Investors in this fund are looking for attractive income but are unwilling to take significant risk in order to achieve this. With this in mind, we have to concentrate not only on the reward but also the risk, both in terms of volatility and drawdown.
We tend to be cautious and avoid asset classes that have high volatility whenever stress hits the markets. An easy way to generate income is go out in duration and down in quality but we do not believe this is a sensible policy in today’s market conditions. Three trades that sum up this philosophy are as follows:
With global growth positive but still fairly underwhelming we like equities but do not expect them to have significant upside. As such, we feel we can get good income from harvesting option premium in return for selling away upside. We mitigate how much we are selling away by writing a relatively short-term 5 per cent out of the money calls. This delivers greater than 10 per cent annualised income and offers the potential for some upside.
The secondary feature about this trade that is so appealing is the fact we can diversify our equity holdings away from pure high dividend stocks into cyclical names. In the quest for yield, high dividend paying stocks have been bid up versus the broader market and so look both relatively expensive and sensitive to interest rate rises: two unattractive qualities relative to cyclical stocks.
Fed rate rise
We have been very active in our positioning regarding when the Federal Reserve will raise rates. In general we have shortened our portfolio duration and, in recent months, it has been around two years.
Coming into the start of the year we were concerned about when the Fed was going to start normalising policy and the subsequent market reaction. As such, we hedged out our exposure at the front end of the yield curve and were content to have risk at the back end.
Over the first quarter this view became fairly consensus and, as more people put the trade on, the markets reacted accordingly, pushing up the front end. Therefore our hedge, which had protected us from this movement, was now redundant so we took them off. The decision proved beneficial when rates backed up more at the back end relative to the front end.
We believe the market is underestimating the risk of a lack of liquidity in the bond markets. Liquidity has been getting steadily more challenging for all credit and fixed income over the past few years as investment banks have reduced their inventories significantly. As such, we have taken a prudent decision to take roughly half our high yield risk in ETFs and other liquid indices.
The remaining cash bonds we hold we are happy to hold to maturity if needs dictate. This means we will still have the ability to adjust our portfolio positioning even through stressed environments.
Justin Christofel is co-manager of the BlackRock Global Multi-Asset Income fund