Case study: Multi strategy fixed income

Mar 7, 2016
By BlackRock

Diversified beta, complementary alpha

The BlackRock DC team was recently asked to put together a proposal for a new fixed income fund that would include multiple managers, remain anchored in a core plus investable universe and had an active return target 75 to 150 basis points beyond the Barclays Aggregate Index. The client also wanted a fairly tight risk budget, keeping to within 100 basis points of the Barclays Agg expected risk.

But to deliver a meaningful proposal, the BlackRock team wanted to know more. What need was the client trying to meet? What are their fundamental beliefs about the fixed income market? What do they want to achieve for their participants? The team believed that only through ongoing, transparent dialogue could they create proposals to meet — and anticipate — the deeper need behind the request.

In this article, we will explore how that dialogue shaped the proposed solutions and enabled the team to leverage the full range of fixed income capabilities in service of the client's goals.

Understanding the
client's objective

Justin Patnode, a relationship manager on BlackRock DC's Institutional team, described the client's philosophy. "They wanted to identify areas where they believed they could add value for participants. If there was an opportunity to capture alpha in an asset class, they would explore it. If there was no opportunity, or if the cost of extracting alpha was too high, they would focus on capturing beta through index strategies."

The client requested a multi-manager structure, but the BlackRock team saw an opportunity to move beyond the relatively simple barbell approach of layering active and index managers offered by many providers. "We believed we could deliver more consistent returns by evolving proposals that identified diversified beta sources and complimentary alpha streams."

That shifted the conversation away from a multi-manager approach to a multi-strategy structure on a single fixed income platform. Or as Patnode described it, "With one risk platform we could analyze everything under one hood, including fundamental and model-based alpha sources." The strategy mix could then be optimized periodically to keep the expected risk and return within the proposal's specifications. "

In addition, the white label, multi strategy structure would allow the client to seamlessly implement changes. "They would be able to get out of a strategy immediately, without a notification requirement," explains Patnode.

The BlackRock team created a proposal with four distinct strategies that emphasized either alpha or beta diversification. The first option within each (See Proposals 1 and 3 in the table) is consistent with exposures typically seen in core plus portfolios throughout the industry. The second options in each (Proposals 2 and 4) extend the eligible asset classes beyond the client's original request by the addition of a Total Return sleeve.

"For the alpha plus proposal, we asked the client to look a little bit beyond the core plus universe," adds Patnode, "to consider the types of assets that they'll need to generate the return they want." By expanding their thinking, the client could get access to return sources across a broader range of fixed income sectors, give their active managers more leeway and still remain sensitive to an appropriate benchmark.

The alpha diversification proposals move beyond the relatively simplistic barbell approach of layering active managers with passive managers used by many providers in the industry. The white label structure, backed by BlackRock's Aladdin® risk management platform, was the critical component, making it possible to manage unique alpha sources across the portfolios.

The beta diversification proposal combines many of the insights present in the alpha diversification approach while also seeking to better balance interest rate and credit risk — the two predominant risks associated with fixed income investing. Patnode explains, "Our research suggests that by managing these factors independently within a fixed income solution, we can potentially deliver returns consistent with the Barclays Aggregate Index, but at a lower absolute level of risk."

Once again, the multi-manager structure on a single platform was key. In addition to optimizing the strategy mix, the platform allows BlackRock to dig into the expected sources of risk and return across strategies to ensure that they remain diversified and complementary.

For Patnode, a deep understanding of the client's objectives was key. "By having an ongoing dialogue, we could bring a full range of BlackRock's fixed income and risk management capabilities to table and offer the client several choices to consider."