The pandemic, geopolitical tensions, and international conflicts have disrupted supply chains and have led to unprecedented monetary policies, the full effects of which we are now learning to navigate. In this episode, we hear from Uwe Helmes, Investment Strategist at Blackrock, as he discusses the many nuances of inflation, BlackRock’s recently completed annual Capital Market Assumptions which looks at the expected returns across various asset classes, and the importance of asset allocation strategies when creating resilient and flexible investment portfolios.

 

Transcript

Paul O’Connor (POC):

Welcome to the Netwealth Investment Podcast Series. My name is Paul O'Connor and I'm the head of investment management and research. Today, we welcome Uwe Helmes from BlackRock Incorporated, who is an investment strategist in BlackRock's multi asset strategies and solutions group based in Sydney. Good morning, Uwe.

 

Uwe Helmes (UH):

Morning.

 

POC:

BlackRock is the world's largest asset manager, managing over US $10 trillion as at 31, December 2021, across all asset classes. The firm employs more than 16,000 professionals and maintains offices in over 35 countries around the world. BlackRock has no single majority shareholder and has a majority of independent directors. The BlackRock local MASS team is responsible for the management of diversified investment strategies offered by the business in Australia. The team currently comprises seven investment professionals with an average of 17 years investment experience. The MASS team sits within the BlackRock Australian Investment Team, which is split into three capabilities, equities, multi-asset strategies and fixed income and all capabilities report to the Chief Investment Officer, Mike McCorry.

 

POC:

MASS also has functional reporting lines to the Global Multi-Asset Strategies and Solutions Group which is led by Richard Kushel. MASS is responsible for the management of BlackRocks diversified strategies, absolute return strategies, factor based strategies, incoming capital stable strategies, and customised solutions. Uwe is the lead strategist for BlackRock's model portfolio business in Australia and New Zealand, which has over three and a half billion AUD in assets under management. He's been in the investment industry for 13 years and has been part of BlackRock's multi-asset team for six years. Prior to joining BlackRock, he worked as a senior market research analyst at Investment Trends. Uwe holds a Bachelor of Economics, majoring in econometrics and finance and an Honors in Finance first class from the University of New South Wales, and he's a CFA charter holder and member of the CFA Institute. Uwe was born in Germany and lived there for 17 years before moving to Singapore and then eventually found his way to Australia to study. He's the father of three young children and currently is very tired as a result.

 

POC:

So, I hope Uwe, you can manage to relax during the week to recharge those batteries for the kids. The MASS team are responsible for BlackRock's diversified funds, enhanced strategic models and BlackRock GSS index plus funds that are all available on Netwealth's super and IDPS investment menus. In addition, the MASS team of the consultants who provide the asset allocation for the GSS index models. Yearly BlackRock's global MASS team undertake a review of their capital market assumptions or CMA's, the documents, their outlook on macro issues, including global economic growth, regional and country GDP growth, inflation, interest rates, etc... The CMA is then used as the basis for the MASS team's asset allocation views. As this review was recently completed, I thought it would be timely to discuss this with Uwe this morning, and particularly in light of the increased geopolitical risks and the global spike in inflation.

 

POC:

The challenge for asset allocation today includes equity market valuations and earnings multiples being near all time highs, bonds facing an ongoing headwind due to the pressure to increase interest rates caused by the rise in inflation and cash rates being at all time lows. So I'll be certainly interested in Uwe's views on how we can navigate these challenges from an asset allocation viewpoint. Perhaps to start with Uwe, can you provide the listeners with a few comments on your life journey from growing up in Germany to now working for BlackRock Australia and living in Sydney?

 

UH:

Hi Paul. Thanks for that introduction and... Yeah, first of all, thanks for having me. And yes, I am a bit tired, I won't lie. Three young kids at home, including a newborn. But no, it's good. Thanks for having me. I did, yeah, grow up in Germany. I still can't shake the accent, but I hope that's okay. I moved to Singapore when was about 17 to go to high school there. And then as you said, made my way to Sydney in my early twenties and never looked back. So it's been what? 17 years now in Australia, I graduated in 2008 from the University of New South Wales. Not the best timing to start a career in finance, but I think it worked out quite nicely. I actually got lucky to get a job in a small startup company.

 

UH:

Yeah. Just after the global financial crisis in 2008 as a consultant. And to be honest, I really loved it, experiencing that, this startup scene and yeah, it was good. So I learned a lot. And then six years ago I went the complete opposite side of the spectrum and I joined BlackRock, the largest asset manager in the world and obviously completely different area, huge asset manager, but it's been fantastic and learned a lot along the journey. So it's been good.

 

POC:

Yes. Well, it would've been a good baptism of fire commencing in the industry in 2008, given we were having the small global financial crisis there, but would've also been a valuable learning... I guess, experience for yourself in your early days there in the market.

 

UH:

Indeed.

 

POC:

So yes. And hopefully providing you with some good experience now to navigate the current challenges we're all facing. As mentioned in the introduction, BlackRock recently completed the annual review of your capital market assumptions. Can you provide the listener with a summary of how BlackRock reviews these capital market assumptions and how does BlackRock reconcile then a global macro outlook with asset and sub asset class valuations to distil those into your asset allocation recommendations?

 

UH:

Yeah, it's a good point Paul. And you certainly right, CMA's or capital market assumption are really important for multi asset investors or anyone really that's building portfolios as they feed into the portfolio construction process. We have a dedicated team here at BlackRock called the BlackRock investment Institute. So they're responsible for determining our capital market assumptions. Now it is important to keep in mind, whenever anyone talks about capital market assumptions or CMA's, as we often refer to them, they're long term in nature. So, we typically capture five to 10 year horizon in our portfolios via these capital market assumptions. And they're produced across virtually all asset classes, in all regions. We update our capital market assumptions on a quarterly basis, and that's pretty frequent. So, not all asset managers update their CMA's so frequently, but we think it is quite beneficial to have a refresh every quarter, because markets can change quite quickly.

 

UH:

As we are seeing now earlier this year a lot has changed obviously in the first quarter of the year. And then we use these capital market assumptions on an annual basis to review our SAA. So we think reviewing... Or strategic asset allocation SAA. So we typically do that once a year. We find that's the sweet spot, because you do want to evolve your portfolio over time. So doing it annually makes sense, but you don't want to do it too frequently, otherwise there might be transaction costs and it defeats the long term purpose of these. So to answer your question on what factors actually feed into these capital market assumptions, we could easily spend an hour on this alone, but let me... So it's a fairly extensive and complex process, but let me try and summarise it in a few sentences.

 

UH:

So on a high level, there's a bunch of macro factors, such as economic growth, inflation rates and other key variables that feed into these forecasting processes. And then it also depends on the asset class. Let's pick equities for example. So here we use... And I'm trying not to get too technical, but we're using an augmented discounted cashflow model to determine these long term expected returns and risk metrics and key variables that feed into this expected return model, basically expected dividends, pay out ratios, earnings forecasts, earnings growth, expected GDP growth. And then to come back to your second question, well, how do you reconcile this with the current market outlook? Well, essentially the current market outlook does affect a lot of these variables, whether it's the micro variables or macro variables.

 

UH:

So they then feed into the capital market assumptions and ultimately affect your portfolio. So it is worth calling out though that the capital market assumptions again are long-term in nature. So they don't fluctuate as much as some people might think. So, even now, they did deviate a little bit quarter on quarter, but not too much. It's the tactical traits that tend to be more short term in nature. And there more variables. So we have made some tactical trades to the portfolio in recent weeks and happy to take you through it later in the series as well, if you're interested.

 

POC:

Yes. Interesting comments there. I think firstly, around the fact that you revisit these assumptions on a quarterly basis. I think that makes a lot of sense, because I think for example, just with strategic asset allocation, a lot of people have criticised it for just being a set and forget. Whereas I think what you are saying there, firstly is, it's not quite a set and forget asset allocation. You'll always keep an eye on markets, as they're evolving there, but I'm also interested, is the outcome of the capital market assumptions effectively to arrive at a return expectation over the longer term for equities, for bonds, for currencies and with an understanding of the volatility? And then that's fed into an optimizer to arrive at your asset allocations. Is that essentially how it works at a high level?

 

UH:

Yeah. No, you're spot on, that's exactly what happens on a high level and you spot on, it's not just the expected returns, it's also expected volatility and correlations that affect your portfolio or expected X and T risk figures. And yes, so essentially it's optimising both in combination. So optimising return, so you obviously want to maximise expected return, but at the same time you want to have that subject to a risk constraint. So for example, for multi-asset portfolios, you want a growth portfolio to behave like a growth portfolio, with a particular expected risk figure in there. And then same with the balance portfolio and so on. So, it is a bit of both. So it's basically feeding expected risk, expected return into this model and correlations and then essentially optimising for return, but also for risk, depending on the risk profile that you're targeting.

 

POC:

So for fear of boring our listeners here, it does sound like it's structure at a higher level is around Markowitz's work and modern portfolio theory.

 

UH:

Yeah, correct. It has evolved since then. So we'd still use a mean variance optimizer, which is what you're referring to. But... And again, I'll try not to get too technical, but these days we are augmenting that with a... Or supplementing that with stochastic processes as well. So essentially... And I'm going to try and keep it short and high level, but essentially your capital market assumptions are point estimates. So you come up with a point estimate in 10 years time, let's say, and we all know that that's not true. As in like, we all know that expected return of whatever... Call it 7% annualised return is a point estimate. But in reality, there's actually a whole distribution behind that. Is it 7%? Is it going to be eight, 9% or even lower? And so you can build this uncertainty into models then, but you need stochastic processes to do that. And we do that as well. So we look at a mean variance optimizer, and we also look at stochastic processes to build that uncertainty band into our portfolios.

 

POC:

So risk appears to have risen recently with markets focused on inflation. What's BlackRocks views as to whether the recent rise in inflation is structural, or is it more transitory based on the COVID impact on the supply chain?

 

UH:

Yeah. Inflation is certainly a big topic right now. So whether it's investors, central banks, governments, everyone is grappling with this topic around inflation at the moment, but it is worth maybe even taking a step back and just looking where we've come from and where we are now. So, before the current energy shock that a lot of people are talking about, and you go to your local petrol station and you see that the price of petrol has gone up a lot. And it is on everyone's mind right now, but let's look at how things have changed over the last few years. And essentially, even heading into this year, the environment was quite different. So over the past decade, we've essentially gone from low and stable inflation over a whole decade to now high and variable, which is a whole new environment for a lot of people, a lot of investors and central banks, and in particular in the US.

 

UH:

So just to give you a few statistics, the situation in the US is probably worse than it is in Europe and Australia, even though we have seen inflation increases here as well, but in the US, inflation is now... Or heading into the year, it was close to 7% and now it's pretty much close to 8%, hitting a 40 year high. So, that's in the US. And in Australia, it's a bit lower than that, but that also means that potentially we can see further inflation coming through here locally as well. But it is also worth looking at the different drivers of inflation and how that has changed over the years. So, if you cast your mind back two years, or maybe just after we came out of the first set of lockdowns post COVID, initially that first burst of post pandemic burst of inflation was largely driven by the more volatile categories within a price basket.

 

UH:

So it was driven by things like airfares and used cars. So largely goods driven was initially the first spike in inflation. But then towards the end of last year, we saw increasing evidence that inflation was a lot more broad based and other components have also picked up. So rent and food prices were actually starting to pick up even towards the end of last year, including some of the services sectors as well saw price increases. So that surprised some people in the industry, because initially I guess the consensus was more, oh yeah, inflation is probably going to be transitory, and then through that, it's probably more broad based, more and more people have actually switched to the other side of the camp where they said, it's more structural and more sticky.

 

UH:

And then more recently, so especially after the Ukraine crisis, we are seeing this oil and gas shock going through markets. So that's putting further pressure on inflation and inflation at this stage was already running quite high. So, that's why a lot of people at the moment are talking about inflation and it is certainly a pretty interesting topic. Another area to watch though, is the labour market. So the labour market can be a powerful source of inflation and typically it's quite sticky. So in most developed markets, the labour markets are pretty tight right now, again, especially in the US, but even in Australia. Our unemployment rate is at multi-year lows and it's pretty tight. Our under utilisation rate is also quite low and falling. So, that puts pressure on wages, and this is also adding to inflation.

 

UH:

Again, it's probably a different story here in Australia. So in Australia, we haven't seen too much wage inflation yet, but again, it's something we are certainly watching pretty closely. So yeah, to come back to your question around, will inflation be sticky? There's still different opinions, but I'd say most investors, and then also most of my colleagues here at BlackRock would probably say, "Yes, it is going to be stickier", but then again, there's more to the story in that it also depends on what category and also what region you're referring to. So if you're looking at, let's say goods inflation, it's largely driven by supply constraints right now. And you would think that over the next... Call it couple of years or so... One, two, maybe three years, some of these supply constraints are probably going to ease somewhat.

 

UH:

So that should soften inflation in some areas going forward, but yeah, inflation in other areas is probably going to stick around for a bit longer. And another thing that we are watching and we think is actually quite telling for this high inflation trend is central banks. So we see that central banks around the world are actually signalling that they are willing to live with higher levels of inflation, compared to previous cycles. So, that's important, because in the past, as soon as there was the sniff of inflation, the central banks would jump on and then basically increase rates and basically make sure that inflation drops down again. But we're seeing already signs that even right now, rates across, or interest rates across many countries are still at historic lows. And in Australia, the RBA still hasn't increased rates yet. So we still at these ultra accommodative levels, and even though inflation has picked up a while ago and is running higher as we speak. So yeah. So, while inflation dynamics differ by region, we think inflation will be higher this time around compared to previous cycles, and then also the last decade.

 

POC:

Yeah. And I guess my thinking there, Uwe, is also the fact that I think the central bankers are comfortable to stay a little behind the curve at the moment, which is different to how they have reacted to inflation over the last 30 years, which has really tried to stamp it down. But with a huge amount of debt that's been taken on courtesy of quantitative easing across the developed world, that it certainly makes sense that a bit of inflation... You can inflate your way out of a bit of that debt as well. So it will be interesting there, but obviously a key challenge for investors and the central bankers alike, is how and when they raise rates in the attempt to keep inflation in the target bands. I think as we are saying there, they're going to be comfortable to be behind the curve there. But how do you think unwinding of QE and normalising of monetary policy and even quantitative tightening will impact on bonds and credit and even stock market valuations?

 

UH:

Yeah. It's another good question. So I think the short answer is interest rates are definitely having a significant effect on asset prices. So whether it's bonds, credit, markets or equities. For fixed income or for bonds, there's a very clear linkage between interest rates and bond prices. And it's often referred to as duration, so longer dated bonds have higher duration, and duration essentially measures interest rate sensitivity. So again, there's very clear linkage where rates go up, bond prices go down. So very clear linkage there. And this is more pronounced for higher duration exposures or higher, longer dated bonds. But then for equities, there's also a pretty clear linkage there between interest rates and equity prices, or equity valuations. So now going back to, I guess, finance 101, you can say that the price of a security is essentially the present value of future cash flows.

 

UH:

So, again, you are essentially discounting projected future cash flows by a particular rate. That rate is often called the required rate of return or discount rate. And this discount rate is highly influenced by interest rates set by the market. So again, rates go up, there's downwards pressure on prices. So given we are in this rising rate environment, we are certainly seeing pressure on asset prices, but it's not the only driver. So it is important to note that there's obviously other drivers as well. So for equities, earnings growth, corporate earnings results, especially on a forward looking basis are really important. So, what that means is you could theoretically have positive equity returns even in a rising rate environment. So if earnings growth are really strong, or your earnings forecast and growth is really strong, you can actually have positive equity returns even in a rising rate environment.

 

UH:

So it's more than just rates that affect this. But another thing that I think is really worthwhile calling out at this point is, financial markets are forward looking. So what that means is... The real question really is, what has already been priced in? So yes, I think most people know by now that we are in this rising rate environment, central banks have pivoted from this ultra accommodative policy setting to now being a bit more hawkish or a bit more, "Hey, we're going to have to start increasing rates", but that's very well understood by markets already. So, for example, financial markets are already pricing in about six rate hikes by the Reserve Bank of Australia or by the RBA this year. So that's essentially one and a half percent, is already priced in by financial markets.

 

UH:

So one and a half percent hike is already priced in this year. So things have already very much flexed in financial markets. So in the US it's even more pronounced. So in the US financial markets are now pricing in 2% worth of hikes by the federal reserve in the US this year alone. And even in longer dated government bond rates, they have already picked up pretty meaningfully this year alone. So approximately 1% and 10 year government bond yield have gone up by about a percent year to date. So, to summarise, markets have already priced in a lot of this hawkish pivot by central banks. The question then is okay, what's left? And we think there's still potential for further rate increases. But the question is by how much, and we don't think there's maybe too much left in the tank yet.

 

POC:

Yeah. Interesting your comments there Uwe, because I have noticed that both the Aussie 10 year and the US 10 year treasury yields rising, and I think even the Aussie closed at about 2.77 last Friday there, which so it's really pricing in trying to get forward pricing of what the RBA will do with the cash rates ultimately. So yes, I think we're in for certainly a period of increasing interest rates over the shorter term.

 

POC:

Geopolitical risk has also been on the rise recently with Western countries increased tensions with China, and of course the recent tragic Russian invasion of Ukraine. How does BlackRock incorporate geopolitical risk into your asset allocation views? And I assume at a simplistic level that your views will impact directly on perhaps emerging market equities and bond exposures.

 

UH:

Yeah. Certainly. Yeah. Unfortunately geopolitical risks are back in focus, which is pretty sad. Having grown up in Germany, I can't believe we are back in an environment where we're talking about a real full blown war. So, it is shocking, but it is what it is. So, let's focus on market implications and you're right. So initial news, or the initial headline coming out of the region, the Ukraine crisis in particular, it did have a significant effect on asset prices. So initially there was this typical sort of risk off environment and risk assets sold off. Since then things have stabilised a bit, but also, it is worth pointing out again that financial markets do have an amazing ability to look through this.

 

UH:

So, we've been here before, so there've been a few instances over the past decade or so where we've had geopolitical tensions. And then again, it typically does have a short term effect on financial markets and then financial markets look through the noise and sort of move on. But again, it is important to understand the macro channels and how the war or the crisis can affect these macro variables. So again, one way to think about this is, we think that there's three, maybe four major channels through which these geopolitical tensions and the current Ukraine crisis can affect acro markets. One is inflation. Two is economic growth. Three is policy. And then the fourth one, which initially I didn't have in there, but I thought it's worth calling out as well, is structural changes.

 

UH:

So let's go through each of them one by one. We've already talked about inflation, so probably don't have to go into detail here, but essentially the Ukraine crisis has already triggered an oil and energy shock, which then feeds into inflation, and inflation was already running really high. So this is causing further stress, I guess, and concern for central banks and ultimately might effect central bank policy. So, that's one channel. The second channel is economic growth. So if you look at economic growth, again, it's important to understand the backdrop. So heading into the most developed market economies were actually growing above trend. So the backdrop was actually pretty positive. So now then the question becomes, okay, is this war going to materially change this positive outlook? And that is really hard to say, so I won't pretend to know the answer and then how this war is going to unfold, but there will be... Or there are a lot of different potential outcomes.

 

UH:

So, all of them could affect economic growth, or maybe less so. So, for example, how long is this war going to last, who's going to win? Is NATO going to get involved? What's, China's stance on all of this, is it going to turn into a nuclear war, or, I guess more on the more positive side, do we have potentially a peaceful diplomatic resolution in the near future? So any of these outcomes could have a different effect on economic growth. So certainly a lot of uncertainty, but even that is, when it comes to financial markets and building portfolios is important to understand that right now the distribution of outcomes is really wide. It's really hard to forecast, it's really wide. And later on maybe we can talk about this, but this is where diversification, it comes into play.

 

UH:

And it's really important, because ideally you want to have a portfolio that's really resilient and can deliver positive returns in a wide range of market scenarios. Okay. And then the third channel through which this crisis can make its way into financial markets is policy. Again, we talked about central bank policy and Paul, I know you mentioned this as well, that central banks have pivoted to be more hawkish already. It looks like the RBA is going to start hiking rates later this year. But then also the fiscal policy side is important too to understand. So, several governments have already announced increased defense spending. Governments are thinking about further infrastructure build out, new energy sources, in particular renewable energy. So that can create opportunities and challenges for financial markets.

 

UH:

And then the fourth key challenge... Oh, sorry, fourth key channel through which this crisis can make its way in markets is structural changes. So one thing in... Me, I guess, as a European, I guess I'm allowed to say that, but I've never seen Europe so United. So in the past, Europeans tend to fight over very petty things all the time. Whether it's the French, the Germans, the Italians, the English, always fighting over really petty things. But for the first time, I see Europeans are actually pretty United coming out or following the outbreak of this war and Europe has also moved closer to the US. So, that might have some interesting implications in the long term. And it is, again, interesting to watch, are we going to see this huge bifurcation between west and the east?

 

UH:

Are these two markets going to decouple a little bit like what we seeing in 5g? Are we going to have two separate economies? The west versus the east. And if that happens, it's going to take a few years or decades to play out, but that would have material implications for financial markets and economies, but even something that's bringing more to life again, even supply chains, a lot of companies that we talk to, they're currently revisiting their supply chains and where they source material from. And that could again change pretty significantly over the next few years. So again, lots of uncertainty in markets and lots of noise as well. So it's important to look through all that noise. So Paul, you mentioned, okay, what are our market views?

 

UH :

It's a long-winded answer. So what are our market views? Well, because there's a lot of noise in markets right now, we do think it's important to have this long term mindset. So strategic asset allocations are really important. Don't forget that long term mindset. You want to have good diversification in portfolios and resilience. Things are moving really fast right now. So being flexible can be beneficial when it comes to portfolio or asset allocation. If you have that flexibility, now might be a good time to be tactical. What are our views on emerging markets? The short term view is probably more challenged and a bit negative, I'd say, similar to Europe, but if you zoom out and you put on your long term hat or long term horizon, we are a bit more optimistic on EM and also on Europe, on a long term horizon. Short term, less so.

 

POC:

Yes. Well, there's a lot to take in from your comments there Uwe, and I guess as you were talking through the implications of the increased geopolitical risk there, I started to turn my mind to globalisation, the future of globalisation, but I think that's for another podcast. Otherwise we'll be here all afternoon. So maybe keeping it to the asset allocation, back to the focus of the podcast, defensive allocations must be a real challenge there, given the comments we've made around bonds facing a headwind and inflation rising and credit spreads are compressed and cash rates paying close to 0%. So where are you overweight and underweight in the defensive asset classes? And what are a couple of key points, I think that the listener could take away when thinking about making allocations to cash and Australian fixed interest and global fixed interest?

 

UH:

Yeah. No, you're spot on. Government bonds used to be a very good hedge and diversify in portfolios, but yeah, then they don't appear to be as effective as they once were. So you're right there. And it has become harder for investors to build resilient, diversified portfolios. So this year, first quarter of this year was a good example where we had this risk of environment and risk assets pulled back to some extent following the outbreak in the Ukraine. But even in Jan and February, certain equity and share markets have already struggled. But then at the same time, usually, once you've got that environment, usually bonds kick in and give you that ballast or that diversification that you after. Hasn't really happened so far.

 

UH:

So, you're spot on. So investors do have to be a bit more creative when it comes to building diversification in portfolios. And so currently we do like inflation in bonds. We like commodities, and particular gold can play a nice sort of defensive diversifier. And we also use currencies in our portfolios to get diversification into portfolios. So again, maybe just to elaborate that last point on currencies, having unhedged exposure to international assets can be a good diversifier in a risk of environment. So yeah. Where are we overweight and underweight? I mentioned inflation in bonds because we do think these types of securities can protect the real value of your portfolio better in case of inflation spikes. But then also on a more tactical basis, we're currently underweight some of the riskier fixed income markets.

 

UH:

So we recently went underweight high yield, and we increased our allocation to cash. And that was mainly a risk reduction trade. So cash doesn't have any duration, or very little duration. It's not very sensitive to interest rate hikes. Yes, you don't get a whole lot on cash right now. So that's the negative, but as a risk reduction tool, we think right now it is pretty prudent to take some risk off the table. So we have recently increased our allocation into cash. And also yeah, where we have the option, so we don't have the option in every portfolio, but where we have the option, we do like liquid alts. So, that can... Liquid alternatives can play an important part in portfolios. And even to some extent, defensive hedge funds, if you have the flexibility in your portfolios, defensive hedge funds, again, can in certain cases provide resilience. Again, due diligence is quite important because there's a whole broad range of hedge funds out there. But yeah, we think that if you find the right bonds, they can play an important part in portfolios.

 

POC:

Yeah. Interesting comments you make there Uwe, around, I guess for mine, it's about trying to extend the lens in the defensive section of the portfolio and the points you've made around gold and around defensive liquid alternative strategies, and even currencies potentially providing some defensiveness in a portfolio. But I think it's showing we really do need to go to work and think deeply about the defensive allocation in a portfolio. But moving across more to the growth assets and equities specifically, they've sold off a little recently, but growth stocks continue to trade at elevated earnings multiples. So what is your outlook over the short to medium term for equities? And are you typically holding an overweight position or neutral, or perhaps underweight compared to what a neutral position would be?

 

UH:

Yeah. The short answer is we're pretty neutral to equities at this stage, but you're right in that valuations have indeed come under... Come down in recent weeks and... But they're still elevated. So, that's interesting. The selloff in equities probably hasn't been as pronounced as a lot of people would've thought and including us here as well. We would've thought that there probably would've been a bigger pullback in global equities and following the recent uncertainty in spike and volatility. So, we are currently close to neutral when it comes to our equity allocation and again, on a forward looking basis, so more long term. We still think that equities... Or allocating to equities, does make a whole lot of sense. And equities can give you pretty attractive, positive returns in the long term. We are a bit more nimble.

 

UH:

And you mentioned this as well, growth stocks versus value stocks and so on. So we are still somewhat cautious when it comes to growth stocks, because you're right, in a rising rate environment, these type of stocks tend to underperform, especially when you compare those two value stocks in other more cyclical sectors. So at the moment within equities, we are leaning toward sectors and regions with more attractive valuations. So again, somewhat leaning into value stocks, I'd say at this stage.

 

POC:

And how are you then dividing the asset allocation between Australian and international equities?

 

UH:

Yeah, it's actually changed in recent weeks. So in recent years we've reduced... More and more we've reduced our allocation to Australian equities in favour of international equities. That was [inaudible 00:41:01] of the last two to five years, gradually it's been coming... Like that allocation to Aussie equities has been coming down. However, more recently we actually increased our allocation to Australian equities on a medium and short term basis. So on a tactical basis, so more short term, we actually quite like the domestic market at this point. And one of the reasons is, it's very resource and energy heavy. So currently we are seeing this commodity shock coming through the various markets and this could potentially benefit the domestic market, given our heavy reliance on resources and energy, and also the composition of the index.

 

UH:

But then also we do like the [inaudible 00:41:53] theme. So as the domestic economy [inaudible 00:41:56], we get more tourists in, we feel that this could potentially be a bit of a tailwind for domestic markets in particular for domestic equities. So if you think about it, the headlines out there, they're all about, oh, developed markets have really recovered well and bounced back incredibly strongly post the pandemic. And that's true, especially the US. So in the US last year, for example, real GDP growth was about 6%. So it's pretty high, way higher than the long term trend. However, in Australia, we only grew just below 4%. So yes, we did bounce back following the pandemic, but we feel that there's still some catch up we could be potentially playing.

 

UH:

So, we do currently like the domestic economy. And also, a third reason why we like domestic and more Aussie equities is we currently, we want to increase our allocation to the Australian dollar. Again, it's a commodity story. So, if you expect commodity prices to stay elevated for a while, that should be supportive for the Aussie dollar. And if you want to increase your exposure to the Australian dollar, one way to do that is via domestic equities. So again, another reason for currently favouring domestic equities.

 

POC:

Yeah. And I think it does make sense. And again, in light of the tragic events that are going on in Ukraine at the moment where it's really leading the spike in energy inflation. And also the fact that I think Ukraine was the largest wheat supplier to Europe. So both, Australia obviously is a big energy exporter and also potentially has a market there in Europe that it can also assist a service in the absence of the dropoff of in supply from Ukraine. So it certainly makes sense, both your comments around short to medium term, overweight to Australian equities that I think will benefit out of the sad circumstances going on in Europe, but also then the A dollar, and the A dollar will have a tailwind behind it there at the moment there. So I was going to ask about your outlook for the Australian dollar there, but I think you've summarised it well there. Would I be right then in terms of the exposure to international equities, do you have an increasing allocation to hedged international equities as a result of this view?

 

UH:

Yeah. Spot on Paul. Exactly. So, because we are currently quite bullish or optimistic on the Aussie dollar, yeah, we recently increased our allocation to international hedged equities. So essentially, yeah, we increased our hedge ratio. It is an interesting one because long term, we do like our exposure to be unhedged, because we feel that it can give you that diversification in a portfolio, and it typical in risk off environments, the Aussie dollar usually sells off and it gives you... Because of that, it does give you that diversification benefit, if your international exposure is unhedged. However, more short term, yes, you're spot on. Short term views are positive on the Aussie dollar. So hence, we've recently increased our hedge ratio on a short term bases. Yeah.

 

POC:

Yeah. No interesting, because you're right. But normally when there's a global risk off environment, the A dollar can sell off, and can sell off quite significantly. I remember the cliff it fell off back in the last quarter of 2008. So I guess I've always had a disposition to an unhedged international equities position, but it's certainly rational the comments you made there. And I think it's something that all of us from an asset allocation viewpoint need to be thinking about in our portfolios. So I guess in light of time there Uwe, I think we'll draw the podcast to a conclusion. So certainly I'd like to thank you very much for your input and your insights into asset allocation and broader risk, I think, and major issues that we all need to be thinking about at the moment. So, your time and your input certainly very much appreciated Uwe.

 

UH:

Thanks, Paul. Thanks for having me.

 

POC:

To the listeners, thank you again for joining us on the Netwealth investment podcast series. And I think particularly it's been an interesting discussion today with Uwe from BlackRock there around asset allocation. And I tend to think it has been... To a degree, it has been a set and forget exposures in portfolios for many years because of the long bull run that we've had both in equity markets and in bond markets. So, the bond market bull runs gone on for probably 30 years and we are now faced with our first genuine structural long term bear market or medium to long term bear market potentially in fixed interests. So I think as a result, we're all going to have to do a lot more effort and a lot more focus on our asset allocation. And given that it is the major driver of returns in diversified strategies, for mine it makes a lot more sense to focus on your allocations to asset and sub asset classes, rather than looking at individual equities and trying to pick, which is going to be the best performing of the Australian top four banks.

 

POC:

I've always thought that the time is best spent focusing on asset allocation there. So again, Uwe, we do very much appreciate the time that you've spent with the podcast this morning. And to the listeners thank you again very much for joining us. And I look forward to the next instalment of the Netwealth investment podcast series. Thank you all.