“We’re trying to optimize portfolios to what’s happening,” Rieder explains. “The big shift we’ve been making recently is, because the Fed is giving us a lot of front-end yield, we can buy one-year credit at 5% and buy triple-A rated commercial mortgages and triple-A CLOs at 5% to 5.5%. We’re upgrading the quality of the portfolio and shortening the interest rate exposure on the curve where there’s not as much interest rate risk.”
Morningstar’s Jacobson wrote that the fund’s duration (or interest rate sensitivity) can range between negative 2.0 and positive 7.0 years (a negative duration means the security moves in the same direction as interest rates). But the range is typically within the tighter range of 0.0 to 4.0 years. As of August 31 the effective duration was 2.45 years.
Get Small Wins … Rinse And Repeat
The BlackRock Strategic Income Opportunities Fund is a very actively managed product with more than 4,600 holdings. Rieder and his team emphasize risk management and diversification, and they aren’t afraid to hedge risks to protect against the downside. “My core thesis is to make a little bit of money a lot of times,” Rieder says.
In a commentary piece from August, Bob Miller explained that the fund’s strategy combines top-down direction-setting from the three portfolio managers with bottom-up opportunity identification and security selection made by specialists who cover specific fixed-income sectors both in the U.S. and abroad.
The first step is determining the current investment regime and establishing a macro view of the markets, a process that takes into account various factors such as interest rates, inflation, labor market conditions, economic growth expectations, and central bank and fiscal policies by country and region. After the aggregate portfolio’s risk level is set, the managers allocate risk across geographies and sectors according to their macroeconomic views. The sector specialists then combine that macro view with their own bottom-up credit research, valuation estimates and expected returns to determine which securities to buy or sell.
Rieder says the aim is getting the big picture right and not putting all of the proverbial eggs into one basket. “In the case of today where the front-end assets are so attractive I’m not putting everything into the front end,” he says. “We have such big teams around us so we stress-test each scenario and analyze everything to make sure our assumptions on risk and volatility are right, and then do it every single day,” he notes.
The result, according to Morningstar, is a fund that on average has consistently provided more upside capture and less downside loss than the nontraditional bond category during the three-, five- and 10-year periods. The fund’s turnover rate is high, but Rieder emphasizes that the managers are sensitive to its transaction costs and aim to maneuver their trades to minimize those costs. The managers actively trade securities targeting interest rates, currencies and beta. They also use call options on equities as well as inflation breakeven swaps to protect against inflation.
When it comes to the portfolio’s core holdings, assets such as high-yield bonds and securitized assets, the team generally doesn’t trade them much and instead holds them for their yield. (The fund’s 30-day SEC yield was a hair under 4% at the end of August.) “During the times when we are increasing or decreasing risk, we use more liquid assets to try to make sure we don’t eat up returns in paying too much in transaction costs,” Rieder says.
The fund’s portfolio mix includes a heavy dose of derivatives to hedge risks and take outright positions. That includes Treasury futures, which Rieder says are more efficient for financing reasons. The fund also uses a lot of interest rate hedges to manage duration exposure.
“About 85% to 90% of our use of derivatives is for hedging,” he says.
40/60?
Rieder believes the traditional 60/40 portfolio is tired. “I think 40/60 makes sense right now because the yields you’re getting in fixed income are more attractive than equities.”
He and his team posit that fortifying a traditional core bond strategy with a healthy slice of an unconstrained strategy, such as the one in their fund, can help improve returns and reduce volatility in the overall bond portfolio. And they think that can be especially true in the current economic environment.
“Fixed income at these yield levels is as attractive as it has been in a really long time,” Rieder says. “In a modern portfolio you want to think about how much interest rate exposure you want to have and how much income carry you want, and that’s where unconstrained comes in.”