Re-focusing on fixed income in a low-yield environment

•

• •

•

• •

•

•

•

•

•

•

• •

•

• • • •

A D M A S T E R S T A M P !

M K T G M 0 5 2 0 A 1 1 9 0 9 7 8 1 / 3 4

Craig Vardy Head of Australia Fixed Income, BlackRock James Kingston Head of Portfolio Analysis & Solutions, BlackRock May 2020

Re-Focusing on Fixed Income in a Low-Yield Environment

MKTGM0520A-1190978-1/34

Recall. Retool. REFOCUS

Choice Use the full spectrum of exposures available

Our decisions don’t need to be binary.

We don’t need to be “Active or Passive”

New tools and technology Help us measure and manage our fixed income risks more effectively

Recall our investment thesis. Retool our investment set. RE-FOCUS on Fixed Income.

MKTGM0520A-1190978-2/34

8

A D M A S T E R S T A M P !

M K T G M 0 5 2 0 A 1 1 9 0 9 7 8 3 / 3 4

Macro trends, industry trends and investor demands are reshaping portfolio construction

+ Liquidity Needs

ESG Requirements

MKTGM0520A-1190978-3/34

9

Common themes/questions we see

Blending How and why to blend index and alpha strategies together

Selection Fixed income is more than just picking a manger. It has a significant impact on portfolio objectives

?

Overreliance High income exposures such as hybrids are attractive for income portfolios but can lead to concentrated risks

Liquidity Investing in liquid instruments is important during market stress

WHAT HAPPENS NEXT?

MKTGM0520A-1190978-4/34

10

We believe in following a thoughtful process for portfolio construction

Benchmark

Budget

Invest

Monitor

Translating investor outcomes

Evaluating risks and opportunities

Identifying cost-effective and efficient holdings

Keeping a “hand on the wheel”

Clearly identify the client’s investment objectives

Decide where you want to incur costs and take risk

Determine the most appropriate vehicles to implement your strategy

Regularly measure success, rebalance with discipline and consider this sleeve in the context of the entire portfolio

MKTGM0520A-1190978-5/34

11

Benchmark Translating investor outcomes

MKTGM0520A-1190978-6/34

Know your objective when selecting a Fixed Income benchmark

The BlackRock Fixed Income Pyramid

Income

You seek the potential for . . .

Higher income

Decide on your preference for yield requirement and risk tolerance

Consistent returns across various markets

Identify your tolerance for negative return outcomes

Protection when stocks sell off / growth opportunities

Decide if use is for defence (interest rate/duration exposure) or return enhancement (non govt. FI sectors)

Credit/High Yield

Capital Preservation Low duration / flexible strategies

Diversification / Asset Allocation Core bonds, investment grade, longer duration

Considerations

Other Preferences Identify other key investment beliefs & requirements Home bias requirements: Local or Global | FX Hedging | ESG |

Single Sector exposures

MKTGM0520A-1190978-7/34

13

(Masters of ) the Fixed Income Universe

MKTGM0520A-1190978-8/34

14

Yield Rate of return anticipated on a bond if held until maturity

The two fundamentals concepts of Fixed Income

Duration A measure of sensitivity of the price of a bond to a change in interest rates

MKTGM0520A-1190978-9/34

15

First rule of Fixed Income Yield, Coupon & Price

Price

bond’s coupon

YTM

<

YTM

the bond sells at a discount

Price

bond’s coupon

>

YTM

the bond sells at a premium

YTM

bond’s coupon

=

YTM

the bond sells at par

MKTGM0520A-1190978-10/34

16

The Yield Curve and Credit Spread

The Yield Curve

The “credit spread”

A line plotting yield or interest rates, at a set point in time, of bonds that have equal credit quality, but different maturities

Is the difference in yield between corporate bonds and government bonds. It represents the ‘Risk Premium’

Long Dated (15+)

7.5 7.0

x

6.5

x

x

x

x

x

Hypothetical “Normal” Yield Curve

6.0

x

AA rated corporate bond Credit Spread

Government bond Yield curve

5.5 5.0

Yield

Yield %

Short Medium Dated (0-5) Dated (5-15)

x

4.5 4.0 3M 1Y

5Y

10Y

20Y

50Y Maturity (Years)

Maturity (Years)

MKTGM0520A-1190978-11/34

17

Global Fixed Income Update

MKTGM0520A-1190978-12/34

A D M A S T E R S T A M P !

M K T G M 0 5 2 0 A 1 1 9 0 9 7 8 1 3 / 3 4

Activity standstill Public health measures to combat coronavirus are bringing economic activity to a near standstill. Second quarter growth will decline sharply. The depth and duration of the disruption remains highly uncertain.

Bold policy action

Looking through the market turmoil

A decisive and coordinated policy response should prevent the coronavirus shock from sparking a 2008-style crisis. So far government responses appear to have avoided the risk of a 2008-style crisis in financial markets.

Resilience rules The valuations of developed government bonds look stretched in light of our economic outlook, but they may be able to provide diversification â&#x20AC;&#x201C; albeit less so with some yields near levels we consider to be their lower bounds.

The opinions presented are those of the BlackRock Australian Fixed Income Team as of March 2020 and may change as subsequent conditions vary.

MKTGM0520A-1190978-13/34

19

Activity standstiall Making sense of the ultimate macro implications for asset prices is not about making a heroic call on the near-term trajectory of activity. It’s about trying to get a grip on the orders of magnitude involved.

•

Global economic activity is not simply slowing or contracting – it is deliberately being frozen and halted. This is unprecedented at a global level.

•

In our view, what matters to long-term asset valuations is not the impact on profits and revenues from such a growth shortfall over a quarter or two – it’s the impact over several quarters and years.

•

An extended interruption could morph into a financial crisis-type propagation leading to an unprecedented wave of corporate insolvencies, putting pressure on the banking system.

•

Even with a rebound in the second-half of the year, there can be no mistaking the very sizeable drop in income taking place right now. The shortfall will be in the trillions for major economies.

•

Discretionary spending is permanently lost to GDP. Social consumption items such as holidays, restaurants, transport and recreational services – accounts for between a fifth to a quarter of total consumption in the U.S. and Europe.

MKTGM0520A-1190978-14/34

20

The hit to global growth Consensus growth expectations point to a further – deeper – drop in output in Q2 2020, even if the lockdown measures start to be lifted in the next few weeks. This would be consistent with the current shock being akin to a large-scale natural disaster that severely disrupts near-term activity Regional Composite PMIs

• The trigger for this recession is an exogenous shock in the form of a public health crisis, rather than the classic, endogenous adjustment triggered by rising imbalances.

• For the G4 and China combined, fiscal deficits as a percentage of GDP will be 1.5 times GFC levels.

• The US and Europe are more consumption-based economies. Based on China’s reopening experience the pace of recovery has varied across different segments.

• The reopening of economies has prompted concerns about a second wave of infections and potential double dip in the economy.

Sources: Refinitiv Datastream, market, Caixin and BlackRock Investment Institute, May 05, 2020. Notes: PMI stands for Purchasing Managers’ Indexes. PMI is an economic indicator that is derived from monthly surveys of private companies. An index level above 50 indicates an improvement in economic activity, while an index level below indicates a decline.

MKTGM0520A-1190978-15/34

21

The hit and potential rebound The GFC resulted in a prolonged large-scale debt deleveraging over many years. The GCC shock will most likely see a deeper contraction in GDP but possibly only a fraction of the cumulative shortfall suffered after the GFC. A significant shock. Hypothetical hit to U.S. trend GDP

• A banking crisis and overextended household balance sheets led to a “lost decade” of deleveraging after the GFC. • This time, the immediate shock is much deeper, but the financial system is not in crisis for the moment.

• The propagation of the shock is most likely linked to the evolution of the virus and the duration of containment measures, in our view.

• Long-run economic forecasts, including the most pessimistic, imply economic consequences that are much less severe than the post-GFC impact in both the US and euro area, as the chart shows.

• For now, we see the much swifter and greater fiscal and monetary response this time that could end up stemming this risk.

Sources: BlackRock Investment Institute, with data from Reuters News, April 2020. Notes: We show the estimated cumulative shortfall of GDP in the US and euro area as a share of 2019 GDP levels as implied by the median (green dots) and most pessimistic forecasts (yellow bars) in a Reuters poll of 41 forecast for the US and 29 for the euro area, published on 22 April 2020. The red financial crisis bars show the total shortfall accumulated between 2008Q3-2019Q4, expressed as a share of 2007 GDP. There is no guarantee that any forecasts made will come to pass. These hypothetical scenarios are subject to significant limitations given the uncertainties surrounding the virus outbreak.

MKTGM0520A-1190978-16/34

22

U.S. household balance sheets may be vulnerable Rising unemployment may make a substantial number of households vulnerable to a drop in income. As a result, we see the unemployment rate increasing, tracking jobless claims. Central bank easing is targeting the tightening of financial conditions. But given limited monetary space left, fiscal policy needs to be a central part of the coordinated response toolkit.

U.S. unemployment rate and consumer loan delinquency rate, 2010-2020 12

10

U.S. and euro area growth implied by BlackRock financial conditions indicators, 2010-2020

5

 Unemployment rate  Loan delinquency rate lagged six months

3

4

3

6

2

4

1

Annual growth (%)

8

Consumer delinquency rate (%)

Unemployment Rate (%)

2

1

0

2 1980

1985

1990

1995

2000

2005

2010

2015

0 2020

Sources: BlackRock Investment Institute, U.S. Bureau of Labor Statistics and National Bureau of Economic Research, with data from Refinitiv Datastream, April 2020. Notes: The charts shows U.S. continuing jobless claims and the U.S. unemployment rate. The unemployment rate projection is stylized to illustrate how a sharp increase can unwind quickly in the recovery phase given the unique nature of the macro shock. The shaded areas indicate U.S. recessions. Forward looking estimates may not come to pass.

 U.S. FCI-implied growth  Euro area FCI-implied growth

-1 2010

2012

2014

2016

2018

2020

Source: BlackRock Investment Institute, with data as of 24 April 2020. Notes: The chart shows our financial conditions indicators (FCI) for the U.S. and euro area. Our FCIs give a forward view of where our Growth GPS may head and are expressed in GDP terms, based on its historical relationship with our Growth GPS. The FCI inputs include policy rates, bond yields, corporate bond spreads, equity market valuations and exchange rates. Forward-looking estimates may not come to pass. Read details of the methodology on our macro dashboard: https://www.blackrock.com/corporate/insights/blackrockinvestment-institute/interactive-charts/macro-dashboard#financial-conditions MKTGM0520A-1190978-17/34

23

Bold policy action Global Central banks were quick to react to the meltdown in risk assets and dislocation in most asset markets by providing unprecedented amounts of liquidity and backstopping certain asset classes.

•

The size, scale and scope of the global policy response to cushion the impact of the pandemic have been extraordinary, particularly in the U.S. The Fed has adopted “whatever it takes” actions.

•

Central banks have crossed the Rubicon in their monetization of fiscal spending programs, starting with explicit or implicit pledges to curb long-term bond yields to enable fiscal expansion.

•

Unwinding these arrangements will be tricky, and central banks have not yet unveiled exit plans. A key question: how central banks stay above politics, maintaining their independence from authorities. Proper governance of fiscal and monetary coordination is needed.

•

For the economy, we see three risks: 1) policy exhaustion (extending jobless benefits, for example, will be politically contentious in the U.S.); 2) implementation (will stimulus funds reach households and small businesses fast enough – and in sufficient size?); and 3) premature exit with many programs time-limited.

MKTGM0520A-1190978-18/34

24

Large-scale fiscal stimulus is being rolled out We expect governments to most likely significantly increase fiscal spending – far beyond what was already estimated in 2020 – on health systems and to provide support to small businesses and households.

Global fiscal impulse from G3 and China, 2002-2020

Sources: BlackRock Investment Institute, IMF, OED and the European Commission, April 2020. The 2020 estimates are for discretionary spending and do not include increasing support from various social security programs. Initial estimates are as of the start of the year. There is no guarantee that any forecasts made will come to pass.. Past performance is no guarantee of future results.

Fiscal spending and funding – U.S. is ahead of Europe

Source: BlackRock Investment Institute, April 2020.

MKTGM0520A-1190978-19/34

25

Central banks adding reserves to buy government debt Central bank balance sheets in key economies have reached over $20 trillion and are poised to increase a lot further. Most governments started with very high debt levels and levels will rise following the Covid-19 crisis.

Major central bank balance sheets and projection, 2004-21

Sources: charts by BlackRock Investment Institute, April , 2020, Refinitiv Datastream.

General government debt/GDP, 2019

Sources: Bank of America Global Research , April 2020 MKTGM0520A-1190978-20/34

26

Central bank policy changes in perspective The monetary policy response by central banks has effectively been â&#x20AC;&#x153;whatever it takesâ&#x20AC;?. This view can be seen as necessary as the underlying loss of economic momentum has been sudden and severe. A key difference is that policy rates have started at a much lower (post GFC) level.

Developed markets weighted policy rate (16 countries)

EM GDP weighted policy rate (27 countries)

Sources: UBS, Haver, April , 2020, MKTGM0520A-1190978-21/34

27

Resilience rules Government bonds helped cushion the equity market sell-off, albeit less so then in the past with some yields near their lower bounds. Portfolio resilience should try and go beyond nominal government bonds.

Government bond performance and hypothetical allocations, April 2020

100%

115    

U.S. Japan Germany China

 UK

 China

75%

110

 Euro area

 Japan

50%

105

 U.S.

25%

100

95 Jan-20

0% Feb-20

Mar-20

Market-cap weighting

BlackRock hypothetical weighting

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index.

Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, March 2020. Notes: The left chart shows the rebased performance in total return terms of government bond indices between 13 Jan 2020 – the date of the first reported coronavirus case outside China – and 24 March 2020. The right chart show how our government bond allocations in a hypothetical unconstrained, U.S.-dollar based portfolio on a 10-year horizon stack up against an allocation based purely on a market-cap weighting. The market-cap weighting is calculated on BlackRock’s Aladdin as of 6 November 2019. The left chart shows only the fixed income part of our unconstrained portfolio, scaled up to 100. The chart on the right shows the results after running our robust optimisation on our CMAs and incorporating our asset class views. Hypothetical data results are based on criteria applied retroactively with the benefit of hindsight and knowledge of factors that may have positively affected its performance. The actual performance of a strategy or fund may vary significantly from index performance due to transaction costs, liquidity or other market factors. An inherent limitation is that the hypothetical allocations were not made under actual market conditions and, therefore, cannot completely account for the impact of financial risk in actual portfolio management. The performance shown does not represent any existing portfolio, and as such, is not an investible product.

MKTGM0520A-1190978-22/34

28

Low earnings visibility Corporate earnings estimates have created low earnings visibility, with the spread of estimates the largest since the GFC. Profit estimates are holdings up in the tech, communications and healthcare sectors.

Global equities spread of analystsâ&#x20AC;&#x2122; estimates around average, 1995-2020

Analyst earnings estimate dispersion (%)

20

15

10

5 1995

2000

2005

2010

2015

2020

Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, April 2020. Notes: Line shows the aggregate standard deviation of analyst earnings estimates around the average. Higher values indicate a greater level of analyst uncertainty. The shaded areas show U.S. recessions.

MKTGM0520A-1190978-23/34

29

Summary The scale of financial market moves in response to the coronavirus outbreak has been reminiscent of the global financial crisis. However, we do not think this is 2008.

•

Market moves have been reminiscent of the financial crisis. But we don’t think it’s 2008 as most developed economies are on a stronger footing.

•

The negative shock is not originating from a credit squeeze. Banks have considerable ability and flexibility to provide credit to the real economy. The shock has come from households and governments deliberately limiting demand side economic behavior because of the threat of infection.

•

The impact will most likely be deep and sharp. With the potential that risk asset volatility could remain high.

•

Market moves have been compounded by oil prices plunging more than 50%. This should ultimately benefit global growth, but risks exist in energy and parts of U.S. high yield.

•

We still believe the shock should be temporary as the outbreak will eventually dissipate and economic activity will normalize – assuming the needed policy response is delivered.

Source: BlackRock April 2020. Represents BlackRock's opinions. Subject to change.

MKTGM0520A-1190978-24/34

30

Budget Evaluating risk and opportunities

MKTGM0520A-1190978-25/34

Yield/Return

A more considered portfolio combines different return drivers

Income

Portfolio Diversification / SAA

Alpha Capital Preservation

Factor Index

Risk MKTGM0520A-1190978-26/34

32

The role of liquidity in Fixed Income investing

Basket Bid/Ask

iShares Bid/Ask

263

17 AUD Investment Grade Bond ETF Source: BlackRock, as at 30 April 2020. For Illustrative purposes only.

MKTGM0520A-1190978-27/34

33

A D M A S T E R S T A M P !

M K T G M 0 5 2 0 A 1 1 9 0 9 7 8 2 8 / 3 4

Range and median of Broad Global Fixed Income fund returns 7.00

5.00

3.00

1.00

Considerations for alpha strategy selection

-1.00

-3.00 6 months

1 year

2 years

3 years

5 years

7 years

Horizon

Range and median of Broad Australian Fixed Income fund returns 7.00

5.00

Beyond the numbers, consider: ⁻

Asset class “efficiency”

⁻

Selection skill

3.00

1.00

-1.00

⁻

Trade rationale

⁻

Regime dependency

⁻

Total cost

6 months

1 year

2 years

3 years

5 years

7 years

Horizon

Source: Morningstar Direct. Data as at 30 April 2020. Past performance is not indicative of future results. Global Fixed Income Funds’ representative index is taken as Bloomberg Barclays Global Aggregate Bond Index (AUD Hedged) and Australian Fixed Income Funds’ representative index is taken as Bloomberg Ausbond Composite 0+ Yr Index.

MKTGM0520A-1190978-28/34

34

Invest Identifying cost-effective and efficient holdings

MKTGM0520A-1190978-29/34

A D M A S T E R S T A M P !

M K T G M 0 5 2 0 A 1 1 9 0 9 7 8 3 0 / 3 4

Make your portfolio â&#x20AC;&#x153;Swingâ&#x20AC;?

Build a team, rather than assemble individuals

Concluding Remarks

1

Target an outcome

2

Combine complementary exposures

3

Find the right mix

Income Capital Preservation Diversification

Index

Alpha

Factors

36

The image set out in this document are used only for the purposes of this presentation MKTGM0520A-1190978-30/34

36

A D M A S T E R S T A M P !

M K T G M 0 5 2 0 A 1 1 9 0 9 7 8 3 1 / 3 4

Investment Philosophy What are my investment beliefs?

Itâ&#x20AC;&#x2122;s not all about the numbers

Value / Cost What am I getting for my money?

Analysis considerations What metrics best target my desired outcome

Oversight & constraints Do I have the resource & governance structure for manager oversight

MKTGM0520A-1190978-31/34

37

Monitor Keeping a “hand on the wheel”

MKTGM0520A-1190978-32/34

When to change?

Objectives

Risk

Due Diligence

Perspective

The investor objectives have changed.

There is unintentional risk in the portfolio.

Performance, fund manager change etc

The financial professionalâ&#x20AC;&#x2122;s views on the market or fund managers have changed.

What is rebalancing?

Rebalancing is the process of shifting the weightings of the assets in a portfolio.

MKTGM0520A-1190978-33/34

39

Important information Issued by BlackRock Investment Management (Australia) Limited ABN 13 006 165 975, AFSL 230 523 (BIMAL) for the exclusive use of the recipient, who warrants by receipt of this material that they are a wholesale client as defined under the Australian Corporations Act 2001 (Cth).

This material provides general information only and does not take into account your individual objectives, financial situation, needs or circumstances. Before making any investment decision, you should assess whether the material is appropriate for you and obtain financial advice tailored to you having regard to your individual objectives, financial situation, needs and circumstances. This material is not a financial product recommendation or an offer or solicitation with respect to the purchase or sale of any financial product in any jurisdiction.

This material is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. BIMAL is a part of the global BlackRock Group which comprises of financial product issuers and investment managers around the world. BIMAL is the issuer of financial products and acts as an investment manager in Australia.

BIMAL, its officers, employees and agents believe that the information in this material and the sources on which it is based (which may be sourced from third parties) are correct as at the date of publication. While every care has been taken in the preparation of this material, no warranty of accuracy or reliability is given and no responsibility for the information is accepted by BIMAL, its officers, employees or agents.

Except where contrary to law, BIMAL excludes all liability for this information.

Any investment is subject to investment risk, including delays on the payment of withdrawal proceeds and the loss of income or the principal invested. While any forecasts, estimates and opinions in this material are made on a reasonable basis, actual future results and operations may differ materially from the forecasts, estimates and opinions set out in this material. No guarantee as to the repayment of capital or the performance of any product or rate of return referred to in this material is made by BIMAL or any entity in the BlackRock group of companies.

No part of this material may be reproduced or distributed in any manner without the prior written permission of BIMAL. Š 2020 BlackRock, Inc. All Rights reserved. BLACKROCK, BLACKROCK SOLUTIONS, iSHARES and the stylised i logo are registered and unregistered trademarks of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners."

MKTGM0520A-1190978-34/34

40

•

•

• • • •

•

•

•