Sumit Desai: Hi, I'm Sumit Desai, fixed-income analyst with Morningstar's Manager Research Group. Joining me today is Rick Rieder. Rick is the fixed-income chief investment officer for BlackRock. Rick, thank you for joining me.
Rick Rieder: Thanks for having me.
Desai: We are sort of at a crossroads right now within fixed income--making your job a lot tougher. Can you talk a little bit about your current views of where we're going within the world of fixed income, and how you've come to those conclusions?
Rieder: The most important thing today is monetary policy around the world is evolving, and there's an incredibly different construct about how monetary policy is evolving. We think about the United States starting to exit this excessively easy monetary policy accommodation, same thing in the UK; however, in Europe and Japan, you are going to be in this really easy policy framework for a long period of time.
So how you think about where to take interest rate risk and where to take yield curve risk and credit risk flows right from where those things are evolving today. For example, we don't like to own a lot of front-end interest rate risk in the US, because we think that's where the Fed is distorting the market, which is the exact opposite of last year, when they were distorting the long end of the curve through quantitative easing. Now they are distorting the front end of the market.
At some point--we think sooner rather than later--they are going to allow that to start to evolve, and I think as early as the first quarter of next year, they are going to start to move the front end of the curve and let the funds rate drift higher. So we're trying to keep our exposure down in the front end of the interest rate curve here, and the same thing in the UK, but we are willing to take front-end interest rate risk in places like Europe, because we think the growth paradigm and the leverage paradigm is such that you are going to have very slow growth for a long period of time.
So it's a question of, in today's fixed-income market, how do you optimise? There is nothing cheap in fixed-income anymore. How do you optimize, where do you take interest rate risk, where do you take credit risk, and I think today it's all got to be on the backside of how is monetary policy evolving, and then what is growth going to be in those different regions?
Desai: You made an interesting comment about being in the back-end of the curve relative to the short end, and I think that makes a lot of sense. When you think about six months ago, there was a pretty strong consensus view of where interest rates were going to go and how various managers were positioning their portfolios. That consensus view was wrong, it's fair to say, six months later in hindsight. So, is there a consensus view today, and how do you think BlackRock is positioning themselves differently than that consensus?
Rieder: I think there are couple of interesting things here. First, there are two parts of the rate view--one is, are rates going up or down? And then two, where on the curve does it make sense, because I think that's a really important dynamic.
First thing I would say is, I think this year is going to be the opposite of last year, literally in so many different ways, what asset classes you invest in are going to be the opposite of last year, because the long end was distorted last year to extreme levels, and now it's normalized to a more equilibrium level, although we'll talk about why it's still a bit rich. But the front-end is the place that's literally distorted today.
Our view is, rates will drift higher this year, but we have a very strong view that the curve will flatten and that the back-end will do extremely well relative to the front-end of the yield curve, and that's what's played out this year. The curve continues to flatten, but you've pulled down rates. Some of the reason why you pulled down rates even more so than you would have thought is clearly geopolitical risk--Ukraine, Middle East. I also think there is a realization that there is not enough financial assets in the world today, and there is a realization that there is not enough supply coming into the marketplace, so that continues to drag down the rate curve.
And there is one last point: spread assets have done extremely well. If you think about it, in the last two or three weeks or last month or so, the risk-reward of owning interest rate risk or Treasuries relative to some of the credit assets, it makes sense to own Treasuries, so that also has pulled down some of the interest rate levels to where they are today.
But our view, as the curve keeps flattening, we think rates will drift up as the Fed starts to move faster, but really led by the front end of the curve, and we think, particularly the belly of the curve, the five-year point, is where you could have some more volatility as the year goes on.
Desai: You hinted toward how your various portfolios are positioned. Can you get a little bit more specific in terms of where you are making your big bets right now?
Rieder: Because we believe that this year is the opposite of last year in so many different ways, we are comfortable taking long-end interest rate risks. Things like long-dated municipals that were damaged last year when the yield curve was distorted in the long end. We like long-dated municipals; they give you a lot of yield, especially on a tax-adjusted basis. So, we like that.
Credit, and high yield particularly, was a big exposure for us. We've shifted some of that into real estate related assets--we like commercial mortgages, we like non-agency mortgages. Some of the reason was the technicals of, you haven't seen tremendous inflows into those asset classes, and we actually think the real estate market will do extremely well, and so, we've shifted there more from a technical perspective.
Last year, peripherals--we were very vocal about Spain and Italy as attractive opportunities. I would argue they're not terribly attractive today at these levels. The 10-year of Spain and Italy are pretty close to 10-year Treasuries, and we'd rather own 10-year Treasuries. But we think emerging markets are attractive, particularly in the short end of the curve in local rates. Places like Brazil, where policy has got to move, with the economy slowing, to easier policy.
So, we've shifted some of our Europe risk now to emerging-market risk, and we think that makes sense from a fundamental perspective, given that policy has to be easier in the emerging world today.
So we made a number of shifts in the portfolio that are very, very different than where we were a year ago.
Desai: We're definitely at a crossroads for the fixed-income space, so it's interesting to hear your thoughts. Thank you for joining us today.
Rieder: Thanks for having me. I appreciate it.
