Forget Great Rotation, Think Fixed Income Risk Mitigation - BlackRock

Chrissy Coleman

27 February 2013

In the investment hunger for yield, banks are hailing the “Great Rotation” from bonds to equities as a development that will deliver high returns but US investment manager BlackRock suggests investors should “skip this chapter”, citing flaws in the idea.

In its latest market commentary, BlackRock said money is seeping out of cash and other safe havens as risk appetite increases. However, rather than diving onto the “equities bandwagon”, the firm said investors should instead consider the hidden risks in today’s fixed income portfolios.

“Rather than worry about the bursting of a bond bubble and/or salivate over a massive shift to equities, investors would do well to focus on these hidden risks,” the report said.

Equities no guarantee

While the firm notes that fixed income investments have become progressively riskier as a result of ultra-low yields, it said: “a resumption of robust global growth that would justify a strong move back into stocks is by no means certain".

Also, though the “Great Rotation” scenario assumes that strong inflows into bond funds since early 2009 came from stocks – and will now return there - in fact these flows more likely came from money market funds, BlackRock said. “The bottom line for investors is: the interest rate risk in fixed income remains acute, and portfolio mitigation measures are in order,” it said.

Mitigation measures

So what does this mean for investors? The report suggests that investors consider the following steps to manage potential fixed income risk:

-- Uncover Risks: Recognise hidden risks in bond portfolios and consider diverging from fixed income benchmarks—or even abandoning them;

-- Go Short: Shorten duration and emphasise higher yielding credit over “safe” government bonds;

-- Change Gears: Markets tend to overshoot. Be ready to take advantage by rotating duration, credit sectors or asset classes;

-- Quality Bargains: The hunt for yield has boosted not-so-great income assets. Climb up the quality ladder for a small loss in yield;

-- Buy Insurance: Volatility in most assets is very low, so options to protect against downside risks or participate in upside opportunities are cheap;

-- (Bond) Pickers Welcome: Correlations between asset classes are breaking down. This puts a premium on security selection;

-- Neutral Bliss: Reduce market exposure by buying favoured assets and simultaneously selling short similar but less desirable securities.

The “Forget Rotation: Think Risk Mitigation” commentary was authored by a panel of BlackRock global investment strategists and fixed income experts, released earlier this week.