Bonds and alternatives will likely provide the best portfolio ballast amid stormy perma-crisis conditions, BlackRock chief, Larry Fink, told investors in his annual letter last week.
Fink says with inflation likely to settle in the 3.5-4 per cent range for years, sustained higher interest rates and geopolitical “fragmentation”, investors will have to adapt portfolio settings.
“Against the current backdrop, BlackRock has an even greater obligation to help our clients wade through the uncertainty and give them confidence to invest for the long term,” he says.
“We see many opportunities for our clients to capitalize on market disruption – to rethink portfolio construction, to benefit from the renewed income-generating potential of bonds, or to reallocate to sectors that may be more resilient in the face of elevated inflation and market distress.”
Investors are turning to opportunities in global infrastructure and sectors poised to benefit from the low-carbon “transition”, Fink says, but bonds are back in a big way.
“The role of fixed income in a portfolio is increasingly relevant – for the first time in years, investors can earn very attractive yields without taking much duration or credit risk,” the letter says. “Institutions and individuals targeting something around a 7% return have had to manage allocations across equities, bonds and alternatives to try to reach that yield. Today, they can meet that target by investing almost entirely in bonds.”
But the end of the easy-money era also poses a few tough systemic challenges, as showcased by the recent US banking turmoil that has taken out three institutions to date, Fink says, flagging further fundamental issues ahead.
He cites higher interest rates and the “asset-liability mismatches” seen in the Silicon Valley Bank collapse as the first two dominoes to fall as the free money runs out.
“And, there could yet be a third domino to fall. In addition to duration mismatches, we may now also see liquidity mismatches. Years of lower rates had the effect of driving some asset owners to increase their commitments to illiquid investments – trading lower liquidity for higher returns,” Fink says. “There’s a risk now of a liquidity mismatch for these asset owners, especially those with leveraged portfolios.”
With banks likely to assume an even more conservative lending stance, capital markets will probably pick up the slack, he says.
But in a letter exceeding 9,000 words, Fink ranges from big-picture global ramblings to nostalgic vinyl memories.
He also reiterates familiar BlackRock themes such as the growing ease of market access for investors (starring exchange-traded funds), climate-change adaption, democracy for proxy-voters and the outsize influence of the firm’s risk-management monster, Aladdin.
Digital assets, too, could have some “exciting applications”, Fink says, outside the “media’s obsession with Bitcoin”.
“In particular, the tokenization of asset classes offers the prospect of driving efficiencies in capital markets, shortening value chains, and improving cost and access for investors. At BlackRock we continue to explore the digital assets ecosystem, especially areas most relevant to our clients such as permissioned blockchains and tokenization of stocks and bonds,” he says.
“While the industry is maturing, there are clearly elevated risks and a need for regulation in this market. BlackRock is committed to operational excellence, and we plan to apply the same standards and controls to digital assets that we do across our business.”
BlackRock remains the world’s largest fund manager despite recording a US$1.7 trillion decline in assets under management (AUM) last year.
Peaking at more than US$10 trillion in 2021, the manager still booked US$400 billion in net flows last year while down markets and US dollar movements shrunk AUM.
Over the last five years, BlackRock attracted about US$1.8 trillion in net flows, Fink says, but he still wants more.
“Even as the largest asset manager in the world, we still have only 3% share of a fragmented industry’s revenue,” he told investors. “We continue to target 5% organic growth through a market cycle and expect to outperform the industry in both down and up markets.”