Rick Rieder who oversees $ 1.7 trillion as chief investment officer of BlackRock’s global bond division (BLK), said at a briefing on Wednesday that bond investors had to rethink their management strategies when the Federal Reserve began to raise rates and exit its quantitative easing mode, creating an “extraordinary” period for the market.
Using longer-dated bonds as a means of hedging a portfolio’s equity risk is a popular strategy that may not work as well, Rieder said. A risk parity strategy of balancing equities and bonds and neutralizing risk with tools has generated a return of around 8.2% over the last decade, but a 6.9% decline since beginning of the year.
One of the reasons is that long-term bonds have been affected this year. The Bloomberg Barclays US Aggregate Bond Index is down 1.61 percentage points since the beginning of the year, but those who took a duration risk were hit harder. The long end of the curve is down by four percentage points, while the one to three year portion is down only 0.21 percentage point.
To cover the risk, Rieder said investors should invest in riskier options rather than using tools to manage that risk. What other popular strategies may not work as well? He also distinguished the volatility of sales, which he described as using tools to earn income or risk spread and taking more credit risk to get a return.
“The story of the year shows that the short end of the interest rate curve has increased and the markets have underestimated the importance of this deal,” Rieder said. Now investors can earn two-year Treasury bills, for example, without having to take a lot of risk, whether in terms of credit risk or international risks.
And the risks are many. Rieder, who still fills his presentations of paintings, has highlighted a particular: the growth of the US deficit while the US economy is doing well. “You do not usually see that, so the question is how are we going to pay for that, which is a big problem for the fixed income markets,” he said, pointing out that the debt needed for finance US growth and what the market the issuance of net debt by the US Treasury will have historical value.
This feeds his outlook: Rieder expects that much of the growth resulting from recent fiscal stimulus, such as tax cuts, will be anticipated. In other words, he expects growth to be strong in the short term, even if a recession could occur in 2020 or 2021. Although Rieder expects a pickup in inflation, he says growth will not be as fast as some hope. Some fear that the Fed will increase its rates at a rate of five rises, but expects three to four rises a year.
For Rieder, to earn money in bonds, one must now stick to short-term bonds and take a risk by holding emerging market debt. Not only is this part of the world less indebted than most developed countries, but valuations remain attractive enough for investors to be compensated for taking the risk, he says.
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