Now that the Fed has, as Rabobank put it, “carved central planning into the bedrock of the US financial system“, and moral hazard is not just universally accepted but a widely expected component of the investing process (or what’s left of it), it probably also means that conflicts of interest are also a thing of the past. Because when the asset manager tasked with executing the Fed’s takeover of the bond market says that it plans on co-investing with the Fed – its client whose trades it is executing and thus potentially frontrunning – what is that if not one giant conflict of interest? Worse, what does it say about the future of the entire financial industry and investing itself?
BlackRock, which manages roughly $7 trillion in assets and is the world’s largest asset manager, said it plans to keep a “significant cash cushion” for now given uncertainty about length and depth of economic downturn, and “will follow the Fed and other DM central banks by purchasing what they’re purchasing, and assets that rhyme with those”,wrote Rick Rieder, head of the firm’s global allocation team, in a blog post.
“We are thinking about the coming weeks in terms of two intervals,” Rieder who is also chief investment officer of global fixed income and manages about $2.3 trillion in fixed-income assets, wrote: an initial phase which involves having a large cash pile and then following central banks’ purchases and buying “assets that rhyme with those.”
“That means buying U.S. nominal duration where there is still scope for rates to rally further (i.e., the back end), which also provides a dependable risk hedge.”
BlackRock will own some U.S. breakevens “that are cheap for technical reasons, and we will be selling U.S. rate volatility as rates come down and are pinned lower, especially at the front end.” The firm will rotate out of agency mortgage-backed securities and into investment-grade credit, along with buying other high-quality assets not included in Fed’s purchase programs.
BlackRock also wants to “pick away at some sectors of the equity market that have had valuations destroyed beyond even worst-case scenarios such as healthcare, biotech, technology, defense, home builders, and others” and, since the Fed has assured that volatility will remain contained, will “target moderate equity exposures but can take on more exposure through selling volatility that would put us into long positions at lower levels and thereby benefit from still crazy-expensive implied volatility.”
Rieder writes that the “potential to construct a 4% to 5% yielding portfolio is now significantly more attractive than at the beginning of the year as we can get those yields with an even higher quality mix of assets today. Moreover, with many of those assets trading at nice discounts to par, there is also the potential for near-term capital appreciation.”
In the longer term, Blackrock “envisions getting more invested, allowing cash to run down” and will “rotate down the credit spectrum, swapping investment-grade credit for higher quality high-yield or loans” which the Fed is also buying.
Finally, Blackrock also plan on growing the equity exposure, “this time in outright expressions as well as through buying options that will likely have cheapened considerably.”
Rieder concludes that “while the magnitude of this unfolding crisis is truly historic, eventually things will return to a more normal equilibrium, and as is often the case, the markets will lead the way back to normalcy.” Because what can possibly go wrong by piggybacking on the same Fed trades that led us to the edge of collapse?
And just like that, not only is “investing” as we know it dead, but it has been reduced to the tedious exercise (which a 5 year old can do) of simply buying whatever the Fed and other central banks are buying, and for some lucky investors, not only frontrunning the Fed but getting paid for it.
Read Rieder’s full blog post “Wall Street’s believe it or not” here.