance department in 2006 after working as a corporate lawyer for Davis Polk & Wardwell. For the past four years, Small has been overseeing BlackRock’s iShares in the U.S. and Canada, a critical part of the firm’s ETF business. ETFs, of course, have become a huge force in the markets and investors’ portfolios, and it’s a category that BlackRock dominates.

Small’s promotion was part of major leadership changes—and 500 job cuts—that BlackRock announced in January, due to what president Rob Kapito called “growing market uncertainty” and “evolving investor preferences.” But ETFs remained one of the strongest sectors for the firm last year, even during the December market swoon.

Finance runs in Small’s family. The Manhattan native’s father was a corporate banker and his grandfather a stockbroker with Shearson Lehman. After graduating from Brown with a double major in Portuguese and Brazilian studies and public policy, he went on to get a law degree from New York University. But finance was his second career choice. “I wanted to be a musician,” says Small, who plays the guitar—everything from blues, jazz and rock to Spanish flamenco. “It’s much harder than this,” he says, referring to his BlackRock career.

Worth recently sat down with Small to discuss investing trends, including ETFs and alternatives—and Larry Fink’s famous yearly letter to CEOs.

Q: Since iShares is such a significant and growing part of  BlackRock’s business, it seems natural for the person heading that to move into heading all of U.S. wealth advisory services. What does the future look like?

A: The modern portfolio is going to incorporate a multi-product agenda and build more resilient portfolios for what will surely be another highly turbulent and uncertain five years in investing. ETFs will continue to play a fast-growing role.

Why do you think that is?

What you see now are goals-based investments. It’s not about whether we beat the S&P 500 this month, it’s about are we on track to generate a 5 percent return or a 7 percent return so that you can pay for your kids’ college. Once you move into that goals-based framework, advisors focus on the whole portfolio as opposed to individual product selection. The second thing is just cost and value for money. Competitive pressure in and around fees is really starting to squeeze the industry and I think that trend is not going to abate.

But there is criticism of the passive investing trend. People have compared ETFs to CDOs, which were the newfangled financial instruments at the heart of the last financial crisis. There is a fear that somehow ETFs are driving the prices of stocks or will be responsible for a market downturn.

We had $81 billion of flows into iShares in the fourth quarter, in the worst equity market correction since the Great Depression. If you look at the industry, it was mutual fund investors who redeemed their money at the end of the year, not ETF investors. ETFs took in money. Mutual funds had huge redemptions.

So why is there distrust of ETFs?

We’re talking about a 30-year investment product, still relatively young. And any product that is ascending is going to draw criticism. But daily ETF trading in stocks and bonds accounts for less than 5 percent of the tape and trading. Hedge funds and mutual funds have 70 percent average turnover. We’re not trading, and that’s the big misnomer when they say you’re driving up the price of stocks. Actually, we have plenty of days when we’re doing nothing—where there are no new assets coming to the fund but we hold the 505 stocks of the S&P.

BlackRock laid off 500 people after last year’s downturn. That seems to reflect some uncertainty about markets.

The macro risks—geopolitical risk, an uncertain Federal Reserve outlook, a trade war with China—are unassailable, and have contributed to uncertainty and volatility in the market in a way that seems contradictory to the fundamental economic results that we’re seeing in the economy.

So what should investors do?

Two key things. One, don’t stray from your long-term strategy and maintain broad market exposure. If you are a long-dated investor saving not for things to do in two to three years but rather for intergenerational wealth transfer, don’t stray from the stock market. The stock market is still an excellent place on today’s valuations for long term investment returns that are oriented towards growth.

On the other hand, the era of super normal stock market returns is over, and so the experience of the last 10 years is not the one that we believe you’ll have over the next 10 when it comes to the stock market. That leads me to the second piece. High net worth investors in the U.S. are generally underexposed to things we call alternatives—though they’re essential. A long-dated ultra high net worth investor should start incorporating a much larger allocation to non-traditional investment categories, and the reason is I don’t think we’re going to get 10 to 15 percent stock market returns but if you need to generate 7 percent in order to pay for everything else, you’re not going to do that on a traditional stocks and bonds allocation. One needs to actually build in a much healthier allocation to higher risk return.

And what would those be?

Private credit, infrastructure, specialized parts of fixed income as well as I think real estate, private equity, private credit, private debt, infrastructure. If you look at some of the top teams in private banks or you look at some of the more sophisticated registered investment advisor firms, they’ll allocate 30 percent of a high net worth portfolio to alternatives.  

Why is credit going to offer excess returns?

It’s the long-term effect of Dodd-Frank and financial sector regulation, which has resulted in a pullback of the traditional financing intermediary: banks. So there’s a wide swath of the marketplace that traditionally would have gone to a bank for financing that is now looking for financing from the private markets.

What kind of returns are those making?

These are steady 7 to 9 percent returning investments.

And lower risk?

Lower risk, top of the capital structure. They are bond-like but the reason that they return 7 to 9 percent is somebody has to do a lot of work to create private financing transactions.

Isn’t it a lot easier for people to just invest in the stock market? It’s easy to buy a stock index or an ETF. Are many investors really comfortable getting into this exotic credit stuff?

The stock market’s fun. It’s gamification on the screen. I mean it’s the reason that we scroll the ticker tape all the time on TV. An entire industry has come around to make speculation fun. That is decidedly different than investing.

Speculation is fun?

It’s very powerful in the psyche. People are always talking about what are the markets doing. Those things are really different than long-term investing, and I think changing one’s mindset is particularly important there.

The credit markets are the opposite in that they’re totally boring and so I’m very fond of that. Do you know how often the bond indexes change? Once a day. The bond market price is once a day at the end of the day. There’s no intraday pricing in the bond market.

That’s quite different from the stomach-churning stock market indices.

There’s no exchange. So there’re no markets. Bonds are traded over-the-counter. Broadly speaking, financing markets are at least a decade if not 20 years behind the electronified and gamified stock markets. You can understand how by the time you get to a private financing transaction, people are like, “I don’t know, I just don’t know a lot about this. I’m less comfortable with it,” and so I think this is about investor education. It’s about helping people understand and also I think it’s finding the right client base where this stuff is appropriate.

Switching gears a little, BlackRock CEO Larry Fink recently released his annual letter, in which he called for corporate responsibility on the part of CEOs.

It’s one of our core principles, the idea that a firm needs to have purpose. Purpose is the animating force for profit generation.

Read Worth’s 2016 Q&A with Fink here.

How so?

You will not be profitable over the long term if you’re not aware of the impact your company has on society. Look at what happened to tobacco companies. These are very, very tangible things when it comes to long-term strategy, particularly for companies that are engaged in higher risk activities but also for any company that, for example, has consumer data at the center of what it does, consumer protection at the center of what it does.


I’m not naming any companies but I’m saying these are issues that if a company does not have a strong sense of how its business impacts the community and the global community at large, the company will not be as profitable and successful over time.

How can BlackRock help?

Larry’s letter is about really catalyzing thinking and also inviting more engagement with us and our stewardship team from all the companies in which we are a stakeholder. It is a really powerful thing around here. When I went to Brown 10 years ago to recruit and we didn’t talk about this stuff, people didn’t want to come work here. It was just another financial services firm. Today, we put this at the center of everything we do. It’s the driving force of why we’re engaged.

Fink says millennials think businesses should be more concerned about “improving society” than “generating profit.”

That’s 35 percent of today’s workforce. How are you going to attract and retain the best talent to work at your company if you can’t talk about these things?

And the clients?

Yes, these clients all have ample choice. In the United States alone, there are 9,000 mutual funds with 24,000 different share classes from 900 different fund companies. We’ve got to fight every day for mind share with people. Our investment performance, great pricing, operational resilience, those are just the table stakes. The most important thing is somebody says, “I identify with BlackRock. I identify with the way they do business. I identify with what they care about.”

Have you had any tangible results of focusing on corporate responsibility?

The answer is categorically yes. I’d argue there are demonstrable, visible signs that the composition of the boardroom is changing. It’s nowhere near as fast as everybody wants it to change. But inclusion and diversity in the boardroom has made substantial swings from where it was five years ago. The second thing is that corporate transparency is markedly improved. An array of environmental disclosures by energy and oil companies were largely catalyzed by BlackRock shareholder advocacy in our investment stewardship team. Pushing corporations broadly into setting corporate governance standards has come from shareholder advocacy.

It seems like Fink is saying we can’t count on government right now.

This idea is to use private capital to compel action when government and public institutions have fallen away. Private institutions are having a crisis of faith in the ability of public institutions to do multilateral leadership, to bring people together, to address extremely difficult issues of inequality, of rising income inequality, eroding purchasing power for the consumer. It would be great if the government would help. But the private sector has to solve those things.

See all of Michelle Celarier’s monthly columns here.

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