It’s time. Consider a dynamic approach to portfolios.

New regime, new playbook

Stable inflation and economic growth in the Great Moderation supported an investment approach that relied on static, set-and-forget allocations to equities and bonds. We’re now in a supply-driven world that’s fuelling volatility and inflation, forcing central banks into a structurally tighter policy era – which doesn’t bode well for a hands-off approach. We think outperforming market returns in this new regime requires a new playbook, with more dynamic and nimble asset allocation. See New regime, new approach.

Staying nimble

A whole portfolio approach

This move towards more dynamic asset allocation and more frequent evaluation of strategic portfolio weights makes a holistic multi-asset portfolio approach even more critical than it already was. Getting the asset mix right in the new regime will be more difficult, but in our view it will also be more important for maximising returns. The impact of getting the asset mix wrong – calculated as the ratio of the relative returns for each illustrative asset mix – could be up to three times as much in the new regime, we find. See the chart below.

For illustrative purposes only. These do not represent actual portfolios and do not constitute investment advice Source: BlackRock Investment Institute with data from Refinitiv Datastreamand Morningstar. Returns data as of December 2022. Notes: The chart illustrates the contrast between estimated average annualrelative performance of two hypothetical portfolios against a 60-40 global equity-global bond portfolio over the coming decade where we see a regime of higher macro and market volatility and estimated performance over the Great Moderation era (Jan 1990-Dec 2019) of stable growth and inflation. We show hypothetical performance of portfolios comprising a 40%-global equity-60% global bond split and an 80% global equity-20% global bond mix. Index proxies: MSCI AC World for equities and the Bloomberg Global Aggregate Index for bonds. We use the actual returns for both indexes using Refinitiv data to estimate portfolio returns during the Great Moderation and use our capital market assumptions (CMAs) as of 31 December 2022 to estimate portfolio returns over the coming decade. Professional investors can see https://www.blackrock.com/institutions/en-zz/insights/charts/capital-market-assumptionsfor more details on our return assumptions. The chart illustrates that for both sets of asset mixes the overall relative return impact against a 60-40 portfolio is three times greater under the new regime. An inherent limitation of hypothetical results is that allocation decisions reflected in the performance record were not made under actual market conditions. They cannot completely account for the impact of financial risk in actual portfolio management. We also assume no transaction costs in our estimates. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index.

Equities: taking a more selective approach

The new, more volatile economic regime provides different yet abundant investment opportunities. Persistent supply constraints are compelling major central banks to hold policy rates high. We seek to find opportunities by getting granular within asset classes and harnessing mega forces.

Moving up in quality

Adding quality exposure may help to boost portfolio resilience in the face of macro volatility and still-high inflation. Quality’s tilt towards companies with high profitability, low debt and strong balance sheets could help provide capital protection in volatile markets, in our view, while remaining invested for potential capital growth.

Pivoting to new opportunities

In a more volatile macro and market environment, investors may find opportunities by getting more granular, tilting portfolios to areas where the damage is priced in. We look to emerging market (EM) equities and opportunity in selective sectors such as healthcare.

Emerging market investments are usually associated with higher investment risk than developed market investments. Therefore, the value of these investments may be unpredictable and subject to greater variation.

Harnessing mega forces

In the new regime, we believe we need new portfolio building blocks that blend themes with traditional stock and bond asset classes. We look to mega forces, such as artificial intelligence (AI), where we’ve seen tactical opportunities open this year, as well as those – like the transition to a low-carbon economy – where entry points look attractive.

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Fixed Income: rethinking the role of bonds

As the global economy has moved away from a period of steady growth, stable inflation, and supportive central bank policies, investors are now facing a new market regime. We’re in a period of heightened market volatility, stubbornly high inflation in some regions and tighter monetary policies. Against this backdrop, we see a key but evolving role for fixed income in portfolios. As investors rethink the role of bonds, we expect more dynamic decision-making in asset allocation and product implementation.

Get granular

Pivots to more granular new opportunities to help diversify and seek returns beyond broad exposures. We maintain our high conviction towards local currency emerging market debt, for several reasons, among them most EM central banks having paused or being very close to pausing their hiking cycles, as well as less prevalent inflationary pressures in EM, especially in Asia.

Tilting towards quality

Quality is also in demand in the fixed income space: weak growth and even weaker earnings as well as central bank policy paths keep us positive on investment grade (IG) credit over high yield (HY). IG credit is offering decade-high yields while default risks remain low and balance sheets are in good health.

Time for income

Still-stubborn inflation suggests investors will demand higher term premia to own the long end of the curve, in our view. We see pockets of potential opportunity for income in other parts of the US Treasury yield curve. Flexible duration management can also help protect total returns of fixed income assets and add sources of potential income. A relative value strategy, aims to deliver returns less dependent on market beta.

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Alternatives: long term diversifiers

One fixture of the old approach to portfolio construction that we think must evolve is the broad allocation blocks to listed equities and bonds. The increasing correlation of public stocks and bonds means investors are struggling to find reliable diversification and sources of returns. To help make portfolios more resilient for the new regime, investors are increasingly considering exposure to alternatives investments.

Alternatives investments are assets that don’t fall into traditional categories such as stocks, bonds, or cash. There are two main types of alternatives investments. Private markets, such as Private Equity, Private Credit, Real Estate and Infrastructure. They are more complex and less frequently traded than public stocks and bonds. Liquid alternatives such as Hedge funds are the second type.

Alternatives investments can help investors broaden their opportunity set, increase return potential, and enhance portfolio diversification. In some cases, it can also add a healthy dose of inflation mitigation.

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A continuum of portfolio solutions based around you

The new regime of increased macro and market volatility is here to stay, in our view. This will require a new approach to portfolio construction. We are here to partner with you in whatever way suits your objectives, to help implement the dynamic and nimble portfolios you will need in this new environment.

Whether you want to keep control of your asset allocation and are looking for implementation ideas and vehicles, would like to insource some multi-asset or model portfolio capabilities to free up capacity elsewhere, or are looking for a consultation to review and help shape your redesigned portfolio ideas, we can partner with you to find the right solution.