Client Insight Unit (CIU)

With rates at historic lows, it's hard for traditional fixed income investments to earn the income you need. In this video I'll walk through 3 ways to analyze your portfolio to help improve yield with similar risk

Hi and welcome to Quick Insights. I'm Calvin Yu, head of the Client Insight Unit at BlackRock. In this series, we talk about common challenges investors face and insights to help achieve the desired outcome.

So how can we pick up more yield with the same risk?

We've been getting this question a lot, and recently a client asked for ideas to help meet their income needs.

This client had a few objectives:

Achieve income to meet cash disbursements with low-moderate risk.

In this case, a big drawdown could severely impact the client's operations.

Maintain liquidity to support payments

Invest primarily in fixed income, but had flexibility to invest in alternatives and equities as well

We'll walk through this specific case study, but what's interesting is we can use the same framework to analyze different objectives as well

The first thing was looking at the yields and risks of different fixed income sectors. We also look at efficiencies from a yield per unit of risk perspective. You can see areas like securitized and high yield look more efficient than core FI. In this situation, the client was mostly invested in core fixed income. We proposed breaking out this allocation and diversifying across a broader set of sectors, which improved the yield by almost 100 bps, while risk increased moderately. It led to a more efficient outcome and the yield per unit of risk improved from 0.58 to 0.77.

Now the fixed income and credit markets are very dynamic. If you rank the performance of the sectors each year, the rankings are constantly changing. HY was the best sector in 2016, but it was also the worst the year before. The dispersion can be very high.

The ability to leverage our market expertise, analytics, and platform to navigate the dynamic landscape was important to this client.

The second thing we look at is how the new fixed income portfolio impacted the total portfolio's returns and risks. So here, we illustrated different reallocations across fixed income, equities and alternatives. And as we reallocated to more risky assets, the returns improved, but risk increased, forming a frontier. The interesting thing is the new portfolios were more efficient, and had better returns per unit of risk compared to the current portfolio.

The devil's always in the details, particularly when it comes to risk.

It's important to look at the drivers of risk and how the portfolio would do in downside scenarios. And so the third thing we look at was how these portfolios may perform under stress scenarios. We outlined some scenarios here, we can customize other scenarios that you may be focused on as well. In the end, we partnered closely with this client; they implemented one of these portfolios, and were able to better meet their income needs with similar levels of risk.

So if you want to learn more different ways to help improve yield in your portfolio, reach out to your BlackRock relationship manager.

Thanks for watching and I'll see you with the next Insight.

ICBH0822U/M-2339866

Calvin: Hi Ludwig – I have a question about optimizing cash investments, could we catch up over coffee?

Ludwig: Yeah, sure. Sounds good!

Calvin: So Ludwig, many investors are considering additional strategies in investing their cash holdings. I’m curious what trends are you seeing?

Ludwig: Sure Calvin! I have a recent presentation with me, let me pull it up

Ludwig: Current market conditions are providing investors with opportunities to generate additional income with limited risk. Yields have risen across the curve, but particularly in short term fixed income, as Central Banks tightened monetary policy to respond to rising inflation. With many investors sitting on cash in deposits which haven’t repriced yet, it behooves them to consider other more attractive options.

Ludwig: While we believe inflation may moderate, interest rates are expected to stay higher for longer. This should invite investors to reassess liquidity needs and capture additional income by considering other short term fixed income sectors.

Ludwig: One approach is to ‘tier’ your cash needs to calibrate your risk profile.

The first tier is Operating Cash which requires daily liquidity, so it must be invested in the most liquid areas, such as money market fund instruments or bank deposits. 

The second tier we call Core Cash where liquidity may not be needed for 3-12 months, so it may be invested in longer maturities with a more diversified opportunity set.

The third tier is Strategic Cash, where there is little to no liquidity needs. The focus here is on optimizing income and achieve total return potential, with the broadest of opportunity set.

This tiered framework is flexible and we partner closely with clients based on their specific liquidity needs as well as risk tolerance.

Ludwig: So for example, imagine an investor sold a business or raised new debt with cash to be invested over the short and long term. There is a balanced approach required between liquidity needs vs. long term income generation. That’s what tiering is really all about.

Calvin: Got it, thanks. So how does a tiered cash approach change the risk/return profile of the client’s portfolio?

Ludwig: The different risk/return profiles for each tier are based on the opportunity set. For example, an Operating Cash strategy is focused on the very short term and liquid assets, targeting Treasury bills, commercial paper and certificate of deposits.

On the other hand, a Strategic Cash allocation may invest across a more balanced blend or diversified mix of risky sectors, such as bank loans, emerging markets and securitized assets, which may exhibit greater market volatility but also has greater return potential.

So relative to Short Treasuries, adding Short Duration fixed income sectors may increase the yield by roughly 90 bps. A Balanced Blend and Diversified Income approach, which can be considered for the Strategic Cash allocation, could increase the yield by about 2% - 3%.

Decomposing the risks factors, as the portfolio moves from Short Duration to Diversified Income, the composition of risk changes. Most of the risk comes from spread sectors, and pure rates risk decreases, mitigating concerns of a rising rate environment.

As return potential increases, so does the risk of the portfolio. But the Balanced Blend and Diversified Income portfolios are efficient and improves the potential for expected returns with marginally higher risk.

 Calvin: This makes sense. I’m curious, how does the efficient profile impact portfolios over time, and what are the potential downside risks?

Ludwig: Great questions. We ran a Monte Carlo Simulation and you can really see the power of compounding.

For example, starting with a 100 million dollars, a client with a low risk tolerance may generate 33 million dollars over 10 years with a Short Treasury strategy. On the other hand, a client willing to take some risk and adopt a Diversified Income strategy may double the results and generate about 66 million over 10 years.

Ludwig: On downside risks, we stressed the portfolios under different market shocks. Not surprisingly, riskier portfolios may underperform less risky portfolios in stress environments, such as for instance, a global equity selloff. At the end of the day, we use this framework to partner with clients and develop solutions considering the balance between risk and return.

Calvin: Thanks! Looks like there’s a lot of opportunity to expand how cash assets are managed in today’s market. Let’s use this framework to help more clients optimize their portfolios.

Ludwig:  That sounds great! Thanks Calvin!

Clients provide data to BlackRock regarding their existing portfolios. The case study and screenshots in this material are for illustrative purposes only and are intended to describe BlackRock’s capabilities. Actual account outcomes may vary.

THE INFORMATION CONTAINED HEREIN MAY BE PROPRIETARY IN NATURE AND MAY NOT BE REPRODUCED, COPIED OR DISTRIBUTED WITHOUT THE PRIOR CONSENT OF BLACKROCK, INC. (“BLACKROCK”). These materials are not an advertisement and are not intended for public use or dissemination.

Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. You should consult your tax or legal advisor regarding such matters.

This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of yields or returns, and proposed or expected portfolio composition. No representation is made that the performance presented will be achieved by any asset allocation or investment, or that every assumption made in achieving, calculating or presenting either the forward-looking information or the historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein by way of example.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offeror solicitation to buy or sell any securities or to adopt any investment strategy. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. There is no guarantee that any of these views will come to pass. BlackRock does not guarantee the suitability or potential value of any particular investment. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not indicative of future results.

Investing involves risk, including possible loss of principal.

Equity and fixed income characteristics and allocations are for informational purposes only. Such characteristics and allocations are not intended to be predictions or projections of any portfolio's performance. Diversification does not assure a profit nor does it protect against loss of principal.

Aladdin Portfolio Risk Analysis: Charts and graphs provided herein are for illustrative purposes only. Neither BlackRock nor the Aladdin portfolio risk model can predict a portfolio's risk of loss due to, among other things, changing market conditions or other unanticipated circumstances. The Aladdin portfolio risk model is based purely on assumptions using available data and any of its predictions are subject to change. For BlackRock products, data about the specific underlying holdings are used when applying the Aladdin risk model. For third party funds, BlackRock uses underlying holdings, or in certain cases, determines appropriate proxies for relevant holdings using a combination of Morningstar and other publicly available data sources. Product specific inputs are typically based on the latest disclosed data, which may be lagged.

The information contained in this presentation is proprietary and confidential and may contain commercial or financial information, trade secrets and/or intellectual property of BlackRock. If this information is provided to an entity or agency that has, or is subject to, open records, open meetings, “freedom of information”, “sunshine” laws, rules, regulations or policies or similar or related laws, rules, regulations or policies that require, do or may permit disclosure of any portion of this information to any other person or entity to which it was provided by BlackRock (collectively, “Disclosure Laws”), BlackRock hereby asserts any and all available exemption, exception, procedures, rights to prior consultation or other protection from disclosure which may be available to it under applicable Disclosure Laws.

In Canada, this material is intended for institutional investors, is for educational purposes only, does not constitute investment advice and should not be construed as a solicitation or offering of units of any fund or other security in any jurisdiction.

©2022 BlackRock. All rights reserved. BLACKROCK and ALADDIN are trademarks of BlackRock, Inc. All other marks are the property of their respective owners.

ICBH1022U/M-2446290