Color outside the lines for better growth and income

While traditional investment strategies are typically bound to a benchmark or prospectus-mandated asset allocations, unconstrained strategies allow managers the freedom to invest wherever they see the greatest potential at the time. Rick Rieder and Michael Fredericks explain why that’s important, especially now.

Why “unconstrained” funds and why now?

Rick:  Traditional mutual funds typically have an investment mandate that limits the manager’s ability to invest outside of predetermined asset class weightings or regional lines. But an unconstrained mandate allows the fund manager to invest in a wider variety of asset classes in any part of the world – wherever they believe the greatest potential for performance exists at the time. The ability to be flexible as markets change can make a big difference in the performance of a portfolio over time.

The benefits of an unconstrained strategy are more valuable now than ever given how stretched the markets are today. Stock valuations are relatively high, especially in the U.S., and while interest rates may move a little higher, they are overall likely to remain low for a long time. I think it would be very difficult for financial advisors using a traditional 60% equity-40% fixed income portfolio to satisfy client needs in this market, whether they are looking for growth or income.

Michael: I agree. With interest rates as low as they are, most traditional fixed income assets are hardly producing enough income to keep up with inflation. Investors’ purchasing power is at risk, especially now with the economy growing at an above-average rate, which is likely to continue driving inflation higher. Investors will have to get creative in order to produce the outcomes they’re looking for. Unconstrained funds are a viable solution because they can provide exposure to non-traditional assets and employ unique strategies to generate returns and manage risks.

Where do you see interesting opportunities today?

Michael: In the BlackRock Multi-Asset Income Fund, we’re investing more client assets in higher yielding bonds and floating rate bank loans. The strong economic growth that we’re experiencing right now and the fiscal tailwinds are providing a very supportive backdrop for these types of assets. The higher-yielding sectors reward investors for taking credit risk more than interest rate risk, the latter of which I view as a much less appealing prospect right now.

We’re also seeing attractive dividend yield opportunities in some of the stocks that struggled in 2020 but have come on strong this year. There are companies that are generating a lot of free cash flow with solid records of growing their dividends over time. Even if the dividends are lower than historical bond yields, the potential to grow those dividends over time and provide price appreciation is very powerful in this environment of low prevailing yields if you know how to find the best opportunities.

Rick:  I think some of the best growth opportunities are in private assets, both on the debt side and the equity side. For example, real estate-related transactions where you can create your own structures – that’s really exciting to me. The BlackRock Global Allocation Fund gives investors exposure to those assets. We have hundreds of analysts all over the world looking for new opportunities and we have the tools to analyze them and use risk efficiently.

In what areas are you taking more caution?

Michael:  We’re limiting exposure to higher-quality fixed income. Virtually all of those sectors are yielding less than the rate of inflation. Bond markets broadly are expected to underperform stocks over the next few years, so we’ll be more focused on the non-traditional areas of fixed income and we’ll be tactical in our strategic weights.  Not being tied to a 60/40 asset allocation is an advantage for the BlackRock Multi-Asset Income Fund because we can reduce our allocation to fixed income and add more dividend growth-oriented stocks.

Rick:  As Michael said, traditional fixed income does not offer much value these days. Interest rates are probably going to move higher by 2023, and possibly sooner, but even then, we will still be in a low-rate environment from a historical perspective. And if you take a look at historical data, you’ll see why we expect bond returns to remain low for the foreseeable future. Going back to the 1930s, the annualized return on high-quality 10-year bonds over each decade was similar to where the 10-year Treasury yield was at the beginning of the decade. Considering where interest rates began this decade, I don’t expect much from traditional, high-quality bonds for a long time.

Expect another decade of low bond returns
Annualized decade-returns on 10-year bonds mirrored interest rates at the start of each decade.

chart

current decade-to-date; 1/1/2010 to 12/31/2020.
Morningstar and U.S. Treasury as of 12/31/2020. U.S. Bonds are represented by the Bloomberg Barclays U.S. Aggregate Bond Index from 1/3/1989 to 12/31/2020 and the Ibbotson Associates SBBI U.S. Intermediate Term Bond Index from 1/1/1926 to 1/3/1989. Past performance does not guarantee or indicate future results. Index performance is for illustrative purposes only. It is not possible to invest directly in an index.

How do you expect markets to evolve from here?

Rick:  I think investors should prepare for a more volatile period where inflation generally stays contained, but there could be periods when it's higher than people realize, and interest rates could rise alongside of that. Managing a portfolio is going to require a close eye on this dynamic for the next couple of years. I don’t think rates will move significantly higher, but it doesn't take a big rate move to create losses in a portfolio that isn’t prepared for it.

I also think there will be some really exciting investments coming to the market over the next couple of years. The growth of data simulation, artificial intelligence, cloud computing, robotics, health care technology, space exploration, energy evolution – all of these innovations are going to make this a great time to be an investor.

Michael:  I think the shift toward sustainability and the increasing focus on an energy transition is going to create many new opportunities for investors. It’s also going to be a costly endeavor. The infrastructure spending itself is going to be a bit of an inflationary tailwind. The fixed income markets are pricing in a return to the benign levels of inflation post the great financial crisis. There are arguments to be made for that, but I think there are also indicators that suggest inflation could run a little bit hotter than it has.

There will be a lot of focus on inflation and the Fed – when they will start tapering their bond purchase program and when they will begin raising interest rates again. These have really big implications for both fixed income and equity markets. Investors are going to need more flexibility than a traditional 60/40 portfolio will allow, and they’re going to need to be more dynamic to navigate all of these market-changing events and the uncertainty. Incorporating an unconstrained multi-asset fund into a portfolio is an efficient way for financial advisors to pursue the desired outcomes for their clients.

To obtain more information on the funds, including the Morningstar time period ratings and standardized average annual total returns as of the most recent calendar quarter and month end, please visit BlackRock Global Allocation Fund https://www.blackrock.com/us/financial-professionals/products/227680/ and BlackRock Multi-Asset Income Fund https://www.blackrock.com/us/financial-professionals/products/227565/ on blackrock.com.

The Morningstar RatingTM for funds, or "star rating," is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product's monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating metrics. The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods.