March 2020: recent changes to our Smart Portfolios

Uncertainty around Covid-19 has led to large changes in valuations. In line with BlackRock’s latest outlook on financial markets, we have made slight changes to our range of investment portfolios.

The value of investments can fall as well as rise, and you may get back less than you invested. Past performance is no guarantee of future results
March 2020: recent changes to our Smart Portfolios

An unprecedented economic shutdown

Global equity markets plunged in March, as the market attempts to gauge the economic impact that Covid-19 will have on businesses and the real economy.

While economic forecasters estimate that the global economy could contract by between 10%-20%, no one knows when travel restrictions will be reversed or when businesses will be allowed to reopen. Recent business surveys point to a steep fall in activity and confidence, suggesting a deep recession is almost certain.

However, this economic downturn is like no other. Federal Reserve (Fed) chairman, Jerome Powell has said he believes the global economy was in good health before Covid-19 forced the economy to effectively shut up shop. In a recent update, Powell said he expects a robust recovery when the virus is eventually contained, facilitated by the large, coordinated easing of both monetary and fiscal policy across the world.

Large market declines are part of long-term investing

While extremely unpleasant in their nature, stock market declines of 10%, 20% or 30% are not as uncommon as you may expect. Data going back to 1928 for the S&P 500 index shows that the benchmark fell by more than 10% in 59 out of 93 years and by over 20% in 25 out of 93 years. Investors can typically expect the S&P 500 to fall more than 30% one in every ten years.

But while these statistics suggest that the size of the market decline is not extraordinary, it is the speed of the fall which has taken investors by surprise. Unfortunately, in times of high levels of market stress, the temptation to exit the market may result in investors locking in losses and potentially missing out on a large part of the recovery when confidence in equity markets is restored.

Since the end of 2009, global equities have returned an average 9.9% per year, in GBP terms. That figure includes the latest market fall and puts in perspective just how strong equity gains had been for UK investors over the previous decade and why long-term investing is important.

Diversification helps to smooth investment returns

Over the five years prior to the current crisis, the optimal investment strategy from a risk-adjusted perspective was to invest solely in US equities. Above average returns in one asset class for a sustained period can tempt investors chase these higher returns and shun other assets classes such as bonds, cash and commodities.

Looking at how the portfolios have performed since the start of the year reveals why it is indeed critical to construct portfolios that invest in a range of asset classes. As a reminder, your portfolio is currently built using equity, bonds and cash-like securities as well as gold.

In November 2019, when we last made changes to the portfolios, we opted to reduce the amount invested in equities and boost the amount invested in bonds and cash-like securities. This meant that going into the current crisis each of our portfolios were positioned towards the lower end of their targeted risk bands, meaning that we had scope to increase risk in the portfolios if an opportunity presented itself.

At the time of writing, our balanced portfolio has fallen 3.4% month-to-date, with equity positions contributing towards a 4.7% decline. But our exposure to government bonds (+1.0%) has helped to partially offset losses in equities, while our position in gold (+0.3%) has also helped to diversify returns (percentages above are as of 26 March 2020 and are contributions to returns).

How we are reacting to the recent equity selloff

BlackRock’s model portfolio team believe that the recent fall in equity valuations now provides an opportunity to increase our exposure to stocks. It is important to note that we are not traders, but long-term investors and we are not attempting to time the market but instead react to opportunities from a valuation perspective.

The key themes around our changes include:

  • A slight increase in equities, specifically in US equities relative to other regions
  • We have added a small position in UK mid-caps for diversification benefits
  • These have been funded by partially selling positions in cash-like securities and short maturity bonds
  • Increase in duration risk by switching part of our exposure to the middle of the US treasury curve into longer-dated US treasuries

The United States was the strongest developed economy going into the current crisis and will now be supported by a $2 trillion stimulus package designed to help businesses and lower and middle-income individuals, with the Fed also open to buying 'unlimited' amounts of US government bonds. We have therefore increased the amount invested in US equities relative to other regions.

We have added a small position in UK mid-caps via iShares FTSE 250 ETF. Major stock indices are highly correlated, so investing in smaller companies helps to provide diversification benefits.

In November, BlackRock chose to increase duration risk (how sensitive the portfolio is to changes in interest rates) by initiating a position in iShares USD Treasury Bond 20+ year ETF which, year-to-date, has returned 31.2%. Given the downward shift in the yield curve, we have added to this position given that BlackRock expect interest rates to remain close to zero for the foreseeable future.

Expect volatility to continue, but focus on long-term investment goals

To conclude, volatility in financial markets will continue until we see signs that Covid-19 cases have peaked and there is evidence that the virus has been contained. Our recent changes to the portfolios take advantage of lower equity valuations, but we have further room to increase risk in the portfolios through additional equity exposure, and in other ways, to take advantage of even more attractive valuations and for a future economic recovery.

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Remember, your portfolio is a long-term investment product, and while it may be tempting to sell investments during falling markets, by doing so you are locking in losses should the market turnaround. Encouragingly, we have seen net inflows into the portfolios since the start of March, suggesting that many of our investors are taking advantage of more attractive valuations.

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