This month the BlackRock Investment Institute's Midyear 2016 Global Investment Outlook was released and offered a forecast of more volatility looming for the global markets, torn between anxiety from the post-Brexit vote and the prospect of a strengthening U.S. economy. ETF.com caught up with Heidi Richardson, head of U.S. investment strategy for BlackRock’s iShares, and she offered up some actionable ideas to help investors best position their portfolios for the second half of 2016 based on the risks and themes identified by the midyear outlook.
ETF.com: Investors are looking for strategic sources of income in this low-and-keeps-getting-lower interest rate environment, despite what the Fed may or may not do. What are iShares’ thoughts on this? Is that strategic income outside the fixed -income world, such as in stock dividends?
Heidi Richardson: The overarching theme for us is that there's just going to be more volatility in the market as we move forward. You have to be much more selective in terms of the opportunity set for investors. Rather than a traditional 60/40 portfolio and just broad-based S&P 500 Index fund for your 60% [equity] and the iShares Core U.S. Aggregate Bond ETF (AGG | A-98) for your 40%[bonds], you should be really much more selective in terms of your exposure.
In this low-growth, low-return, even negative return in many parts of the world, how can you think about adding some exposure to your portfolio without taking on too much risk?
On the fixed-income side, one of the things we think that’s really attractive is municipal bonds. When we think about the risk/return trade-off with municipal bonds and then look at the tax-equivalent yields, it's quite attractive. Munis aren't sexy, but they're offering really nice returns for the given level of risk that they're taking.
On the other end of the spectrum, if I were looking at the U.S., whether it was investment -grade or high-yield, and thinking about the risk inherent in that—versus some of the opportunity set in emerging market debt—I would say you're getting compensated for the risk that you're taking for the considerable yields you're getting in emerging market debt.
I personally would rather own the iShares JP Morgan USD Emerging Markets Bond ETF (EMB | B-58), our dollar-denominated emerging market bond ETF, than own U.S. high yield right now. And many of the companies or the countries that are issuing debt, sovereign debt, are investment-grade credit.
It's not the emerging markets from 20 years ago. A lot of these are much stabler and just higher quality in terms of the issuance of the bond. It's all about whether you’re being compensated for the risk you're taking.
On the equity side, you have to keep in mind we've got an aging population, not just here in the U.S., but globally, and even some of these other emerging markets. People need income. Dividends have been a big theme for the last few years, but you need to really be selective, even in your dividends.
There's a very large distinction, which I don't think a lot of investors realize, between dividend growers and high-dividend payers. The high-dividend payers are utilities and consumer staples, and those defensives that have really been bid up. Many of those companies have financed those dividends through debt. So, if the Fed ever raises rates, they'll be much more vulnerable.
The dividend growers have a much larger component in cyclical names and those companies that can sustainably grow their dividends year after year. As we look forward—particularly in the U.S. as valuations are getting stretched, and you're just paying more for the same level of earnings—people are going to look for those quality names and look at those companies that can continue to grow their dividends year after year.
ETF.com: Is there a particular dividend-growing fund that iShares has that matches what you said?
Richardson: Yes, DGRO [the iShares Core Dividend Growth ETF (DGRO | A-83)].
ETF.com: Let’s move on to the factors. iShares’ minimum-volatility fund, the iShares Edge MSCI Min Vol USA ETF (USMV | A-76), has been a very popular fund, both in inflows and performance. At what point does the natural cycle kick in where the minimum-volatility play either gets too expensive or it runs its course?
Richardson: Let's start with minimum volatility. Just like dividend stocks, you need to be selective in terms of understanding the portfolio construction and what's in these things. Let's take USMV, which has garnered enormous flows this year because people are so worried about that downside risk and the erosion.
In our U.S. minimum-volatility portfolio, our sector allocations have a +/-5% exposure from the benchmark index. If you look at some of the competitors that are only buying low-volatility stocks, there's an enormous weighting for things like utilities and consumer staples that have been considerably bid up. If we look at the broad index, it's only about 3.5% in utilities. So the largest we could go is 8.5% in the portfolio.
Having the guardrails put in place helps us from not being a closet sector fund. You do have to distinguish the way the funds are being managed in terms of how they’re getting those low-volatility names.
ETF.com: When should investors consider the undervalued factors? Or is that just trying to be a market timer?
Richardson: You always look at the things that are the worst performing and try to figure out, is this the time to be buying these? You never want to buy things when they're at the top of the market. It's very difficult to try to time the markets with those.
Rather than look at value being maybe oversold and not performing as well as the broad market, what I prefer to do is actually just look forward and say, ‘Where do we think, in terms of these factors, investors would be best positioned?’
As I mentioned earlier, with dividend growers, investors want high-quality companies that can consistently grow their dividends.
Our quality fund, QUAL [the iShares Edge MSCI USA Quality Factor ETF (QUAL | A-82)] is well-positioned moving forward. Because, again, I don't think people are going to pay indiscriminately for companies that aren't having earnings. And as we're in this earning recession, you're willing to pay up for companies that are actually showing improving earnings. With quality companies, they have strong balance sheets, they have low debt levels. They're increasing dividends and earnings and those types of things.
If I had to pick a factor moving forward as we continue through this year, I'd still continue to want to have exposure to quality.
ETF.com: One of the considerations in the outlook is to look at markets with more attractive valuations; for instance, by looking at single-country funds. The report mentions the MSCI India ETF (INDA | B-96) specifically. How should investors choose a single-country or an emerging market? It's a pretty tough puzzle for some.
Richardson: Most of the time if an investor is thinking about adding a slice of a single-country fund, they're coming to iShares for our guidance and our advice. For most financial advisors, they're better suited to have broad exposure with EEMV [the iShares Edge MSCI Min Vol Emerging Markets ETF (B | 72)]. Or even our core low-cost solution, which is IEMG [the iShares Core MSCI Emerging Markets ETF ( A | 99)].
Within the swath of single-country funds, the ones we like the most are India, based on the growth prospects and on the reforms. There is also Mexico, which feeds off of the U.S. in terms of the success of the U.S., and it too has seen some attractive reforms. Canada, too, has bounced back because of the stronger currency. Oil prices have improved. The miners have improved this year. And valuation's still really attractive there.
Those single countries are for a select few. If you've been sitting on the sidelines in emerging markets for the last six years, you’re not going to jump in with an India fund. You'd go in with a broad-based minimum volatility.
ETF.com: The last point of the report I wanted to touch on was gold, which the outlook implies should be part of a portfolio.
Richardson: Gold is unique in the commodities space in the sense that it does have a role in portfolio construction. It’s a low-correlating asset to the overall equity market. And it tends to be that slice of safety when there is disruption in the equity market.
We're not recommending gold as an alpha play, but I do think it has a role, particularly as we anticipate volatility picking up as we approach the U.S. elections and as Brexit finds its way.
There are a lot of things going on in the geopolitical front. But investors are going to continue to purchase gold as that slice of safety and that slice of quality. Generally, it's a small position. An advisor usually puts somewhere between 2-5% of a client's portfolio in gold. It has a role as a diversifier.
That being said, I do think it still has legs in terms of enhancing returns moving forward, because there'll be continued purchasing of gold for those people that just want no volatility.
But one of the biggest drivers of gold's return is the real rate environment. Since we're in a negative real rate environment, even here in the U.S. where we have the 10-year yield at 1.5%, we're really in a negative real rate environment. There's no opportunity cost. One of the deterrents from investing in gold is it doesn't pay a dividend; there's no income stream.
We're in this low real yield environment, and gold will continue to be a store of wealth for people, and a diversifier.
Contact Drew Voros at email@example.com.