Rieder, Worah Offer Bond Portfolio Tips In Tough Market

The CIOs and fixed-income experts at BlackRock and PIMCO say focus on quality and trim back risk.

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Reviewed by: Cinthia Murphy
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Edited by: Cinthia Murphy

Chicago – Being a fixed-income investor these days isn’t easy. As sovereign yields around the globe fall into negative territory amid global growth fears, and the U.S. Federal Reserve weighs the decision to hike rates this year, uncertainty abounds.

To fixed-income managers Rick Rieder, BlackRock’s chief investment officer of global fixed income, and Mihir Worah, PIMCO’s chief investment officer of asset allocation and real return, this environment means it’s high time to ballast bond portfolios and hedge risk by opting for high-quality credits and longer-dated Treasurys.

Speaking Tuesday at the Morningstar Investment Conference in Chicago, Rieder and Worah each outlined where they see opportunity and pitfalls in today’s bond markets, and offered some portfolio construction recommendations to the crowd of wealth managers and advisors in attendance:

Rieder: Things are getting harder for the Fed, and the focus is on “hoarding” cash flow by looking globally.

·         On the Fed:

“The window for the Fed was more open a year ago. Now, we are close to full employment and the inflation metrics they want, but momentum has begun to trend down,” Rieder said. According to him, as corporate earnings and revenues start to lag, the labor market tends to follow.

“We’ve seen the best,” he said. “I think the Fed is going to keep the door open for a July hike—a 25% chance—but I don’t think they will get two moves done this year. The influences on the Fed are more outside the U.S. than I’ve seen in a long time.”

·         Cash flow:

In this environment of low rates for longer, Rieder said one crucial metric he is looking at is cash flow.

“Cash flow is actually declining worldwide,” he said. “We are living in a world where demographics suggest growth is going to be slower. And the influence of technology—the efficiencies technology brings create less cash flow around the world.”

“For portfolios, we now live in a lower-growth world distorted by monetary policy, so what do you do? You hoard cash flow,” Rieder added. “Try to capture carry. Upgrade the quality of portfolio.”

·         Portfolio picks:

In practice, that has meant a rotation out of some of high-yield exposure and into investment-grade credit.

In emerging markets, Rieder likes Indonesia, India, Mexico, Argentina and “a bit of Brazil” because, in these countries, “we are getting paid in real rate to take the risk.”

“Take carry in parts of the world where it makes sense, and where you get paid a real rate,” he said. “But the tail risk around the world means we are going to see a lot of tremors, so stay diversified.”

His advice: “Interest-rate risk has gotten extremely long—we’ve never seen anything like this. Small moves in rates can create significant loss.” Any asset allocation and portfolio makeup should keep that in mind.

 

Worah: Treasury and TIPS are the rocks of the portfolio today.

·         On the Fed:

The Fed may still do one or two hikes a year going forward, he said, the first hike potentially in July if the labor market and inflation expectations don’t disappoint. Relatively speaking, the U.S. economy is “OK.”

His base case counts on a global economy that will continue to “muddle along” in the near term, and a U.S. economy growing at about a 2% rate, all helped by central bank action. But there are risks ahead.

“Monetary easing has gotten us this far, but as we reach the end of central bank efficacy, valuations across asset classes are ahead of fundamentals discounting long-term interest rates,” he said. “We think this continues for a year or two, but it’s not a sustainable situation.”

·         Treasurys and TIPS to the rescue

What’s ahead could include either the unraveling of rich valuations, or inflation and high interest rates in some sort of unwinding in the next two years, he said. For those reasons, Worah is looking to be “more defensive, more high-quality, and higher in the capital structure” in fixed income.

To achieve that, he has turned to long-duration Treasurys and TIPs, even in the face of deflationary—not inflationary—pressure worldwide.

“Even with yields where they are, U.S. Treasurys still offer value, and TIPS are cheaper than they should be,” he noted.

Yes, in the short term, TIPS have risk characteristics, especially because right now, it’s deflation risk that’s driving short-term bonds, but TIPS are trading at attractive valuations and are a good investment for the long run, he said.

·         Other portfolio picks:

In credit markets, Worah is looking for income in U.S. consumer and U.S. home sectors—homebuilders, materials, he said.

He also is looking to emerging markets. There, he said, are some budding opportunities where investors are getting paid appropriately for the risk, but that debt of many countries is unsustainable.

Worah’s real worry lies in Europe in the mid- to long run as countries there have done little to tackle their balance sheet issues. He is also wary of high yield and the energy sector.

His advice: “We live in a low-returning world in both bond and equity markets today. To go up in quality now has been more important than it has been in a long time.”

Contact Cinthia Murphy at [email protected].

 

Cinthia Murphy is head of digital experience, advocating for the user in all that etf.com does. She previously served as managing editor and writer for etf.com, specializing in ETF content and multimedia. Cinthia’s experience includes time at Dow Jones and former BridgeNews, covering commodity futures markets in Chicago and Brazil equities in Sao Paulo. She has a bachelor’s degree in journalism from the University of Missouri-Columbia.