MULTI-ASSET INCOME INSIGHT

When markets
defy expectations

Aug 15, 2017

The key takeaway from markets in the first half of this year is to expect the unexpected. For investors, this means being vigilant,
diversified and tactical.

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.

The first seven months of 2017 have challenged expectations for robust global reflation and reinforced the importance of taking a measured and practical approach to investing. While global growth has been above-trend, the breakout many investors anticipated has not materialized. Meanwhile, recent inflation data has disappointed, which is complicating central bank decisions around raising interest rates. Surprisingly, financial conditions are actually looser today than at the start of the year, with the 10-year Treasury yield having moved lower since then. Therefore, against expectations, the equity rally in 2017 has been driven by interest rates more than growth.

We are keeping a close eye on central bank moves toward balance sheet normalization and the potential effects of U.S. political discord as either could present a catalyst that ultimately disrupts the persistently benign market conditions. Our broad outlook remains one of cautious optimism given a multitude of uncertainties against a backdrop of steady and synchronized global growth. That said, with valuations elevated across the board, we resist the urge to chase returns and remain focused on security selection.

The BlackRock Multi-Asset Income Fund continues to maintain a modest overall risk profile. We have reduced equity exposure due to high valuations and the potential for asymmetric returns. Although there is similarly little room for further price appreciation in credit fixed income, we see no immediate signs of frothiness, and compounding a steady coupon stream can be a powerful driver of total return.

We are focused on security selection within industries and companies with stable business profiles and consistent cash flows, while remaining diversified across credit sectors. We continue to maintain limited duration risk given our view that markets may be underestimating the pace at which the Federal Reserve may act to normalize policy.

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Portfolio highlights

  • Bought equity index put options. The CBOE Volatility Index (or “VIX”) hit multi-decade lows in July. We took the opportunity to add downside protection through relatively inexpensive S&P 500 put options amid declining index volatility.
  • Reduced single-stock covered calls. The volatility of individual stocks, although higher than broad equity index volatility, has also been declining, which has resulted in less compelling premiums for selling new call options.
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