(Adds active fund performance statistics)
By Trevor Hunnicutt
NEW YORK, Oct 18 (Reuters) - BlackRock Inc, the world's largest asset manager, reported better-than-expected quarterly profits on Tuesday, showing resilience in what has been a punishing market for fund managers.
CEO Larry Fink nonetheless told Reuters his industry faces a "hostile" environment as investors migrate to products like index funds, which typically carry lower fees than actively managed funds.
Even as BlackRock absorbed $55.1 billion in cash in its core products, revenue fell 2.5 percent due to lower performance fees. A favorable tax rate and income from non-core investments helped the company beat analyst forecasts.
BlackRock has managed to stand above the fray because it owns iShares, the leading exchange-traded fund brand. Still, its transition from being primarily an active asset manager to a more passive one has not been without pain.
"Even in these hostile headwinds that we see as an industry, I think we will benefit over the long run," Fink said in an interview.
Most recognizable ETFs charge low fees and aim to track the market rather than beat it.
BlackRock sliced fees on some ETFs further during the latest quarter to draw in new business. Investors are expected to leave funds that pay brokers sales commissions due to an upcoming U.S. Labor Department rule, and BlackRock has said its ETFs can benefit.
Overall, the company's net income rose 3.8 percent to $875 million, or $5.26 per share, in the third quarter from $843 million, or $5.00 per share, a year earlier.
After adjustments to strip out some compensation, distribution and tax costs, BlackRock said it earned $5.14 per share, beating the average analyst estimate of $5.00, according to Thomson Reuters I/B/E/S.
At Sept. 30, the bond and index fund manager had $5.1 trillion in assets under management.
BlackRock's iShares ETF business took in $51 billion in new money - more than double its inflows a year ago. It accounted for 93 percent of the cash the company took into its long-term funds, a grouping that excludes short-term cash accounts.
So far this year, investors have pulled $110 billion from U.S.-based stock funds, according to Thomson Reuters Lipper.
"Active" funds, whose managers bet on specific stocks and bonds, have lost $119 billion to cash withdrawals this year in the United States, according to Morningstar Inc.
"The whole industry is feeling that," Fink said.
BlackRock's own active performance remains a source of concern and diminished revenue, even as it took in new money last quarter.
The company attracted $37 billion into long-term fixed income investments and $13 billion in equities. Another $1.8 billion went into alternative investments, while its stock and bond-picking franchise took in $4 billion.
Yet BlackRock's performance fees - which are usually earned when a fund beats its target return - fell by 72 percent in the quarter.
Institutional clients withdrew money from one of its key stockpicking groups, known as "scientific" active equity, as performance has lagged over the past year. Just 31 percent of assets managed by that unit are beating their benchmark over the period, BlackRock said.
"Actively managed equity funds generate the highest revenues," said CFRA Research analyst Erik Oja. "Clearly it's a long-term downward trend for that."
But analysts say index funds may be the future. BlackRock's iShares business includes some relatively inexpensive "Core" ETFs that track markets, as well as pricier ones, branded "Edge," that attempt to copy and automate successful techniques used by active managers.
One such product, iShares Edge MSCI Min Vol USA ETF (USMV) , has been a bestseller since it launched five years ago, even though other stock funds have been out of favor with investors. It aims to deliver market returns with fewer price swings, a claim that appears to be substantiated so far by Lipper performance data.
"We feel like there will be more and more adoption," said Rob Nestor, a BlackRock managing director who oversees USMV and other so-called "smart beta" strategies in the United States. He noted that it has become more difficult for active managers to beat market returns.
Meanwhile, Aladdin, a risk-management technology BlackRock uses and licenses to other investment firms, reported a 13 percent rise in revenue.
BlackRock shares rose about 0.6 percent on Tuesday afternoon in New York. The stock has risen about 4.8 percent since the beginning of the year, while a grouping of the company's peers measured by the Dow Jones U.S. Asset Managers Index fell by 3.4 percent. (Reporting By Trevor Hunnicutt in New York; Additional reporting by Sudarshan Varadhan in Bengaluru; Editing by Chizu Nomiyama and Lauren Tara LaCapra)