The BlackRock Way

Building better portfolios

Aug 8, 2018

It’s time for investors to stop thinking in ‘active versus passive’ terms. The traditional approach to portfolio construction looks outdated. Investors should seek varied return sources in cost-efficient ways depending on their objectives and constraints.

Highlights

Know what you’re buying: Investors need to distinguish between alpha, broad-market and factor returns for two main reasons. First, the distinction is needed to allow investors to allocate to genuine alpha opportunities, both within and across asset classes (e.g. tactical asset allocation). Second, clarity on the sources of portfolio returns helps ensure investors stick to their strategic objectives, by allowing them to account fully for factor exposures across underlying portfolio building blocks.

See the full picture: “Active in X, passive in Y” is too simplistic. A blend based on investor objectives and constraints is preferable - there is no one-size-fits-all answer. Blending alpha-seeking managers with indexing and factor strategies should occur at a portfolio level rather than asset class by asset class – a holistic approach must be taken. Alpha-seeking strategies with higher expected alpha – net of fees – should not be ruled out where they also contribute meaningful market and factor exposures as these exposures can be accounted for.

Time is money: What matters are returns net of costs. Yet product fees vary widely by client and over time. Governance costs to find and monitor alpha-seeking managers can also be considerable. Many investors have limited resources for these activities. That’s why investors have to ask themselves: Do I have the ability and research capability to oversee the selection of top performing alpha-seeking managers? Investors with a limited governance budget may opt to oversee just a few alpha-seeking managers – or even keep their entire portfolio in index products.

Snapshot

Our empirical work shows why it is important to have visibility into sources of return. We identify varying alpha opportunities across asset classes. We believe investors can be deceived by looking at active returns alone and need to uncover the factor exposures embedded in them. Investors can then decide whether to maintain the factor exposures or correct for them. Our work clarifies the returns being bought across the portfolio and maximises the efficiency of the risk budget – a priority in a low-return environment.

BlackRock’s portfolio construction framework
Portfolio construction blending alpha-seeking, factor and indexing strategies

Chart: BlackRock’s portfolio construction framework

Source: BlackRock Investment Institute, July 2018. Notes: This graphic depicts BlackRock’s view of how to best blend alpha and indexing strategies in a portfolio. It is for illustrative purposes only.

Jean Boivin
Global Head of Research, BlackRock Investment Institute
Jean Boivin, PhD, Managing Director, is Global Head of Research for the Blackrock Investment Institute and is a member of the EMEA Executive Committee.   His ...
Investment Head, BlackRock Model Portfolio Solutions
Global Head of Investments, BlackRock Client Portfolio Solutions