MULTI-ASSET INCOME INSIGHT

When markets look complacent,
think outside the traditional box

Jun 15, 2017

Strong returns and low volatility have persevered for an unusually long period of time. These non-traditional market conditions call for non-traditional asset classes.

In most markets, particularly in the U.S., interest rates appear set to rise, albeit gradually. Policy uncertainty is certainly a big part of the landscape.

- Michael Fredericks
  • Transcript

    Economic data in most of the world has been getting stronger. Consumer confidence is at very high levels. And I think, we are moving beyond the world where central banks dominate the economic narrative to one of which the fiscal policy, tax reform, nationalism, and deregulation will be much more in front of mind.

    In most markets, particularly in the U.S., interest rates appear set to rise, albeit gradually. Policy uncertainty is certainly a big part of the landscape. But overall, this is a good backdrop for investors. Yes, there will undoubtedly be bouts of volatility but those episodes can create great opportunities for tactical managers.

    For investors who need income, we are focused on higher quality sources of yield, especially in securities where you get paid more as interest rate move higher. The stronger economic backdrop and easing regulatory climate are also a positive for high yield bonds as the probability of default is probably lower. It sets a stage for what we expect will be a year where there is money to be made.

We continue to view the macro backdrop as a fairly favorable one, which warrants taking some economic risk via owning credit and equity assets. However, there are a few macro risks which, combined with less compelling valuations, give us a reason to keep this optimism in check. These include a recent slowing in U.S. economic momentum, multiple central bank decisions slated for the remainder of the year, an impending U.S. debt ceiling showdown in September, and tightening financial conditions in China.

The strong returns and persistently low market volatility of late could easily lull investors into forgetting the importance of risk management. Taking a look back at the last several years, however, serves as a quick reminder that the market’s generous period of calm has at times been interrupted by violent spikes of volatility and the rapid unwinding of crowded positions.

The historical asset allocation of the BlackRock Multi-Asset Income Fund clearly demonstrates a theme of increasing exposure to non-traditional sectors in recent years. Key benefits of owning non-traditional income asset classes in a portfolio today include added diversification to traditional stocks and bonds and a consistent cash flow, which has helped deliver a smoother total return experience over time.

We are particularly focused on preferred stocks, where we’ve increased the fund’s exposure by approximately 4% this year. We purchase preferred stocks mainly in the institutional market, which is dominated by shorter-duration, fixed-to-floating rate securities, in contrast to the longer-duration, fixed-coupon retail market.

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Portfolio highlights

  • Reduced high yield bonds. Credit spreads have tightened significantly over the last year and now sit only marginally higher than the cyclical lows seen in 2014. Although strong underlying fundamentals remain intact, tighter spreads mean less upside potential.
  • Increased preferred stocks. Even though valuations have compressed, preferred stocks still offer relatively attractive yields. Additionally, the underlying issuers are primarily financials, where credit fundamentals have improved and stand to benefit further should interest rates move higher and regulatory pressures diminish.