BlackRock advocates greater portfolio resilience

Jul 10th, 2018 | By | Category: Alternatives / Multi-Asset

BlackRock advocates building greater resilience into portfolios, citing a wider range of possibilities for the economic outlook.

“Build greater portfolio resilience” notes BlackRock in mid-year investment outlook

BlackRock recommends shortening duration in fixed income, going up-in-quality across equities and credit, and increasing diversification.

In its mid-year investment outlook, the asset manager highlights potential downsides including the possibility of a trade war as well as overheating risk, while on the upside, strong US growth fuelled by stimulus may produce positive spillover effects to the rest of the world.

BlackRock, the issuer of the iShares brand of ETFs, argues that the greater variability in possible outcomes − along with rising interest rates − has contributed to tightening financial conditions, warranting increased hardiness in portfolios.

Setting the scene

Market sentiment has shifted markedly since 2017’s upside growth surprises, muted inflation, and unusually low volatility which set the stage for outsized risk-adjusted returns across markets, says BlackRock. Fast forward to 2018, and sentiment on many of these key market drivers has shifted.

While the growth picture is still bright overall, the investment giant believes inflation risks look more two-way, and financial conditions are tightening as US rates rise. Macro uncertainty is the big change for 2018 although the mood is not nearly as bad as 2015.

Wider range of growth outcomes

Despite the changing landscape, BlackRock still sees steady global growth ahead, although growth is becoming uneven and has a broader set of possible outcomes. The US is the growth engine, propelled by fiscal stimulus, while positive spillover effects are likely, especially to emerging markets (EM).

Yet the firm highlights that risks are two-sided: US stimulus could accelerate capex and lift potential growth — or trade wars and/or inflation driven overheating could incite a downshift.

The market’s adjustment to these higher levels of uncertainty will be a key theme for the remainder of 2018 and is already being mirrored in higher risk premia across asset classes, says BlackRock.

Tighter financial conditions

Rising interest rates, less-easy monetary policy and a strengthening US dollar are tightening financial conditions, with ripple effects across markets, says BlackRock, highlighting that tighter funding conditions have played a role in this year’s EM hardships − including Argentina and Turkey.

It notes that further gains in the US dollar could cause more pain, including for global banks that rely on dollar funding. Higher US short-term rates mean renewed competition for capital and less need to stretch for yield when (dollar-based) investors can get above-inflation returns in short-term “risk-free” debt.

Greater portfolio resilience

BlackRock notes that bouts of volatility this year – the VIX tantrum in February tied to leveraged short positions in equity volatility, the explosive selloff in Italian government bonds, and the tech sector suffering a brief shake-out of popular long positions – underscore the need for portfolio resilience.

How to make portfolios more resilient? BlackRock advocates shortening duration in fixed income, going up-in-quality across equities and credit, and increasing diversification.

Market views

The firm remains pro-risk but has tempered that stance given the uneasy equilibrium seen between rising macro uncertainty and strong earnings. US equities are preferred over other regions; momentum equities are expected to outperform; while it prefers quality exposures over value.

In fixed income, BlackRock favours short-term bonds in the US and take an up-in-quality stance in credit. Rising risk premia have created value in some EM assets like selected private credit and real assets for diversification.

It also sees sustainable investing as adding long-term resilience to portfolios.

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