Barclays decided to sell its Investment Management group, Barclays Global Investors (BGI) to BlackRock. As part of the deal BlackRock is also getting iShares, the ETF arm of BGI.

After the consolidation BlackRock will boast an asset base of $2.7 trillion, the largest with any single firm. Yet the combined BlackRock will only have 5% of the global Asset Management industry – such is the fragmented nature of the Asset Management industry.

That is precisely the point here. Unlike a steel industry or even a trading business, in Asset Management scale is not necessarily better.

– When the funds get bigger the fund managers find it hard to execute large trades without the price moving against them. It is hard to work a large order. This will make the fund manager to restrict themselves to liquid stocks and there by foregoing other attractive but less liquid stocks.

– Once the firms get large bureaucracy sets in and that restricts investment freedom for fund managers. They will be hamstrung by policies, rules and restricted styles of investing. Frustrated, some may leave.

– As the funds get bigger and invest in larger universe of stocks they will end-up mimicking the broader index.

Obviously there will be savings in trading, research and technology expenses but the loss of good investment opportunities outweigh any such benefits. A $1mn fund under a good fund manager will do much better than a $1bn fund with a manager of same caliber.

So why did BlackRock want to buy BGI?

The answer is iShares. Despite all the points I mentioned above – in some areas of asset management scale matters (read passive funds). Some examples are index funds and passive ETFs. iShares focuses on ETFs which makes it attractive to BlackRock. Post consolidation BlackRock can consolidate all the ETFs under iShares platform and reduce the operating expenses.

The acquisition points to an interesting trend taking shape in the asset management industry. Passive investment strategies that try to mimic a benchmark with ultra low expense ratio.