BlackRock bonds boss warns markets suffer from tunnel vision

Rick Rieder, BlackRock’s chief investment officer for global fixed income, looks out of the 13^th floor window at a stormy London on one of his regular visits to the UK. But the Brexit clouds on the horizon are a minor problem to him compared to the financial crisis he has been witnessing in Turkey, and the potential contagion which may be unleased across the world’s emerging markets.

“I already rise at a crazy hour in New York, but the Turkish crisis gets me up even earlier in the morning,” says the 31-year bond veteran, forced now to forensically follow the Borsa Istanbul, in addition to New York, Latin American, European and Asian markets. “Turkey has to be at the forefront of our thinking.”

The recently changed dynamics of the bond market have left most investors underestimating the sudden lack of liquidity now that the European Central Bank, the Bank of Japan and the US Federal Reserve have turned off the taps, he believes.

“Previously, you could get financing as a company, public entity or country. If there was any market disruption, you could still get liquidity,” says the bond expert, who oversees $1.9tn in fixed income assets, casually dressed in blue zip-up fleece and white, open-necked button-down shirt.

“Now the paradigm has turned 180 degrees and people underestimate this,” says Mr Rieder, drawing a direct line from the central banks in developed nations to the the volatile markets of the emerging economies. “If you look at Argentina, Turkey, Brazil, once the crisis begins, there is no bucket of liquidity any more to push the market back up. As liquidity decreases, you will get more of these crises in the next few years. This is the big picture that keeps me up at night.”

The extent of dollar funding in Turkey is so large that it is “difficult to get your arms around,” volunteers Mr Rieder. “In the corporate and banking sectors, there are immense liabilities. We are talking hundreds of billions of dollars and it is difficult to see how you can manage this,” he says, sceptical that any potential rescue from Qatar can stabilise the country.

“The main thing I have learned in my 31 years trading bonds is that markets can only focus on one thing and at the moment that is Turkey,” he says. “If we look at dollar-euro and dollar-yen trades, it is incredible how much these markets move due to Turkey.”

Even though they are not geographically close by, “related” emerging markets such as Mexico are immediately put under pressure. Despite a successful recent election and relatively strong economy, the likes of Mexico can be swept away by contagion, presenting an opportunity for major bond investors including BlackRock. Banks exposed to Turkey, such as BNP Paribas and BBVA, are also in the eye of the storm, probably unfairly, he believes with markets prone to over-reaction.

“If you go through the math of their exposure, it is not that significant, but markets are incapable of doing more than one thing at a time.”

A new approach

Whether we like it or not, the old “buy and hold” method of bond investing is now consigned to the history books and the opportunistic trade in these “stress situations” has won the day.

Today’s complexity of bond markets makes it almost impossible for a private investor to manage fixed income exposure without buying into a multi-asset structure, believes Mr Rieder, who also manages BlackRock’s fixed income global opportunities fund and the recently-launched BGF global bond income fund.

“A good part of the market trades actively in rates, currencies and indices. Portfolios have bifurcated onto a liquid bucket you trade actively to manage extremes and a chunk you just hold onto.”

It is necessary to keep some static allocation because bid-ask spreads are just so high that any returns can possibly be swallowed up by the transaction costs of managing an over-active portfolio, although the bigger bucket is dynamically traded.

He backs the “significant trend” for flexible products which can accommodate much broader fixed income portfolios, rather than concentrating on a particular country or type of bond. “Unless you are a professional investor, how would you know whether to be in high yield or emerging markets? Clients are coming to players like ourselves for off-index, flexible mandates. They are not getting enough yield in Europe, for instance, so we need to help them be more targeted and throw out the inefficient parts of the index.”

He rejects criticisms that big brand managers including BlackRock charge excessive fees to clients, suggesting that complex sciences of risk management, asset allocation and portfolio analytics now required from bond houses mean investors receive good value for money.

“I am one of the more sophisticated fixed income investors in the world, but I can’t analyse international mortgages, their complexity and their relation to US mortgages. Clients are willing to pay for these portfolio construction disciplines.”

The BlackRock philosophy in fixed income, says Mr Rieder, is not to make big, risky bets but to “make a little bit of money a lot of the time to create a durable business. If you make huge bets on individual markets in fixed income, you can go badly wrong.”

As well as creating consistent, but modest, profits for clients, it is the fixed income manager’s job to limit their losses, he believes. “Clients are willing to pay you a reasonable fee to prevent a drawdown. For us it is so much about protecting clients’ downside. They are looking for a risk system, analytics and diversification strategies that are world class.”

Active alive and well

Active bond management, and the skills and fees attached to it, is not under the same threat as the equity side, believes Mr Rieder. He estimates there are more than two million municipal bonds in the US, which are very difficult to create an index for.

“This is a heterogenous market, where very many fixed income investors have historically outperformed the index. It is not a zero-sum game like the equities world.”

That said, he is a frequent user of exchange traded funds in his portfolios, especially for quick access to high yield and emerging markets.

In regular internal meetings, BlackRock teams are advised about trends that will affect the industry long term, one of these being the transformative influence of investing around environmental, social and governance (ESG) factors.

“We are increasingly looking at portfolios to make sure we are ESG sensitive,” he says. “We are applying screens and evaluations to credit markets and receiving regular updates on this to make sure we have a leading edge in ESG sensitivity.”

The other catchphrase echoing through the BlackRock corridors in New York and London is that of big data, with the firm developing analytical strategies and tools to make sure fund managers are better informed of which companies they are buying into. “This gives us a faster understanding of corporate and economic trends.”

This is becoming particularly important in a world of “chaotic and unpredictable information flow”. He gives the example of how online articles generated by mining companies were put through the BlackRock big data mixer to search for and analyse the use of the word “believe” in order to judge the “temperament” and corporate culture of the companies. “This data mining is very helpful to us,” confirms Mr Rieder.

But, as with companies’ exposure to emerging markets, the big data advantage often leaves the asset manager well ahead of the market, which can have adverse consequences if the situation is not correctly judged by the human eye.

“We can get detailed info about retail sales and inflation, but the markets will only react to published government data. You might have better info from your big data, but the markets can’t or won’t react to that.”

Is he really saying that BlackRock might have to ignore much of the important information it has about bond issuers because nobody else has the capacity to generate or analyse this data? Absolutely.

“You might know something two months in advance, but you can only invest once markets react. Getting the right answer is not as important as judging when the market thinks they have the right answer. This is one of the funky nuances of being a bond investor.”