Fixed income investors may not be able to see them all right now, but important trends are stirring on the investment horizon. How you position your bond portfolio now will determine future results when the tide of easy monetary policy rolls out and other economic waves start to roll in.
What worked in the past isn’t likely to work in the future. What does make sense, though, is a mix of strategies designed to ensure that bonds can best do what they have always been meant to do in a portfolio, which is to:
Diversify, especially from equities.
Guard against interest rate and credit events.
Provide income.
Current market dynamics require the use of more than one strategy to achieve these goals, however. Last Friday’s strong jobs report, combined with continued steady growth in gross domestic product, offers the Federal Reserve all the ammunition it needs to start raising rates at its June meeting—which we believe it should do—meaning the need for flexibility has never been greater.
And remember, the Fed is not the only game in town. In fact, we think there are four major factors that will influence interest rates around the world: changing demographic trends, innovations in technology and energy, financial conditions as related to leverage, liquidity and cash flow, and monetary policy.
It’s our view that volatility should increase as the world moves from the pervasively synchronized easy monetary policy that we’ve seen over the past several years to the policy divergence that is showing up today. At the same time, the continued lack of fixed income supply around the world, especially in longer-maturity debt, should continue to keep yields contained.
So, how do you invest in such a muddled environment? We believe owning investments that carry healthy balance sheets and offer generous cash flow is vital to investing in 2015. When that proverbial tide rolls out, owning investments that are fairly valued and that minimize the distortion that’s been caused by years of central bank quantitative easing will make sense.
Investors who properly appreciate economic and financial fundamentals — particularly the vital three of leverage, liquidity and cash flows – have the best chance of being rewarded.
At the same time, the reality is that the days of simply relying on one fixed income fund or style are over. When thinking about your fixed income investment options, bear in mind that over the past several years, traditional bond funds have become much more correlated to stocks. Plenty of actively managed bond funds have veered away from their benchmark and taken on more risk in the pursuit of higher returns. And any single component of the income sector has experienced significant loss of capital during times of market stress.
More flexible approaches to fixed income investing can make more sense, offering higher yield potential and meaningful diversification while at the same time seeking to reduce overall volatility. For example, because the BlackRock Total Return Fund has a low correlation to the S&P 500, equity risk in a fixed income portfolio has the potential to be reduced through the use of the fund. The BlackRock Strategic Income Opportunities Fund, meanwhile, can be an appropriate choice for those investors who may be concerned about rising interest rates as it can adapt to changing market conditions through blending traditional and non-traditional investment strategies. Finally, if you’re looking to increase yield you may allocate a higher portion of a portfolio to the BlackRock Multi-Asset Income Fund because it targets alternative income sources.
Of course, allocations will depend on your specific risk appetite and investment objectives, and there is no guarantee that asset allocation strategies will preserve your assets in falling markets, but combining these three strategies is just one way to customize a fixed income portfolio to better navigate today’s complex economic landscape.
Stock and bond values fluctuate in price so the value of your investment can down depending upon market conditions. Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.
Rick Rieder, Managing Director, is BlackRock’s Chief Investment Officer of Fundamental Fixed Income, is Co-head of Americas Fixed Income, and is a regular contributor to The Blog. You can find more of his posts here.