Time to Shed Your Old Ways?
5 Strategies to Revitalize Your Portfolio
So what do I do with my money? It's a question that surely has been asked 101 times before, but it arguably has never been more difficult to tackle. Investors are blown away by record-low yields and high volatility; their confidence is shaken.
Conventional expectations for cash, bonds and stocks have all been upended. It is our view that a "diversified" portfolio comprising 60% stocks and 40% bonds no longer offers the balance and protection it once did. It's a new world of investing, and it requires new approaches to managing your investment portfolio. To be sure, now is an ideal time to question whether your old methods are still the most effective means for achieving your financial goals. It may well be time to shed your old ways and consider some of the following ideas for revitalizing your portfolio:
1. Tap Equities for Income
Traditionally, investors have looked to equities for total return and bonds for income, but that popular wisdom no longer applies. With many areas of the bond market producing yields that are near historic lows, company stocks are an increasingly appealing source of income. "US stocks offer income that rivals or outstrips that of traditional fixed income options today, while also providing capital appreciation potential not available from bonds," says Bob Shearer, Portfolio Manager of the BlackRock Equity Dividend Fund.
Mr. Shearer goes on to note that dividend-paying stocks historically have outperformed non-dividend payers over the long term with lower volatility than the broader stock market, as measured by the S&P 500 Index. Given their generally higher- quality nature (the payment and maintenance of a dividend imposes a certain discipline on company managements), dividend-paying equities can be an attractive option for risk- conscious investors. Of course, no investment is without risk. Investments in dividend-paying equities are subject to the inherent risks of investing in the stock market, and dividend payments are not guaranteed now or in the future. Still, we believe the risk/reward offered by dividend payers is a compelling proposition in the current environment.
For income seekers, the case for dividend stocks becomes even more compelling when you consider the free cash flow that companies have available today and the fact that dividend payouts still have some catching up to do. "The 30% average payout ratio of companies in the US is about half the domestic market's historic average; it's also less than that of Europe, which is around 40%. Going forward," says Mr. Shearer, "we expect to see a return to more 'normal' payout ratios in the US and, subsequently, an opportunity for investors to realize even higher levels of current income in the future."
2. Take Advantage of Tax-Advantaged Income
Not only is income difficult to find today, but it is further eroded once you factor in the effect of taxes. One antidote for this dilemma is to incorporate an allocation to tax-exempt municipal bonds in your portfolio.
Traditionally, municipal bonds offer lower yields than comparable- duration Treasuries before tax, but make up for it on an after- tax basis. In another example of those traditional expectations being upended, many municipal bonds are actually outyielding Treasuries before tax today.
"This reflects two themes that have resonated as of late," says Peter Hayes, Head of the BlackRock Municipal Bonds Group. "First, municipals continue to be priced for close to a 0% tax rate, meaning the market is not factoring in the tax advantage that an investor receives from buying municipal bonds. Second, the flight to quality that sent Treasury yields to record lows has helped propel munis to even more attractive levels on a relative basis."
Mr. Hayes does not see this relationship changing appreciably in the near future, indicating that municipal bonds are a relatively attractive source of income in the current environment. They also benefit from a history of lower default rates than corporate bonds and, recently, lower relative volatility than Treasuries.
3. Embrace Alternatives
Alternative investments were once deemed off-limits to all but the most sophisticated investors. Fortunately, this is no longer the case, as many types of alternative assets and alternative strategies are available today via mutual funds, which are accessible to investors of all stripes.
A wealth of research suggests that an allocation to alternatives— such as long/short strategies, commodities and real estate, among others—can enhance the diversification of a portfolio because they tend to have low correlations to traditional assets. This is important, as it has become painfully clear that during times of crisis, all assets tend to plummet in tandem, so the wider you cast your net, the better. Recognize, of course, that while an allocation to alternative investments may lower correlations and improve the diversification of a portfolio, they do involve substantial risk and present the potential for significant losses, including the potential for losses that exceed the principal amount invested. Some alternative investments also have experienced periods of extreme volatility and, in general, are not suitable for all investors. You and your financial professional should understand the risks involved and how these risks work together to provide appropriate diversification. While diversification cannot protect against investment loss, it has been shown to smooth the ride. Notably, so-called alternative investments generally lost less on the downside during the 2008-2009 credit crisis and, therefore, had an easier road to recovery. See chart above.
4. Make Multi-Assets Your Foundation
While the concept of diversification has proven merit, it is clearly more easily said than done. The task of building a diversified portfolio becomes all the more complicated when you are seeking to factor in more-complex and lesser-known strategies such as the alternatives mentioned here.
For that reason, a professionally managed multi-asset platform can be an ideal foundation for an investor's portfolio. Consider the BlackRock Multi-Asset Income Fund, which offers investors exposure to non-traditional income sources within the construct of a traditional mutual fund. Says Portfolio Manager Michael Fredericks: "This approach removes the burden of asset allocation from individual investors and places it squarely in the hands of professionals who have the expertise to deal with these less traditional, but very high potential, forms of investment."
Another example is the BlackRock Global Allocation Fund. With 700 positions in more than 40 countries and 30 currencies, it's a level of diversification that would be difficult, if not impossible, for an individual to achieve on his or her own.
5. Combine Active and Indexing
Broad diversification can extend beyond the types of investments you select to the types of investment vehicles as well. Many of the world's largest and most sophisticated institutions combine index strategies, which seek to track the performance of a specific market benchmark and are not altered during rising or falling markets, with active strategies that rely on the expertise of professional portfolio managers to seek returns above those offered by a market index.
Index investments, such as exchange-traded funds (ETFs), generally have lower management fees than actively managed funds that employ professional money managers. In seeking to combine the two, work with your financial professional to determine areas of your portfolio that may require special expertise or where you expect you can find fund managers who can deliver consistent above-market returns. In those areas, you may choose to use an active manager. In areas where highly skilled managers are not available or too inefficient, index strategies may be a better fit and a nice complement.
Succeeding in the New World
Investment success does not happen by chance, but by careful planning, execution and long-term portfolio care and maintenance. In a post-crisis world that is still finding its footing, establishing an appropriate blend of investment strategies and vehicles is critical. We encourage investors to work with their financial professionals to ensure their portfolios are spotless, and in peak form for the new world of investing.
Managing Income for a Better Outcome
Going beyond the bounds of conventional income strategies.
Investment involves risks. Stock and bond values fluctuate in price so the value of your investment can go down depending on market conditions. The two main risks related to fixed income investing are interest-rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. A portion of the income may be taxable. Some investors may be subject to Alternative Minimum Tax (AMT). Capital gains distributions, if any, are taxable. Investments in non-investment-grade debt securities (high yield or "junk" bonds) may be subject to greater market fluctuations and risk of default or loss of income and principal than securities in higher rating categories.
For a current prospectus or, if available, a summary prospectus of any BlackRock mutual fund, which contains more complete information, please call your financial professional or BlackRock at 800-882-0052. Before investing, consider the investment objectives, risks, charges and expenses of the fund(s) under consideration. This and other information can be found in each fund's prospectus or, if available, summary prospectus. Read each prospectus carefully before you invest.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are those of the BlackRock investment professionals profiled as of June 1, 2012, and may change as subsequent conditions vary. Individual portfolio managers for BlackRock may have opinions and/or make investment decisions that, in certain respects, may not be consistent with the information contained in this report. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.
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