The rise in risky portfolios

Nov 22, 2016
By BlackRock

Successful investing requires constant negotiation between two risks: the risk of permanent loss of capital, and the risk of eroding
purchasing power.


Portfolios that balance the two are a far better proposition than leaning into either extreme. “Portfolios taking on too much risk can deliver unpleasant surprises when volatility picks up, while those without enough may not meet wealth and spending needs,” says Brett Mossman, Head of BlackRock Portfolio Solutions.

‘Accidental’ risk

Many investors today, however, have ended up with portfolios that are riskier than they used to be — often inadvertently. Their equity sleeves are taking on more risk, their bond sleeves lack diversification and they’ve generally shifted away from a global bent, Mr. Mossman explains.

“Some of this higher risk stems from changing relationships between asset classes; some of it comes from managers simply taking on more risk in what has been a low-volatility environment.”

Reclaiming balance

Whatever the reason, it’s imperative that investors regain balance. In part, this means building a risk-mitigation component into the broader portfolio.

On the equity side, one way to potentially reduce risk is to consider allocating to exchange-traded funds (ETFs) that focus on lower-volatility stocks but still offer broad, market-like sector allocations. Other options include conservative dividend-growth stocks, or global multi-asset funds that seek to deliver equity-like returns with less risk over time by diversifying across asset classes around the globe.

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Market performance is beginning to differentiate within and across asset classes, making diversification even more powerful.

— Russ Koesterich, BlackRock Global Allocation Fund

When it comes to fixed income, Mr. Mossman and his team have found that the majority of portfolios favor credit risk (such as that found in high yield bonds) over rate risk (typical of government securities).

“We believe many investors may have overcorrected in the stampede to avoid rising rates,” he says. “This effectively has them taking on more equity-like risk since the economic factors that drive credit are largely the same as those that drive equities.”

One potential remedy: Adding exposure to traditional, high-quality bonds like Treasuries or inflation-protected Treasuries and high-grade corporate bonds as a ballast to equity risk.

“Balance is more important than ever,” says Mr. Mossman, “even if harder to achieve. Fortunately, a balanced portfolio is the easiest to own. Portfolios that are either too risky or not risky enough are stressful in their own ways, and can lead to hastily made, performance-draining decisions.”

The rise in risk

The time-tested portfolio allocation of 60% stocks/40% bonds has undergone a meaningful change. A BlackRock analysis of over 1,500 portfolios found that 94% of “balanced” 60/40 portfolios were taking on more risk than a 60/40 combination of the S&P 500 Index and the Barclays Aggregate Bond Index. Most of the equity sleeves (61%) were riskier than the S&P 500, and most of the fixed income sleeves (56%) were taking on too much credit risk to be effective equity diversifiers. The result: A rise in risky portfolios.

 

When 60/40 doesn't add up

When 60/40 doesn't add up

 

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Brett Mossman
Managing Director, BlackRock's Global Client Group
Brett M. Mossman, Managing Director, is a member of BlackRock's Global Client Group. He leads BlackRock’s Portfolio Consulting Services group.