Fewer bonds and more alternative investments and multi-asset products: That’s what BlackRock is recommending for advisors’ client portfolios at a time when volatility remains “stubbornly high” while the pandemic continues, fiscal pressures grow and a national election looms.
“The steady hand of advisors remains critical to ensuring clients maintain focus on their long-range investment plans,” according to BlackRock’s latest Advisor Insights Guide.
Following are its highlights of the guide, which is based not only on market developments but analysis of more than 20,000 advisors’ investment models from the firm’s Aladdin-powered Advisor Center and from advisors’ consultations with the firm’s Portfolio Solutions team. Interestingly, there’s no mention of environmental, social and governance or sustainable investments, which BlackRock’s CEO has been touting.
Reduce Bond Allocations
Bonds have historically served as the key diversifier for balanced portfolios, but extremely low interest rates coupled with rising equity risks have reduced their effectiveness. “Higher potential risk and lower anticipated returns is not an investor-friendly combination,” according to the Insights Guide.
BlackRock’s Aladdin platform forecasts annualized volatility of a traditional moderate 60/40 stocks/bonds portfolio above 9%, compared with 8.7% over the past five years, plus lower overall returns for both stocks and bonds.
“Bond allocations should probably decrease a bit compared to their levels in the past, when rates were higher,” the report notes.
Add Alternatives, but Beware Cost Creep
Such additions could help portfolios better balance risk and return for the future, according to BlackRock. It recommends that advisors sell both bonds and stocks to source investments in alternatives, changing the 60/40 traditional portfolio to 50/30/20 (stocks, bonds, alternatives), rather than to 60/20/20, with allocation for bonds equal to that for alternatives.
“Don’t simply sell out-of-favor bonds,” the report says. “Source the trade thoughtfully and measure the impact to ensure the right balance of risks.”
The BlackRock report doesn’t specify which alternative investments makes sense in the current environment, but co-author Patrick Nolan, a director and senior portfolio strategist, tells ThinkAdvisor that alternatives that offer consistent and predictable non-correlation to core stocks, ideally with lower volatility, are preferred.
Market neutral funds, for example, include products with no correlation to the S&P 500, according to Nolan. He cautions advisors, however, to do their due diligence for alternative investments because of the amount of dispersion between funds in that universe, which is much greater than that between core stock or core bond funds.
The BlackRock report also cautions about the relative higher cost of alternative investments — the average fee charged by an open-end alternative fund is 1.47% — which could affect portfolio performance.
The remedy for that, according to BlackRock: Use low-cost ETFs for core bond and stock allocations, though the stock sleeve could be split between core stock ETF and active strategies. “A shift in this area could meaningfully help offset the cost of adding alternatives,” the report notes.
“By shifting some portfolio assets from the lower expected returns of bonds to something higher in alternatives, we can potentially overcome a more challenging market environment for clients,” according to the report. “But we must manage risk and costs while we do it.”