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cynthiatherrera · 4 years

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Investing without a parachute

In the wake of the coronavirus crisis, the U.S. bond market finds itself flirting with negative interest rates and bumping up against the “zero lower bound”—calling into question the ability of bonds to provide ballast in future equity sell-offs.

Rethinking fixed income at the “zero lower bound”

Historically, investors have allocated to fixed income to meet any of three key objectives: capital appreciation, income generation, and preservation of principal. Fixed income’s typical ability to provide ballast against equity sell-offs rests in the normal response of lower interest rates to falling stocks—resulting in a general negative correlation between bonds and stocks. When stock prices fall, bonds prices tend to rise. However, in recent years, super low, zero and even negative interest rates have driven up the value of fixed income securities limiting further capital appreciation and calling into question the asset class’s ability to diversify against future equity drawdowns.

At the same time, the coronavirus crisis is pushing the Fed to lower interest rates to zero for the second time in just over a decade. Now, policy makers are bumping up against the “zero lower bound” on interest rates—or theoretical lowest level that interest rates can fall to before they become unenticing to investors and ineffective as a way to stimulate economic growth. While it is true that negative rates have been seen in other countries around the world before, the scope of negative rates is limited. Why? Interest rates cannot fall (much) below zero because if they do, investors have the option of holding cash which pays no interest, but that is better than a negative-yielding asset.

In this historically unprecedented period, investors should be rethinking the role of fixed income in portfolio construction and ask themselves: Am I investing without a parachute? The answer requires a reexamination of the Global Financial Crisis and the last bout of zero interest rate policy.

From the fear of rising to the fear rates can’t go low enough

After the Global Financial Crisis, the fear was future increases in interest rates. Today, it is the fear interest rates won’t be able fall far enough to provide the safety investors expect from bonds.

The below graph puts the discussion in its historical context. The average decline in the Fed’s policy rate during recessions averages nearly 400 bps – yet the cuts to zero in response to the coronavirus crisis amount to only 175 bps. For longer maturities, the 10-year interest rate on average falls over 300 bps during recessions. Coming into the coronavirus crisis, the 10-year Treasury stood at around 1.75% and has fallen around 100bps. And unlike during the Global Financial Crisis, further declines in longer term interest rates are clearly more limited. Today the 30-year Treasury yield stands just under 1.4% in contrast to close to 5% in the leadup to the Global Financial Crisis.

This implies simply less room for rates to fall when the Fed needs to again provide future accommodation. With zero as the effective lower bound, potential rate declines from here stand clearly lower than in past recessionary periods, implying less potential for positive fixed income returns to offset negative equity returns. So, bond ballast likely remains, but the ZLB limits its amount. In such an environment, alternative forms of ballast take on even greater importance.

icon-pointer.svgRead Jeff’s full take on the outlook for bond markets here.

Exploring alternative forms of portfolio diversification

In the following section we review an alternative approach to adding ballast to a portfolio we call “Defensive Alpha”—which attempts to take advantage of “dispersion” across a broad universe of equities. There are three key structural components to what can make Defensive Alpha an effective portfolio diversifier which we will now walk-through (see figure below).

1. Equity dispersion has tended to rise when markets fall

First, Defensive Alpha seeks to generate returns based on individual stock performance through long and short positions. The potential return, or “alpha” available from this type of investment strategy is the degree to which the market differentiates these individual, or “idiosyncratic” characteristics of stock returns relative to each other. We call this “dispersion.” Higher dispersion is synonymous with events catalyzing greater winners and losers. This is the opposite of the idea that rising tides lift all boats. Falling markets may create greater differentiation between winners and losers and potentially greater return opportunities.

2. Companies with leverage have tended to show increase dispersion

Second, leverage on the balance sheet has increased dispersion. So, a universe of companies using debt may exhibit more dispersion than companies without debt. Limiting the stock selection universe to companies with debt increases the dispersion and hence the potential alpha of our approach.

3. Equity valuations has been more dependent on debt-based metrics during drawdowns

Finally, in good markets the income statement perspective has dominated equity valuation (e.g. revenue growth, net income, EPS). In bad markets, debt-based metrics that are found on the balance sheet rules. This regime dependence of information provides an important third source of structural diversification. The more stressed the environment, the more important debt-based measures of resilience (e.g. indebtedness, liquidity, cash flow and funding costs) become. This increasing relative importance of credit information occurs most strongly when stock markets have fallen in anticipation of recessions and that has tended to increase the defensive nature of the potential alpha returns.

The below figure highlights these important structural characteristics. As you can see, as the volatility of the market rises (pink area), a universe of the most highly levered companies (orange line) display greater levels of dispersion than the typical universe of companies in the S&P 500 (yellow line).

Ultimately, this higher level of dispersion can potentially lead to more opportunities to generate positive returns even when equity markets fall.

Putting it all together

Putting all three of these structural characteristics together can create an alternative form of diversification that may complement the traditional ballast provided by bonds.

Note that while these structural characteristics may be expected to be persistent, not every down stock market is associated with these trends. We have seen occasions when dispersion falls during rapid equity market declines and even quality balance sheet companies under-perform during sell-offs. Hence, these structural characteristics support an expectation, though not a guarantee, of diversification.

The bottom line

In the post-coronavirus investment world, proximity to the ZLB challenges the long-term ability of fixed income to provide diversification for equity portfolios.

Alternative investment approaches such as those targeting Defensive Alpha can provide investors with additional forms of portfolio diversification when bond allocations may not be sufficient.

Jeffrey Rosenberg, CFA, is a senior portfolio manager for BlackRock’s Systematic Fixed Income (“SFI”) team and a regular contributor to The Blog.

Investing involves risks, including possible loss of principal. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of June 2020 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. ©2020 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners. USRMH0620U-1216816. from BlackRock Blog https://www.blackrockblog.com/2020/06/29/investing-without-a-parachute/

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cynthiatherrera · 4 years

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How alternative data can lend clarity amid uncertainty

When conditions are not only unusual but evolving at a furious pace, as they have been since the novel coronavirus was identified early this year, clarity can seem an impossibility.

During such times, official data is often a mix of slow and noisy observations ― making it difficult for investors to develop a holistic and clear picture of the state of play. At the same time, many companies have been withdrawing guidance amid heightened uncertainty, making analysis at the industry and company level even more challenging.

Against this backdrop, alternative data and analytical tools take on new importance in identifying emerging economic and market trends that traditional sources can be slow to efficiently isolate.

What is alternative data?

Alternative (or big) data is physical, unstructured (text) or non-financial data generated by the technologies of our everyday lives ― smartphones, GPS and smart home devices, to name just a few. When aggregated and analyzed in the right way, alternative data can provide valuable insights into country, industry and company prospects.

The BlackRock Systematic Active Equity team has been using various forms of alternative data for more than a decade. Some data sources have proved particularly valuable this year, especially when analyzed with the right context in mind. Here we look at three examples and how they have been additive in assessing the macroeconomic and investing environment during the global coronavirus pandemic.

1. Foot traffic

Foot traffic around shopping facilities was one of the original big data metrics embraced by systematic investors early on, though its relevance has gradually diminished as a significant share of shopping has moved online.

Online buying is even more prevalent amid coronavirus-driven closures, yet foot traffic patterns have reasserted their importance in new ways. Differences in social-distancing policies have led to wide dispersion in activity across countries. We find that comparing foot traffic activity at various points of interest has provided a faster read on economic activity across countries and industries. Our readings at the end of May, for example, showed movement in China was more than two-thirds back to normal since re-openings began in March and April.

2. Natural language processing

Natural language processing (NLP) of text has proved especially useful in gleaning insights from analysts, many of whom were relatively slow to update their earnings estimates for the first quarter of 2020. This is understandable, and similar to what we saw during the global financial crisis of 2008-2009, as point-in-time numerical forecasts are difficult in a world with tremendous room for error. While an analyst may take some time to update a numerical forecast, analyzing the text of their reports helps paint a more complete investing picture in the absence of a definitive arithmetic stance.

NLP also has been helpful is getting an early read on fiscal policy, allowing us to parse analyst language for a sense of how policy is moving across countries. We then lean into those with easing tendencies, such as the U.S. The chart below shows the magnitude of change in fiscal policy direction as determined from sentiment measures gleaned from thousands of analyst reports.

3. Job postings

Hiring trends can reveal important information about both industry- and company-level growth prospects. During the COVID-19 crisis, we’ve extended our coverage of job postings to emerging markets where data scarcity would normally make it less informative. But given the velocity of change today, even lower-breadth measurements have proved useful in identifying potential winners and losers. We also have been able to identify firms seeking skillsets that support work-from-home and accelerating digitalization in general. First movers may have opportunity to gain market share versus competitors.

icon-pointer.svgGet Jeff’s views on Navigating an uneven road to recovery.

From big data to meaningful insights

We have seen this year ― and over our long history using alternative data ― that different insights tend to add value at different times. Some are more effective around earnings releases, while others pick up on slow-moving trends that play out over several months. We have experimented with timing but found that the most effective approach is having diverse and differentiated insights to inform our investment decision-making.

Ultimately, all alternative data sources have flaws and the goal is to get better, not perfect. Our experience has taught us that having multiple datasets to draw from can reveal inconsistencies and anomalies just as well as potential trends. All of this together helps us to develop a picture of the backdrop before it is evident in the official data. This is the type of information edge than can make a difference when the world and the opportunities and risks in it are changing fast.

Jeff Shen, PhD, is Co-CIO of Active Equities and Co-Head of Systematic Active Equity (SAE) at BlackRock. He is a regular contributor to The Blog.

Investing involves risk, including possible loss of principal. Stock values fluctuate in price so the value of your investment can go down depending on market conditions. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks may be heightened for investments in emerging markets. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of June 2020 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. ©2020 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other marks are the property of their respective owners. USRMH0620U-1216796-1/4 from BlackRock Blog https://www.blackrockblog.com/2020/06/24/how-alternative-data-can-lend-clarity-amid-uncertainty/

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cynthiatherrera · 4 years

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Don’t miss the rise of the “value” phoenix

As of this writing, recent jobless claims in the U.S. are zeroing in on 40 million. The S&P 500, while rallying over 30% since March 23rd, 2020, is still negative for the year[1]. Mathematically, we have seen the end of one of the longest bull runs in history. And after a bounce-back from growth and innovation heavy industries like technology and healthcare, some investors today are doubling down on their belief that the value factor may in fact be dead.

Don’t count it out yet. We have seen flickers of value’s reemergence. After outperforming momentum by roughly 6% in September 2019, value has staged another noteworthy rally, outperforming momentum by over 2.5% in just one week[2]. The real question is: when will the value rally stick?

For those skeptical that the value phoenix will rise from its ashes, it’s important to remember three key tenets to factor investing:

Factors have been cyclical

Factors have delivered premia over the long term

Factors have been diversifiers

Value underperformance: cyclical, not structural

Investors have expressed concern that the value factor is “broken” due to a structural change. They point to the price-to-book ratio[3] (P/BV), a common fundamental metric used by traditional value strategies to identify undervalued companies. They highlight P/BV’s inability to account for things like brand value and invested R&D, causing it to underestimate a company’s worth.

While this critique is certainly valid, and one reason the indexes underlying our iShares value factor ETFs are screened for multiple value fundamentals simultaneously, we don’t believe that any single fundamental should be a scapegoat for an entire investment style. After all, value can be found in all sectors and segments of the market, even in those that may not screen well on one individual metric such as P/BV. Rather, we would reiterate that the value factor, like all factors, typically exhibits cyclicality. While factors have tended to outperform over the long-run, in the short-run, they can have periods of underperformance based on the current phase of the economic cycle.

Due to the capital-intensive nature of many value-oriented companies, this factor has tended to outperform during recovery periods and may lag during periods of economic slowdown when flexibility is key. (See below.) As such, we would argue that recent underperformance of the value factor is not caused by a structural change, but instead can be explained by where we are in the economic cycle.

Factors for the long run

In September of 2018, my colleague Andrew Ang explained why he still believes in the value factor. He discussed its academic foundations and noted that while recent underperformance of value is historic – as of this writing, the aggregate value drawdown is the worst in magnitude and the longest going back to the 1920s – he also emphasized that there is no reason to think that the long-term premium is gone.

To support these claims, we looked at the value premium (using Ken French’s data) since the 1920’s to see just how often cheap U.S. stocks have outperformed expensive ones.

Interestingly, value has historically had a positive premium only 50% of the time when looking at daily data. However, as the periods observed increase, so too does the percent of times value has outperformed. Over rolling 20-year periods, the value premium has been positive every time, highlighting the potential benefit of sticking with value strategies for the long run.

Don’t forget diversification

While it’s true that value is currently in the throes of a historically significant drawdown, it’s important to realize this shorter-term underperformance is standard factor behavior. The evidence supporting the value factor is still convincing and abundant. All historical return-enhancing factors — value, size, quality, and momentum — have experienced periods of out- and underperformance at different times. Therefore, much as investors diversify across stocks and bonds, they may want to consider having exposures across multiple factors, to balance the prolonged drawdowns of any one individual factor. They also may look to tactically tilt to one or more factors based on the current economic environment.

From a factor perspective, while BlackRock continues to advocate for portfolio resilience through allocations to quality and minimum volatility, our views on the value factor have become increasingly more constructive, and some are taking notice. In my experience, in anticipation that the value phoenix may soon rise from the ashes, stalwarts and skeptics alike are beginning to increase allocations to a neutral or even overweight position in value in anticipation of a sustained, cyclical and, for many, long-overdue recovery.

Holly Framsted, CFA, is the Head of US Factor ETFs within BlackRock’s ETF and Index Investment Group and is a regular contributor to The Blog. Elizabeth Turner, CFA, Vice President and Christopher Carrano, Associate are members of the Factor ETF team and contributed to this post.

[1] Source: Morningstar as of 6/11/2020

[2] Source: Morningstar, pertains to the week of 5/25/2020. Value represented by the MSCI USA Enhanced Value Index, and momentum by the MSCI USA Momentum Index

[3] Price-to-book ratio is a commonly used financial ratio to determine the value of a company. It is calculated by dividing a company’s stock price by their book value per share.

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.iShares.com or www.blackrock.com. Read the prospectus carefully before investing. Investing involves risks, including possible loss of principal. There can be no assurance that performance will be enhanced or risk will be reduced for funds that seek to provide exposure to certain quantitative investment characteristics ("factors"). Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. In such circumstances, a fund may seek to maintain exposure to the targeted investment factors and not adjust to target different factors, which could result in losses. Diversification and asset allocation may not protect against market risk or loss of principal. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results. Index performance does not represent actual iShares Fund performance. For actual fund performance, please visit www.iShares.com or www.blackrock.com. 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 document 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 advisor before making an investment decision. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this material is at the sole discretion of the viewer. The iShares Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”). ©2020 BlackRock, Inc. iSHARES and BLACKROCK are trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners. ICRMH0620U-1216425-1/4 from BlackRock Blog https://www.blackrockblog.com/2020/06/23/the-rise-of-the-value-phoenix/

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cynthiatherrera · 4 years

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Why we are warming up to Europe

Europe was initially slow in launching policy measures to combat the coronavirus shock. Not any longer. An impressive array of fiscal and monetary measures is getting into place to bridge the economy through the shock. In addition, the euro area has had relative success in curbing virus growth, positioning it well for reopening its economy. We see these two factors as supporting the region’s economy and markets in coming months.

Lockdowns in Europe started relatively early and caused mobility to plummet. Google data – which use mobile phone location data to measure the change in visits to stores and workplaces as well as use of public transit – show average mobility levels across Germany, France and Italy plunging more than 70% below pre-virus levels. See the yellow line in the chart. The sharp drop was a huge drag for activity in the short term but helped curb the virus spread more effectively. Mobility has rebounded quickly and is now on par with the level in the U.S. This bodes well for a pickup in activity, especially as it comes with a lower risk of infection resurgence, in our view. As a result, we could see the pace of recovery in the second half outpacing other regions, including the U.S.

icon-pointer.svgRead more in our Weekly commentary.

After an initially slow start, the euro area’s policy response to the virus shock is picking up pace, with additional spending measures announced recently by Germany and France. Combined with additional monetary support, the size of stimulus is broadly sufficient to match the income shortfall on a euro area level, our analysis shows. The European Central Bank (ECB) has launched new and more flexible quantitative easing: the pandemic emergency purchase program (PEPP). Its targeted longer-term refinancing operations (TLTRO) scheme holds the promise to provide support to the private sector via cheap loans to banks. The ECB has also made clear that it stands ready to do more in monetary policy stimulus if the inflation outlook is still not showing sufficient progress toward price stability in September.

In addition, we see the new 750-billion-euro European recovery plan as a crucial turning point for Europe’s economy and financial markets. The bulk of the proceeds will be distributed as grants – over and above offering cheap financing to ensure the flow of credit to virus-hit economies through new European Stability Mechanism (ESM) credit lines. It will also for the first time create a jointly issued European “safe” asset of a meaningful size. Such pan-European debt would start to rival the total volume of German federal government debt outstanding, after including the almost 300 billion euros of ESM debt outstanding. To be sure, this is not a “Hamiltonian moment” for Europe – harkening back to the U.S. federal government assuming the debts that states incurred in the War of Independence. It’s about newly issued debt, and more work is needed to move the euro area toward a fully-fledged fiscal union.

Policy implementation risks remain. And the risk of a no-deal Brexit looms. Yet our BlackRock geopolitical risk indicator already shows elevated market attention to the European fragmentation risk, suggesting markets may have priced in at least part of that risk.

Bottom line

We are seeing many reasons to be optimistic about the euro area in the second half of 2020, including the ramped-up policy response and effective public health measures. The total of the euro area’s policy actions looks impressive – and they come on top of relatively large automatic stabilizers such as generous welfare benefits. As a result, we maintain our overweight in European peripheral government bonds and are considering an upgrade to European equities.

Elga Bartsch, PhD, is Head of Macro Research for the BlackRock Investment Institute. She is a regular contributor to The Blog.

Investing involves risks, including possible loss of principal. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of June 2020 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. ©2020 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners. BIIM0620U-1221871-1/4 from BlackRock Blog https://www.blackrockblog.com/2020/06/23/why-we-are-warming-up-to-europe/

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cynthiatherrera · 4 years

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Today’s portfolios “Can’t get no satisfaction” from yesterday’s instruments

The Beatles, The Rolling Stones, and The Who captured our imagination (as they did much of the world’s) from the ‘60s through the ‘90s. While we still love listening to them today, we can’t help but notice that modern bands use a variety of new instruments. While guitars and drums are still ubiquitous, it’s hard to find a band today that doesn’t also have a MacBook laptop plugged into a DJ controller and a deck of synthesizers to create richer and deeper overtones for their music.

The investment-instrument landscape has evolved similarly over recent decades. When The Who sang “Talkin’ ‘bout my generation,” the portfolios of that generation would have been well served by traditional high-quality fixed income instruments, such as Treasury bonds, but after a forty-year, 1000 basis point rally, the portfolios of today’s generation “…Can’t Get No Satisfaction,” as The Rolling Stones said, with yields on most components of the Bloomberg-Barclays Aggregate index currently below 1%.

With a nod to the Eagles in “The Long Run,” it will be difficult to generate attractive positive real returns from high quality fixed income over a long time horizon, until and unless yields reset meaningfully higher (something we don’t foresee for quite some time). In the meantime, investors will need to employ new instruments – MacBook and synthesizer equivalents – to create the portfolio enhancements necessary to meet income and return targets, while still solving for the myriad market influences that have no historical precedent today.

These secular influences have become even more onerous with the onset of the Covid-19 pandemic. A cataclysmic global economic shock that will result in lingering headwinds to growth and inflation for years to come. But offsetting this is an epic global policy response that has exacerbated the existing dearth of attractive yielding assets, while temporarily removing the real economy left tail risk of an entrenched and deep recession. Unpacking the nuances of these policies and understanding the influences they’ll continue to have on 2020 asset markets is critical in order to identify the new investment instruments that will help our portfolios remain resilient.

The extraordinary U.S. fiscal and monetary response

The U.S. policy response has been the most remarkable of the developed markets, not least because of the explicit marriage of monetary and fiscal policy for the first time since World War II. In fact, in the first four months of 2020, the U.S. government ran a fiscal deficit of about $1.5 trillion while the Federal Reserve purchased nearly $1.8 trillion of Treasuries, amounting to a direct transfer of ~$1.5 trillion in printed money from the central bank to the private sector. Moreover, the Congressional Budget Office estimates a $3.8 trillion federal deficit for fiscal year 2020, ending September 30, leaving another roughly $2 trillion to spend over the next 3.5 months. To wit, the Treasury currently holds $1.5 trillion in cash, shattering the previous record high, representing demonstrable real-economy policy “dry powder.” The impact of such massive Main Street targeted programs could be the equivalent of almost 37% higher household income over these crisis months, than was the case pre-crisis.

These U.S. policies have also had an immense impact on the financial economy. As with previous bouts of quantitative easing (QE), the Fed bought large chunks of fixed income assets, thereby growing its balance sheet relative to the size of the U.S. Aggregate index in ways that create a “crowding in” effect – essentially forcing investors to buy ever-riskier assets – and the 2020 version of QE has been unprecedented in that regard. The Fed has purchased assets that equate to nearly 10% the size of the U.S. Aggregate index over the last 100 days, bringing the balance sheet to more than 30% the size of this index and shattering its previous record share.

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To be sure, the job losses have been devastating to many, and certain segments of the labor market will be negatively impacted indefinitely. However, the first economic readings from the initial phases of the nascent U.S. economic reopening provide evidence that these polices have been highly effective at stabilizing overall consumption, as well as building private sector savings that now provides an important buffer to the uncertainties that lie ahead. As a case in point, the overall policy response resulted in April data on personal consumption spiking with a record increase, which contrasts starkly with the ugly labor market data we’ve seen in the wake of the lockdowns. As April’s unemployment rate rose to 14.7%, U.S. personal income climbed 8.5% from January’s pre-virus rate. Moreover, through the first four months of 2020, U.S. personal saving has risen by $907 billion, more than twice as much as the last four months of 2019. Relatedly, U.S. commercial bank deposits have grown by near $2.1 trillion since the end of 2019. Thus, there is massive dry powder to offset lost 2020 growth potential, which is estimated to be around $1.1 trillion (estimated at roughly a 5% full year 2020 U.S. GDP contraction).

The policy response in Europe

Simultaneously, Europe has also instituted some critical initiatives that constructively marry fiscal and monetary policy. In what appears to be a “Here Comes The Sun” moment for Europe, the EU Recovery Fund transcends the decade-long intra-continental debate on how to allocate fiscal leniency. Instead, the Coronavirus crisis has given way to an increasingly common narrative among policymakers that no country is at fault for the pandemic and that this exogenous, symmetric, shock has produced asymmetric outcomes. Accordingly, the EU Recovery Response is intended to provide a disproportionate benefit to peripheral countries, with Italy, Spain, and Greece appearing to be key beneficiaries.

Indeed, PEPP’s flexibility on both the timing and destination of policy relief, means the Recovery Fund will likely bring sovereign spreads closer to pre-Covid-19 levels. The mutualization of the program’s financing is also an important structural evolution for markets as the EU will ultimately become the largest global class of AAA assets in coming years. The EU already has roughly EUR 50 billion in bonds and we estimate that could ultimately grow to nearly EUR 850 billion over time, making it a major sovereign bond market comparable to Germany and France. Even a $100 billion re-allocation by foreign exchange reserve managers from USD into EUR bonds would be significant for FX markets.

We are witnessing a historic time for Europe and a potential investment game-changer for markets there. Few incentives have existed over recent years to drive investment toward Europe, but with European asset valuations relatively attractive today, and potentially efficacious economic policy now in place, a low geopolitical risk profile, and U.S. investors increasingly nervous about the upcoming election, Europe may be the beneficiary of incremental capital flows.

The upshot for asset allocation

So, virus-shock challenged fundamentals have quite possibly been more than offset by a blunt-force global policy response. At the same time, a deficit of attractive yielding assets has been compounded by aggressive central bank QE. For asset allocators, a complex, but opportunity-rich, environment of dispersion has become a dominant influence over portfolio construction.

In fixed income, high quality yields are too low to justify holding meaningful positions, so optimal portfolio construction involves moving down the quality spectrum. However, the paradigm of relying on traditional monikers of “Investment grade” and “high yield” is “All Over Now” (hat tip to the Stones). Indeed, the old orthodoxy of maximizing yield for a given rating has given way to a world where IG and HY have “Come Together” (Beatles) in ways that make industry and security selection far more important than adhering to generic asset-rating labels. For example, all else equal, we’d rather own a BB-rated communications company than a BBB-rated energy company.

The same is true for equities, where we choose to eschew the conventional debate about the relative merits of factors such as growth vs. value. Today, identifying durable cash flow generation is the holy grail of equity investing. The wedge between growth vs. no-growth entities, cash flow generators vs. cash burners, those who make ongoing research and development (R&D) investment vs. those who don’t, etc., is widening. The market is rewarding those who are investing in the instruments of the future, while the relics of the past stagnate.

Relatedly, we are passionate about analysis around leverage, liquidity, and cash flow. We see the hyperbolic narrative of excessive leverage in the U.S. corporate sector as missing critically important free cash flow trends. In fact, balance sheets are broadly quite healthy and companies’ ability to service low yielding debt has arguably never been better. Similarly, the common refrain that equity PE ratios are too high vs. history misses the more relevant metric of free cash flow yield. The obvious and persistent outperformance of companies that generate large cash flows renders traditional valuation metrics less useful and provides a much cleaner comparison to fixed income yields. Through that apples-to-apples lens, free cash flow yields for much of the U.S. equity market offer compelling relative value versus depressed fixed-income yields.

So, the 40-year era of rate declines is largely over. high quality fixed income assets offer tactical opportunities but only de minimis return potential from here. Fiscal stimulus is epic and is creating an impact on savings and consumption that will buoy the economy significantly more than most are expecting. Monetary policy stimulus is ubiquitous and will crowd investors into risk as the singular avenue to generate needed return. Europe has put into place a historic evolution of fiscal policy that radically changes an investment climate that was heretofore relying solely on overly aggressive interest rate policy.

And while the world has been screaming “Gimme Shelter” (Rolling Stones) for the past several months, as people are gradually unlocked from their homes, we have little doubt that pent-up up savings and consumption will transition into real economy velocity and growth. Yet perhaps investors still need just a little bit of “Patience” (Guns ‘N Roses), as the coming U.S. election, increased social unrest, and ongoing coronavirus headlines all risk creating more volatility in markets.

It is against this backdrop that we are tasked with selecting the new instruments for 2020’s portfolio. We plan on employing a slate of middle-quality fixed income instruments, mixed with equity exposure (both in the U.S. and in Europe) to sectors that fall on the right side of leverage, liquidity and cash flow dynamics. That combined with opportunistic use of hedges like duration, gold, FX and volatility tools should create a successful and harmonious portfolio, able to withstand the volatility brought on by ongoing virus uncertainty, and the reflationary pressure brought on by its eventual successful resolution.

Rick Rieder, Managing Director, is BlackRock’s Chief Investment Officer of Global Fixed Income and is Head of the Global Allocation Investment Team. Russell Brownback, Managing Director, is Head of Global Macro positioning for Fixed Income, and both are regular contributors to The Blog. Trevor Slaven, Director, is a portfolio manager on BlackRock’s Global Fixed Income team and is also the Head of Macro Research for Fundamental Fixed Income, and he co-authored this post.

Investing involves risks, including possible loss of principal. 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. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks may be heightened for investments in emerging markets. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of June 22, 2020 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Prepared by BlackRock Investments, LLC, member Finra ©2020 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States or elsewhere. All other marks are the property of their respective owners. USRMH0620U-1222539-1/6 from BlackRock Blog https://www.blackrockblog.com/2020/06/23/todays-portfolios-cant-get-no-satisfaction-from-yesterdays-instruments/

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cynthiatherrera · 4 years

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The Race to Zero

A critical project I have taken on during the coronavirus quarantine is measuring and reporting on the impact of green bonds. A key traction of investments in green bonds is that they deliver positive environmental benefits that are measurable. Investors want to quantify how their green bond investments are contributing to their environmental objectives. Asset managers, pension funds and insurers also want to report the environmental benefits of their green bond investments to their end investors, plan participants and customers. The impact reporting exercise addresses exactly that. The million-dollar question I want to answer? What is the impact, the positive environmental and social outcomes, of $1 million investment in a portfolio tracking the Bloomberg Barclays MSCI Global Green Bond Index?

As I set off to engage with over 200 issuers as COVID-induced lockdown measures around the world are put in place, a parallel became clear. Tracking the impact of green bonds has many similarities to containing the coronavirus – they are both races to zero. In the case of the former, it’s the race to a zero-carbon economy. Leveraging the framework for best practices on containing the coronavirus as guide posts, I present here my key takeaways on the exercise of green bond impact reporting.

1. Containment and lockdown

Just as countries and cities have adopted virus containment measures with varying degrees of control, individual green bond issuers have also applied different measures to ‘lock down’ the impact of their projects.

Some have joined forces to figure this out. International finance institutions including the Nordic Investment Bank, Asian Development Bank, European Investment Bank, among others, signed onto a harmonized reporting framework for project-level greenhouse gas emission accounting. Nordic public sector issuers like Kommuninvest, SEK, Kommunalbanken and MuniFin carry out their impact analysis based on the recommendations of the Nordic Position Paper on Green Bond Impact Reporting (2020). This makes sense, as these groups of issuers share commonalities in the way they provide financing.

Investors also want to understand green bond impact figures at the portfolio level. To do so, the indicators need to be scalable and aggregable, issuer-agnostic. We locked down a list of 50 commonly tracked quantitative indicators. These are measures in absolute terms, like tonnes of waste treated/collected per year, tonnes of CO2 emissions reductions or avoided/year, annual renewable energy generation (in MWh), annual energy savings (in MWh), and the number of jobs created, to name a few.

We then do an annual impact reporting exercise for green bond issuers whose bonds we hold. In our attempt to align issuers’ reported impact figures to our set of commonly tracked indicators, we asked each of the issuers to complete a template based on their latest available impact and allocation data. Within hours, my inbox was flooded with responses.

2. Expanding testing capabilities and diligent ongoing monitoring

Based on the endless streams of live COVID updates in my notifications, once everyone has been warned to stay home to prevent the spread, it seems that phase II hammers hard on expanding virus testing and tracing capabilities.

Similarly, in our impact tracking, we want to know how much of their green bond money issuers have spent, understand what projects they have financed, and how much impact these projects have. Our template did streamline and scale the process, but it further highlights the complexity of this exercise, and the variability across issuers. Oftentimes, our verification of their provided figures led to more questions and us digging even deeper.

As an example, green bonds from issuer A and issuer B both finance energy efficiency improvements on buildings. How can $1 billion in green bond allocation from issuer A result in 300,000 megawatt-hours in annual energy savings, while the same allocation from issuer B only translate to 10,000 megawatt-hours? In the case of green buildings, the base energy consumption in each country and region varies, and the baselines for comparison used by the issuer can also vary. Thus, context matters when looking at impact figures, even within the same sector.

Another key consideration is to ensure that impact is attributed proportionally to an issuer’s participation in the project. In cases when green bond issuer A and green bond issuer B both finance the same project, they each should only claim the project impact for their share of financing to avoid ‘double-counting’. In our due diligence process, we take care to engage with issuers where the share of project financing is unclear and provide feedback for the next iteration of their impact reports.

The diligent tracing, engagement and tracking that this exercise has unlocked is unprecedented, but this is still by no means clean and straightforward. However, there is progress towards transparency and standardization. Increasingly, we see better and more commitment to impact reporting from players in all sectors of the market. With every iteration, we as investors are also refining our own approach to tracking impact figures at a portfolio level. As with anything, practice makes perfect.

3. Making a breakthrough into a sustainable long-term solution

The world is racing towards a vaccine, because no matter how successful containment and tracking measures are, there needs to be a viable long-term solution. The ‘vaccine’ for impact reporting, to make this a more seamless and scalable exercise for the green bond community is an open source, transparent platform.

This is why, in 2020, BlackRock has partnered with Cicero and Stockholm Green Digital Finance to support Green Assets Wallet, an independent platform for green securities. The platform gives issuers the opportunity to transparently and efficiently communicate their green bond offerings and achievements, and gives investors the capability to track our portfolio impact over time.

We have pushed issuers to leverage the platform to disclose their impact figures and use the tool to streamline their green bond impact tracking procedure. The network effect of scaling up transparency and reporting is certainly going to be a game changer in the sustainable finance market, starting with green bonds.

How did we do?

As an illustration of your possible impact on the world, for a hypothetical green bond portfolio that tracks the Bloomberg Barclays Global Green Bond Index, the graphic below summarizes key metrics such as the amount of renewable energy generated, energy or water saved and emissions avoided per $1 million invested[1].

Emily Weng is a member of the Global Fixed Income Responsible Investing team.

[1] In this exercise, we capture a representative majority but not all of the hypothetical portfolio’s impact. There are 228 issuers represented in this portfolio, who together have a total of $529 billion in green bonds outstanding. Of these issuers, 79%, representing 91% of total assets, reported on environmental impact in 2019. Investing involves risks, including possible loss of principal. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of June 2020 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. ©2020 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners. from BlackRock Blog https://www.blackrockblog.com/2020/06/18/the-race-to-zero/

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cynthiatherrera · 4 years

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Seeking yield? Don’t put all your eggs in one (income) basket

Once again, yields are low… really low. This creates an obvious challenge for investors that still need their portfolios to generate income. While junk bonds offer high levels of income, you probably shouldn’t have risky junk bonds as your only income generator. But how can we build a portfolio with the primary goal of income while being mindful of not having all our eggs in one basket?

For the DIY crowd, there are an almost limitless number of income-seeking portfolios you can make with bond ETFs. You could invest in U.S. Treasuries, mortgage-backed securities, corporate bonds, emerging market debt, and even floating rate bonds. But knowing how to combine and manage these different types of bond exposures in a portfolio can be overwhelming.

A bond ETF with a lot of “baskets”

iShares Yield Optimized Bond ETF (BYLD) is optimized to simplify the process of diversified income generation. BLYD seeks to track the Morningstar® U.S. Bond Market Yield-Optimized Index which is designed to deliver current income by including bond funds that have demonstrated strong risk-adjusted returns. To do this, it dynamically updates its bond sector exposure depending on the current market environment.

The underlying index for BYLD is built from a diversified set of bond ETFs that are selected from a vigorous screening process. ETFs in in the index must have a minimum of one year of history, over $100 million in assets, and meet minimum daily trading volume to ensure liquidity. BYLD can invest in U.S. Treasuries, mortgages, and both investment grade and high yield credit (see below graphic).

In order to determine the composition of the index, Morningstar looks back over the past 3 years at indicators such as return, standard deviation or risk, correlation and yield of the eligible securities. As a result, the ETF is based on a rules-based, transparent approach to maximizing yield and keeping risk in line with the overall market. BYLD is a one ticker, low cost solution to a portfolio’s bond allocation optimized for income.

Broadening your “baskets” beyond bonds

In addition to bonds, investors may also want to incorporate stocks and alternative sources of income. With a multi-asset approach, there are additional avenues to typically higher yielding asset classes and diversification, such as exposure to real estate and high dividend-yielding stocks (see above graphic).

The iShares Morningstar Multi-Asset Income ETF (IYLD) is designed to do just that. IYLD seeks to track the Morningstar® Multi-Asset High Income Index which seeks to optimize a combination of iShares ETFs to maximize yield per unit of risk. The index rebalances back to a 60% fixed income, 20% equity and 20% alternative allocation on a quarterly basis.

Finding a balance between yield and risk

Let’s take a look at how the risk and yield of these approaches compare to other similar investments. The graphic below compares the index of BYLD versus aggregate bonds and high yields bonds. Similarly, the index of IYLD is compared to U.S. stocks and U.S. dividend stocks. As you can see, the diversified approach of BYLD and IYLD has offered a middle ground of yield and risk versus traditional asset classes.

For investors who have recently been hit hard by the sell off in high yield bonds, or has not been able to meet income targets by investing in aggregate bonds, the index of BYLD has been able to add incremental yield without the same level of volatility as junk bonds. The index of IYLD has also shown that you can achieve a similar level of income as U.S. stocks and dividend stocks, while having and overall lower level of risk.

The bottom line

Income is an important aspect to many portfolios and often the top priority when it comes to investing. Although we may be in a low yield environment today, opportunities for potential income continue to exist both in bonds and broader asset classes. Constructing the optimal portfolio while weighing risk and return is difficult. Accessible and adaptable ETFs like the iShares income optimized BYLD and IYLD may be a good solution for many investors.

Karen Schenone, CFA, is the Head of U.S. iShares Fixed Income Strategy within BlackRock’s Global Fixed Income Group and is a regular contributor to the Blog. Blair Amorello, Associate is a member of the iShares Fixed Income Strategy team and contributed to this post.

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.iShares.com or www.blackrock.com. Read the prospectus carefully before investing. Investing involves risk, including possible loss of principal. 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. 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. Investment in a fund of funds is subject to the risks and expenses of the underlying funds. Diversification and asset allocation may not protect against market risk or loss of principal. Buying and selling shares of ETFs may result in brokerage commissions. The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective. The information presented does not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy or investment decision. This document 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 advisor before making an investment decision. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this material is at the sole discretion of the viewer. The iShares Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”). Morningstar is a trademark of Morningstar, Inc. and has been licensed for use by BlackRock. The iShares Funds are not sponsored, endorsed, issued, sold or promoted by Morningstar, Inc., nor does this company make any representation regarding the advisability of investing in the Funds. BlackRock is not affiliated with Morningstar, Inc. ©2020 BlackRock, Inc. iSHARES and BLACKROCK are trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners. ICRMH0620U-1211666 from BlackRock Blog https://www.blackrockblog.com/2020/06/17/seeking-yield-dont-put-all-your-eggs-in-one-income-basket/

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