Rick Rieder is BlackRock's chief investment officer of fixed income, fundamental portfolios, and head of the firm's global credit business and credit strategies, multisector, and mortgage groups. He recently answered our questions on how to find opportunities in one of the most dynamic investment environments in history, especially the strengths found in corporate credit, and explained how the "Five-Point Plan for the Eurozone" has viable strengths to improve the current challenges.
1. How have you used the BlackRock Strategic Income Opportunity fund's lack of sector constraints to capitalise on market shifts in the recent periods of market volatility? What sectors would you say are currently offering attractive investment opportunities and in which areas should investors take caution?
It has been, and will continue to be, one of the most dynamic investment environments in history. The recent volatility, which has largely been caused by European debt crisis fears, has driven spreads wider on a number of risk-asset classes, and it simultaneously has resulted in a flight to quality into the safest and richest asset classes (such as Treasuries, German bunds, gilts, and so on). This has provided a tremendous opportunity to purchase attractive-yielding assets such as U.S. high yield, U.S. financials, European financials, long-dated municipal bonds, and a variety of securitised sectors, such as commercial mortgage-backed securities and automobile-related asset-backed securities. Moreover, we have maintained a moderate weighting in the sovereign debt of Italy and in emerging-markets issues. Simultaneously, we reduced or maintained only moderate exposures to sectors that offer little value or are close to where the risk could emanate from, such as French rates, euro currency, or U.S. Treasuries.
We think that there will continue to be a structural need for yield today and for the coming years, and we regard the fundamentals in corporate credit as very attractive, across high yield and in long-duration investment-grade issues (including some financials). We do continue to worry about the economic headwinds in Europe, which has likely already entered a recession, as well as the still-large issuance requirements in the months ahead for European sovereign, agency, and banking sectors.
All these factors, and the fact that the European dynamic is still unfolding, require caution on the sizing of positions and where investments are made. For example, we do favour a modest exposure to sovereign debt in Italy and prefer its valuation to that of debt issues from Spain. Still, we believe in ultimate yield convergence in Europe, namely, the yields in Italy, Spain, Germany, and France. In addition we do believe that staying quite cautious in the so-called programme countries (Greece, Ireland, and Portugal) still makes sense. Finally, though we are relatively sanguine about growth in Asia, and China particularly, we do recognise the potential stress points in China and thus monitor that situation quite closely.
2. Where should investors be looking for yield in today's market?
As mentioned, we like corporate credit, parts of the asset-backed securities sectors, and munis quite a bit, though we recognise that muni valuations could become stretched and underperform when rates drift modestly higher, as we expect they will over the coming months. Within credit, we do like a number of the hybrid/preferred securities and see these as attractive complements to an equity dividend portfolio.
3. How high of a position are you willing to take in a sector that you feel strongly about, and at what point does it become too risky?
We could see weightings of up to one third of the portfolio, but we look at risk-adjusted returns very carefully. We study long-term volatility trends and each position's potential upside versus its risks. We think that these analyses need to also be supplemented with current volatility and scenario analysis. The environment we find ourselves in now, which is one of more moderate global economic growth, lower market liquidity, deleveraging in the developed world, and uncertain geopolitical dynamics, suggests that long-term volatility analysis is less relevant than it has been historically, while scenario analysis and stress-testing are likely more important today than ever.
4. Will the Federal Reserve's decision to publish its interest-rate forecasts affect how you manage the fund?
It will, at the margin. We think that it actually could increase the level of volatility in the market because the forecasts will vary among Fed participants. It also might introduce a bit more uncertainty into the internal Fed decision-making process and its market perception. Still, that added transparency and the commitment of the Fed to keep rates low for a long time yet increases our confidence in short- to intermediate-term-spread sector investments. Moreover, as I've argued in my Fixed Income Market Outlook, we think an increase in the perceived volatility of longer-term inflation expectations adds to the argument for owning Treasury Inflation-Protected Securities and aggressively managing duration exposure at the longer part of the curve.
5. Is there a good solution to the sovereign debt crisis in Europe? What do you think is the most likely outcome? Have you made any changes in the fund to account for your view?
As we've also argued in recent months, we do believe that a "Five-Point Plan for the Eurozone" could go some distance in stabilising the crisis situation and placing the continent on a path toward recovery. The main issues that require decisive resolution include:
1. Dealing with the programme countries' (Greece, Ireland, and Portugal) debt loads on an individual basis;
2. Clarifying the role of the European Financial Stability Facility (or European Stability Mechanism or other entity) and what a fiscal compact looks like alongside these;
3. Providing a tangible longer-term backstop plan for intermediate- to longer-term sovereign issuance;
4. The setting of growth-sensible austerity programmes across much of the region;
5. Achieving some clarity for additional capital into the banking system.
The implementation of the European Central Bank's Long-Term Refinancing Operation has given us more confidence in the likelihood of a more deliberate pace of deleveraging in the European banking system and an adequate financing of the sovereign issuances (at the short-end at least). Consequently, we have been more comfortable in adding risk globally. Yet, we recognise that much of what we outlined as part of that five-point plan remains unresolved, and as a result we are keeping powder dry for potential opportunities. And in Europe, we are slowly and deliberately adding European financials and some sovereign risk (Italy primarily), while expecting a weaker currency and sovereign convergence (France and Germany toward the rest).
Further reading/viewing: Rick Rieder on What the Next Decade Will Bring for Fixed Income.
