Finding long-term value in short-term turmoil

Alan McKenzie| Mike Pyle| Philip Green |Apr 9, 2020

As the coronavirus pandemic roils financial markets, investors need to determine how to allocate risk in the face of unprecedented circumstances and how to think about the long term, even in the face of tremendous disruptions in the short term.

Mike Pyle, our Global Chief Investment Strategist, explored these themes with Alan McKenzie, Chief Investment Officer for Family Offices, and Phil Green, Head of Global Tactical Asset Allocation, as part of our April 2 Market Pulse Call, Rebalancing and Tactical Opportunities. 

It was a timely conversation, as more than half of the respondents to a poll we conducted during the call stated that they anticipate making tactical or opportunistic investments in undervalued or attractive segments of the capital markets.

Highlights from the call follow.

How are clients managing the imperative to rebalance portfolios in the short term with the need to stay focused on long-term objectives?

Let’s start with the long term. The world is different now than it was a month ago, and so our views on asset class returns, on the interaction of different asset classes, and on the role those assets play in a portfolio are very different.

We need to ask questions like, What is the role of government bonds in a portfolio when interest rates are effectively zero? How does one navigate a very unclear environment for equity earnings? What is the likely path of interest rates? What’s going to happen with credit spreads? 

The answers to these questions may have a profound effect on what a strategic asset allocation (SAA) should look like. We polled more than 750 clients in a recent Market Pulse call, and more than a quarter of them are making changes to their long-term SAAs, which speaks to the magnitude of the moment and to the importance of getting the SAA right. Also, if the past few weeks have taught us anything, it is that we must approach the construction of an SAA with a great level of humility. BlackRock’s capital market assumptions, for example, and our resulting portfolio optimization processes, factor in the uncertainty around future returns and seek to build more resilient portfolios so that we can be better prepared for a wide variety of market outcomes.

As for the shorter term, we believe rebalancing is a very important tool, and that it instills discipline in any institutional portfolio. But what we strongly advocate is the need to be flexible and dynamic. Even with clients who are very systematic with their rebalancing, like pension plans that may have hit a specific trigger, we would look to rebalance over a period of days to weeks depending on market liquidity.

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What is the role of government bonds in a portfolio when interest rates are effectively zero?

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Does the unprecedented environment that we’re in require investors to reshape their approach to alpha generation?

At the highest level, our process is simple: we’re looking to buy cheap assets. And there are three key things we think about when we’re gauging what’s cheap.

The first is to determine what the fundamental drivers of asset prices are in this environment. The main fundamental driver right now is the virus itself. We’re certainly not scientists, but we are data professionals, and so we look at the data. We think that the balance between supply and demand for ventilation beds in intensive care units is probably the single most important variable that can help us gauge how effectively different countries, states and municipalities are combatting the virus. So that metric is front and center in our analysis of potential opportunities.

The second thing we think about is what is already priced into markets. Basically, we want to know if the market is accurately pricing in the fundamental return drivers that we’ve identified.

Finally, if we’re considering making a trade, we want to know who is on the other side of that trade. We want to know if the price at which they are willing to transact reflects the fundamentals, or if it reflects something else. This has really come into play over the last month. We’ve seen many market participants across risk assets like equities and credit, as well haven assets like government bonds, that did not have a view a on fundamentals, but were essentially what we’d call information-less traders. Obviously, that gives us a greater sense of conviction when transacting with these participants.

Where are you seeing the most engagement from clients that are looking to capitalize on long-term opportunities?

If we look back at the financial crisis, one of the things we learned is that, in periods of market turmoil, you don’t necessarily have to go very far down the capital structure of a company to potentially earn compelling returns. We think that dynamic is at work currently, and that it is creating value in many parts of the credit market. So, we believe that credit can perform quite well alongside equities over the next few years.

This is a theme that is resonating with many clients. And because there are still some sellers that aren’t particularly concerned about the fundamental value of certain assets, we think we’ll continue to see opportunities for clients who are concerned about the fundamental long-term value of those assets to purchase them at potentially attractive prices.

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In periods of market turmoil, you don’t necessarily have to go very far down the capital structure of a company to potentially earn compelling returns.

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Mike Pyle
Global Chief Investment Strategist
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Alan McKenzie
Chief Investment Officer for Family Offices.
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Phil Green
Head of Global Tactical Asset Allocation
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Making sense of market turmoil

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Making sense of market turmoil