BlackRock Insights

00;00;00;00 - 00;00;20;11

Aaron Task

When the facts change, I change my mind. What do you do? John Maynard Keynes’ famous quote has arguably never been more relevant than it is right now. Higher for longer interest rates, a greater dispersion of returns, and the tightest stock bond correlations in a generation has many advisors wondering, what do you do?

00;00;20;13 - 00;00;34;09

Aaron Task

In this episode, we try to answer that question with Bart Sikora, head of portfolio consulting for the Americas at Blackrock. I'm Aaron Task and this Is in the know.

Aaron:

Bart, welcome.

00;00;34;11 - 00;00;35;05

Bart Sikora

Thank you for having me.

00;00;35;05 - 00;01;00;22

Aaron Task

And thank you for being here. So, I started with the Keynes quote. I'm going to read you another quote from Thomas Becker, who's a portfolio manager on BlackRock's global tactical allocation team. He recently wrote, quote, “the aftermath of the global pandemic upended many of the previous decades’ asset allocation rules of thumb, including the primacy of bonds as an uncontested complement to equities.” End quote. So given that what what do you do?

00;01;06;05 - 00;01;25;03

Bart Sikora

Great question. I love both of the quotes that you gave us, and I'm going to take us on a little history lesson here. And I think it's worth it. Right. So over the last 40 years we lived in a wonderful world of great moderation. We can think of it as starting roughly around 1990. Diversification was the main theme of portfolio construction, right?

We had bonds and we've come to rely on bonds for three strong reasons: diversification that they offered, capital preservation and income. Now, after global financial crisis, those three reasons got even stronger, although income did shrink a little bit due to quantitative easing. But you could still say that it was higher than cash. Therefore you still went to bonds for income. You absolutely went to bonds for diversification.

Diversification is defined as negative correlation between stocks and bonds. That's what makes portfolio construction exciting. You put two asset classes like that together. Your risk goes down. And then after COVID a complete change. And I don't want to overuse the term regime, but this was a regime change from a portfolio construction perspective.

We no longer have diversification. Correlation of stocks and bonds is now positive, occasionally goes to zero -- it doesn't really get negative. We have a lot of macro volatility. We have a lot of market volatility. All of that is coming from just uncertainty where things are going. Inflation is a very big theme. There was really a variety of things that are going on, variety of reasons. There were some structural shifts, but it could be said that whatever we've come to rely upon over the last 40 years, which was really below target inflation was not the norm, was the exception. It was just a really long exception. We've really got a very long period where most of us in this industry really don't remember the period before that, right, depending on how long you've been in it.

But you could argue that that was really a very prolonged exception. And now we are going back to the norm. And the norm is going to be that inflation will be a potential problem for quite a while. And that means that this whole construction benefit of bonds from a diversification perspective, has potentially gone away for quite a while.

And we essentially have a new environment to which we have to adapt to.

And what this means is that asset allocation decisions are still important. They're still even more important than they used to be. Now that there is a great cost to being wrong, if you get this whole stock-bond mix wrong, you're going to be essentially, your portfolio is going to pay the price that was much more significant done in the past. Now, of course, there is also the opposite of that. If you get this right, your portfolio is going to benefit.

So I don't want to discount the importance of bonds. I still think they have a very important role. But you could argue this environment has become more dynamic. And that means we have to adapt and we can adapt through essentially paying better attention, closer attention, more frequent portfolio monitoring, doing some stress test, outcomes on the portfolio.

But also there is a new cast of portfolio participants that could potentially be needed. And we call this category liquid alts.

00;04;16;19 - 00;04;38;02

Aaron Task

Okay. So a lot to unpack there. As I mentioned, you’re head of portfolio consulting for the Americas of Blackrock, and as I understand it, primarily what you do is consult with our institutional clients. So how have you seen them adjust to this new regime as you as you call it? And where do these alternatives that you just mentioned fit into that?

00;04;39;10 - 00;05;00;28

Bart Sikora

Yeah, and I think it's worth spending a couple minutes essentially describing the categories of alts and what we mean by alts. But if you think, broadly speaking, from an alternative, perspective, institutions have always loved alternatives. We can go back to ‘80s or even ‘70s. Alternatives have always been in demand from institutions. The larger the institution, the bigger the portion of alts. Part of the reason is that large institutions can open doors to alts. They can also afford the illiquidity of alts right? Generally speaking, there's two alts categories: alternative assets like private equity, venture capital, private credit, and alternative strategies. Today's conversation is going to be about that second category alternative strategies.

And what are alternative strategies?

They're essentially traditional investments that are held in nontraditional way. And this is what makes them alts but also makes them liquid. We are talking about taking stocks or bonds individually, or as a category, and going long or short. That's, generally speaking, what most of liquid alts will be doing. Right. So, institutions will be pursuing both alternative assets and alternative strategies.

But for today's conversation we will focus on alternative strategies. Liquid alts is just a name. It's a Morningstar category. It's just a term. That term can be a little bit charged, but I really want to focus on the benefits and how to use it in a portfolio.

00;06;05;21 - 00;06;06;10

Aaron Task

Thank you for differentiating. Because frankly, you know, when I heard when I hear the term alts, I think of private equity or fine art or, you know, any number of other things that aren't typically in the playbook for most of I would think of our financial advisors -- certainly retail investor. So I like that distinction of, you know, the liquid versus the less liquid or illiquid, as you put it.

So what is the role that you see for liquid alternatives in a portfolio today, given the environment you described at the beginning?

00;06;39;15 - 00;07;02;00

Bart Sikora

Now knowing what we learn about bonds, which is bonds are not as reliable from a diversification perspective or even capital preservation at times. Right. We still have the income, but you pay a pretty big price in terms of risk or volatility for that income. Diversification is not there. This is where liquid alts can come in as a source of portfolio diversification.

The reason why they're a source of portfolio diversification is essentially the structure of a typical liquid alt fund going long, short and either removing market exposure or minimizing market exposure. It makes the return of that given instrument, typically speaking -- and I have to generalize a little bit because there's categories quite broad right.

You know, generally speaking they're all going to behave differently from each other. But, the objective is that the best liquid alts from a portfolio diversification perspective will be uncorrelated to the sources of risk in the portfolio. They're going to be uncorrelated to both stocks and bonds. And I think 10 years ago, that would be interesting. But right now it is extremely valuable.

Why is it valuable. Because bonds used to serve that role. And now all of a sudden you have a new category of assets or really funds, right, that are offering something that bonds stopped being able to offer in this new regime. And from a portfolio perspective, we're essentially looking for assets that are going to help to right-size the portfolio risk.

You can now choose what level of risk you can run in your portfolio by selecting what kind of a liquid alt you're going to put in and how much you're going to put in. And also what do you fund it by? Some liquid alts can be funded by bonds, some by cash, some even by by stocks. Right. So all these possibilities now give us more levers to pull that historically were not available prior to this change in the regime. Right. Bonds used to be more attractive, but also now we have higher interest rates, higher for longer or high for longer, whichever you want to call it.

00;08;51;22 - 00;09;08;22

Aaron Task

I'm going to ask you to drill down on that because, you know, again, as we sit here today, money market assets are at an all-time high. A lot of people are saying, well, I can get nearly 5% from the two-year treasury. Why shouldn't I just sit there?

How does that actually help make the case for these liquid alternatives that you were just starting to describe?

00;09;11;22 - 00;09;31;08

Bart Sikora

I'm, to switch my focus to discussion on the return structure. So we're putting diversification on the side for a second. Diversification still very useful, but I just want to, promptly move through each important category. Returns, I didn't speak to much before, but typically liquid alts are going to have a cash plus alpha type of return.

If you have a skilled manager, we're talking top quartile. You're expecting to have alpha being generated by the strategy. But the starting point is cash plus alpha. When cash is at 4 or 5%, you have a higher floor for that return. So you're going to have essentially a cash return plus a certain alpha return. Now why is the cash, the sort of embedded benchmark of a liquid alts? That is because liquid alts, as strategies are either going to deploy derivatives and post cash as collateral and earn a higher cash rate, or they're going to be shorting individual securities and essentially are funding that portfolio structure from the short side by sitting in cash and posting that cash.

So, money market return is a component of a liquid alts structure. From a benchmarking perspective, alpha is what you expect to get from the talent of the top quartile manager, right? Cash plus alpha means we have two separate things separate things that are both attractive, higher cash and also higher alpha.

Why is alpha higher in this environment. It's not necessarily going to be higher for all of the managers, but the top quartile managers are now playing in the world with greater dispersion, which means if you're skilled at picking stocks that are going to go long and go short, you can technically free top quartile manager on a hypothetical level - generate higher level of alpha if you're successful right now, this also means opposite.

A not successful liquid alt manager can have a more negative alpha, right? So I don't think the average alpha is going up, I just think that dispersion of stocks results in a dispersion of potential alpha that good and bad managers can generate. Right. So higher cash and more alpha, if we picked a successful manager, this is why we are looking at liquid alts as an attractive return strategy.

That's a lot of interesting things right. We bring back what we discussed about bonds. Bonds are no longer as attractive. That actually makes liquid alts even more attractive. Right. So that's that's in essence what we're looking at.

00;11;59;21 - 00;12;00;06

Aaron Task

All right. So before we get to the implementation of this one more sort of broad general question here about this category: for advisors who certainly, you know, many of them have clients who are at or near retirement or individuals in that point in their life. Why do you think this is such an important tool in the toolkit right now?

00;12;20;15 - 00;13;06;15

Bart Sikora

Yeah. So historically, we know that investors, or any financial advisors who have investors who are approaching retirement, we have historically counted on bonds to essentially deliver, certain prospects in retirement -- a certain uncertainty and essentially, portfolio behavior or maybe, a limitation of unexpected portfolio drawdowns. Now with, essentially bonds being less reliable to to accomplish this, it's tough for everybody and anybody to constructing portfolios, but it's additionally tough for investors and financial advisors with investors heading towards retirement, because the greater bond proportion is now even more potentially unreliable in a portfolio construction.

When somebody has a 20% bond allocation, sure, diversification would have been nice, but you can still make it through. You have a long time horizon. But when you're looking at 80% bond allocation and you want that certainty of returns, this is where I think financial advisors with investors close to retirement, with clients close to retirement. This is where

the risk of essentially missing your objective is even higher.

Aaron Task

Okay And Bart before we wrap, for those listening who might be interested in pursuing some of these strategies, what would your approach be in terms of implementing this?

00;13;41;17 - 00;14;00;11

Bart Sikora

Every portfolio is different, right? This is really specific to an individual allocation. I'm just going to give you one hypothetical example on how, one would do it. Right. You can either go with a single liquid alts strategy or you can combine few of them.

If you select the right ones on a going forward basis, they should complement each other.

They should be uncorrelated to each other, and they should have an additional level of portfolio benefits.

So the example that I'll give in this case, we have an equity liquid alts that is essentially going long-short on traditional global equities. and this fund should have a fairly low level of correlation to stocks and bonds, and that alpha should be essentially uncorrelated, but the general sources of economic risk.

And for us that fund is BDMIX, which is the Global Equity Market Mutual Fund. Now, I'm going to pair this hypothetically with a fund on a fixed income side. And that fund here is called Systematic Multi Strategy BIMBX. Both of these funds are liquid alts from a traditional perspective of low correlation to stocks and bonds and also low correlation to each other.

So now let's imagine a hypothetical allocation where you go 5% one 5% of the other. And you fund that maybe equally from stocks and bonds. But you also have a choice to fund that fully from bonds. Or you can fund it from cash. You have essentially, a lot of levers to pull in your portfolio. Every portfolio is different.

So you can essentially choose how you're going to allocate. But that's just one idea of how we would think through portfolio implementation. Two tickers, in this case a very simple 50/50 weighting. But there is infinite numbers of ways to implement it. It really is portfolio specific.

00;15;32;01 - 00;15;43;00

Aaron Task

All right. And I don't know about infinitely, but I'm sure we could discuss this further. We do have to leave it there.Our guest has been Bart Sikora, head of portfolio consulting for the Americas at Blackrock. Bart, thanks very much.

00;15;43;02 - 00;15;44;25

Bart Sikora

And thank you so much. Pleasure.

Spoken Disclosure:

Visit www.blackrock.com to view a prospectus, which includes investment objectives, risks, fees, expenses and other information that you should read and consider carefully before investing. Investing involves risk, including possible loss of principal.

Written Disclosure:

Alpha is the excess return of a fund relative to the return of a benchmark. 

Correlation measures how two securities move in relation to each other. Correlation ranges between +1 and -1. A correlation of +1 indicates returns move in tandem, -1 indicates returns move in opposite directions, and 0 indicates no correlation.

Carefully consider the Funds' investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds' prospectuses or, if available, the summary prospectuses which may be obtained by visiting www.blackrock.com. Read the prospectus carefully before investing.

Investing involves risk, including possible loss of principal. Diversification and asset allocation may not protect against market risk or loss of principal.

BlackRock Global Equity Market Neutral Fund (BDMIX): The fund is actively managed and its characteristics will vary. Stock values fluctuate in price so the value of your investment can go down depending on market conditions. International investing involves special risks including, but not limited to currency fluctuations, illiquidity and volatility. These risks may be heightened for investments in emerging markets. The issuers of unsponsored depositary receipts are not obligated to disclose information that is, in the United States, considered material. Investing in long/short strategies presents the opportunity for significant losses, including the loss of your total investment. Such strategies have the potential for heightened volatility and in general, are not suitable for all investors. The fund may use derivatives to hedge its investments or to seek to enhance returns. Derivatives entail risks relating to liquidity, leverage and credit that may reduce returns and increase volatility. The fund may engage in active and frequent trading, resulting in short-term capital gains or losses that could increase an investors tax liability. Short-selling entails special risks. If the fund makes short sales in securities that increase in value, the fund will lose value. Any loss on short positions may or may not be offset by investing short-sale proceeds in other investments. Investing in small- and mid-cap companies may entail greater risk than large-cap companies, due to shorter operating histories, less seasoned management or lower trading volumes.

Systematic Multi-Strategy Fund (BIMBX): The fund is actively managed, and its characteristics will vary. Stock and bond values fluctuate in price so the value of your investment can go down depending on market conditions. International investing involves special risks including, but not limited to political risks, currency fluctuations, illiquidity and volatility. These risks may be heightened for investments in emerging markets. 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. Principal of mortgage-or asset-backed securities normally may be prepaid at any time, reducing the yield and market value of those securities. Obligations of US government agencies are supported by varying degrees of credit but generally are not backed by the full faith and credit of the US government. Non-investment grade debt securities (high yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher rated securities. Investments in emerging markets may be considered speculative and are more likely to experience hyperinflation and currency devaluations, which adversely affect returns. In addition, many emerging securities markets have lower trading volumes and less liquidity. The fund may use derivatives to hedge its investments or to seek enhanced returns. Derivatives entail risks relating to liquidity, leverage and credit that may reduce returns and increase volatility. Effective 1/4/19, the Alternative Capital Strategies fund name was changed to the “Systematic Multi-Strategy Fund”. The Fund’s information prior to September 17, 2018 is the information of a predecessor fund that reorganized into the fund on September 17, 2018. The predecessor fund had the same investment objectives, strategies and policies, portfolio management team and contractual arrangements, including the same contractual fees and expenses, as the fund as of the date of reorganization. As a result of the reorganization, the Fund adopted the performance and financial history of the predecessor fund.

This material represents an assessment of the market environment as of the date indicated; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.

This material contains general information only and does not take into account an individual's financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial professional before making an investment decision.

Prepared by BlackRock Investments, LLC, member FINRA.

© 2024 BlackRock, Inc. or its affiliates. All Rights Reserved. BLACKROCK and iSHARES are trademarks of BlackRock, Inc. or its affiliates. All other trademarks are those of their respective owners.