Huge swings in market prices, asset valuations and economic projections as a result of the Covid-19 pandemic has prompted asset manager BlackRock to rethink many of its expected returns and asset views.
The BlackRock Investment Institute has made several changes to the strategic asset allocation within its US-dollar-based multi-asset portfolios.
“Anchoring investment views to the past is becoming less relevant, in our view, as structural trends such as rising inequality, deglobalisation, the policy revolution and sustainability race toward us,” said Jean Boivin, head of the institute.
Indeed, the sharp market swings seen earlier this year has meant that the strategic views put forward by the BlackRock Investment Institute team have had to evolve “with an unusually high frequency”.
Boivin explained: “From late-2018 until the start of this year, we favoured a barbell approach in our strategic allocation, preferring equities and government bonds to credit.
“In March, we made a case for leaning into equity exposures and significantly upgraded credit after a sharp risk sell-off that we saw as excessive, as we expected the unprecedented policy response would make the cumulative impact of the virus shock likely a fraction of that seen after the 2008 global financial crisis.”
This strategic opportunity, however, has now largely vanished following a sharp rebound in valuations, said the strategist.
As such, the asset management thinktank’s multi-asset portfolio is now mildly underweight global investment grade credit and developed market equities, although Boivin and colleagues believe there remains an important role for private markets and Chinese assets playing in strategic portfolios.
Strategic asset allocations in multi-asset portfolio
Source: BlackRock Investment Institute
And having started the year with a strategic overweight to nominal developed market government bonds, this is now its largest strategic underweight following the pandemic and the policy response it sparked with governments around the world enacting huge fiscal and monetary stimulus programmes to stop the global economy grinding to a halt.
“The policy revolution to cushion the Covid shock challenges the role of nominal government bonds in strategic portfolios by lowering their returns and reducing their ballast properties,” said Boivin.
“We expect negative returns across developed market government bonds on a five-year horizon.”
Boivin added: “Furthermore, the inverse correlation between bonds and stocks weakens as yields are near perceived lower bounds. This reduces bonds’ ballast role, or ability to cushion portfolios against risk asset sell-offs.”
Another significant strategic asset allocation change in the portfolio has been the moving of inflation-linked bonds from a neutral weighting to an overweight position.
In a recent report, the institute noted that US inflation has been picking up more quickly than many officials were expecting just two months ago and has the potential to climb back to annual rates of 1.5 per cent or higher in the near term.
Source: BlackRock Investment Institute
“We see risks of higher inflation over the medium term,” explained Boivin. “Central banks are already explicitly signalling a greater tolerance to let inflation overshoot their targets to make up for past misses.
“That could join force with other factors that we see as driving inflation in the medium term: negative supply shocks, deglobalisation and reduced competition among large firms.”
He said greater inflation might become more tempting politically as increased debt levels make it harder to sustain materially higher interest rates.
“We see inflation-linked bonds as an increasingly attractive alternative to nominal bonds, even though its limited market size creates liquidity challenges in some markets,” he added.
Nevertheless, the medium-term inflation trajectory will likely depend on virus dynamics, the economic restart, and fiscal and monetary policy support.
“Together, a renewed uptick in virus infections, a slowing recovery and a looming fiscal cliff could also create some material downside risks,” warned the institute. “Covid-19 also causes material capacity constraints in a range of contact intense services.
“All in all, we see the Covid-19 shock as having widened the range of plausible inflation outcomes over the longer term, with the balance of risks tilting to the upside.”
It added: “The monetary-fiscal policy revolution, potential changes in central-bank inflation tolerance, debt overhangs and deglobalisation all point to a higher likelihood of a regime change in inflation dynamics in coming years.”