Diversify your diversifiers within multi-asset portfolios

Quick read:

• Strategic allocations to diversifying, liquid alternatives alongside traditional stocks and bonds can potentially result in improved risk-adjusted portfolio returns.
• We favor liquid alternatives that have a proven record of generating alpha relative to cash with low correlations to stocks and bonds and consistent levels of volatility.

Historically, advisors building multi-asset portfolios have looked to bonds to provide their clients with three things: income/returns, capital preservation, and equity diversification.

The global financial crisis solidified US Treasuries as the ultimate provider of each of these characteristics within portfolios. In the subsequent decade, low and stable inflation, bond purchases by central banks (quantitative easing, or “QE”), and stable government budget deficits created a positive backdrop for long-dated fixed income. Upward sloping yield curves also meant that longer-term investors out-earned cash despite relatively low absolute yield levels.

The aftermath of the global pandemic upended many of the previous decade’s asset allocation rules of thumb, including the primacy of bonds as an uncontested complement to equities. Inflation has jumped and remains volatile, many central banks have shifted to selling bonds (quantitative tightening), and fiscal policy has again become a market risk. On the pricing side, low term premiums at the long end of the yield curves are inconsistent with elevated inflation and trade uncertainty. This uncertain environment has many asset allocators rethinking their strategic allocations.

Fixed income characteristics over the decades

Building resilient multi-asset portfolios

In recent years, the market has reacted to elevated US policy risk and continues to respond to shifts in central bank policy rates, inflation surprises, and sovereign fiscal trajectories. Market dispersion across countries, sectors, and asset classes has increased, creating a wider gap between winners and losers. While bond yields are attractive relative to the pre-pandemic years, their role within resilient portfolios has evolved in an environment of elevated cash yields.

As shown below, it is not only that policy rates remain higher across G10 countries, but also that dispersion among those rates has increased meaningfully. This widening divergence in monetary policies is creating a broader opportunity set, reinforcing the case for active management and diversified global exposures.

Macro dispersion across countries is creating opportunities for investors

Beyond yield and income, bonds now exhibit diminished capital preservation and equity diversification characteristics in an above-target inflation environment. This means that, within a portfolio context, bonds are no longer dampening equity risk in the way that they did in previous decades. To achieve improved risk-adjusted portfolio returns in this environment, proven liquid alternatives that benefit from higher cash yields, international exposure and low correlation to traditional assets can play an important role. As the average US advisor portfolio holds less than 5% exposure to the asset class¹, many have ample space to consider additional allocations.

Putting it in practice

The good news is that diversification is an “and” story. In our view, liquid alternatives and fixed income should sit together as strategic complements within a well-constructed multi-asset portfolio.

Our Multi-Asset Strategies & Solutions group puts this in practice by building portfolios that include both traditional and alternative asset classes across geographies and styles to deliver outcomes for a broad range of clients.

Many of our large institutional clients’ portfolios, for example, use the BlackRock Tactical Opportunities Fund alongside a combination of other active and index allocations. We also allocate to the Tactical Opportunities Fund in our suite of active target date funds and our Target Allocation model portfolios, both of which are designed to help individual investors achieve their financial goals. Across different client types, the common investment rationale is to achieve more resilient portfolios by combining alpha and diversification.

Below, we show the uplift by comparing a stock-bond portfolio with a portfolio that combines stocks, bonds, and the Tactical Opportunities Fund. The results are consistent with the value proposition: over each of time horizons shown, we see more attractive risk-adjusted returns over all time horizons, with that improvement coming from both higher total returns and lower overall portfolio volatility.

Better together: liquid alternative allocations have improved portfolio results

Performance data quoted represents past performance and is no guarantee of future results. Investment returns and principal values may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. All returns assume reinvestment of dividends and capital gains. Current performance may be lower or higher than that shown. Refer to blackrock.com for most recent month-end performance.

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 current month-end, please visit Tactical Opportunities Fund, LifePath Index 2030 Fund, iShares Core S&P 500 ETF and iShares Core U.S. Aggregate Bond ETF.

The Morningstar Rating^TM 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.