BlackRock Global Allocation Fund (Aust) (Class D) (MAL0018AU) Report & Performance

Global markets continued to rally in July on the combination of lower-than-expected inflation and better than expected economic growth. Global equities, as measured by the MSCI World Index, advanced +3.4% in July, with cyclical sectors such as Energy, Industrials and Materials among the best performing stocks in the global indexes. Outside the U.S., emerging market stocks, as measured by the MSCI Emerging Markets Index, were among the equity market’s best performing segments, as investors anticipated that China’s government would provide policy support to shore up consumer confidence as economic growth in the country has struggled to find its footing post COVID. Global bond performance was split in July. Corporate bonds, as measured by the ICE BofA/ML U.S. Corporate Index, advanced as the prospects of better than anticipated U.S. economic growth lowered the likelihood of recession and corporate defaults.

Long-dated U.S. government bonds, as measured by the ICE BofA/ ML 10-Year Treasury Index, fell, however, as the U.S. Federal Reserve resumed its increase of the Fed funds rate at the end of the month and signalled that further rate hikes might still be warranted in the future, absent continued progress on the inflation front. International bonds (FTSE Non-USD World Gov’t Bond Index), generally rose during the month, aided by a weakening U.S. dollar. Emerging market bonds (JPM EMBI Global Core Index) were boosted by interest rate cuts in a number of jurisdictions across Asia and Latin America.

Despite a historic rise in short-term interest rates and the abrupt tightening of monetary policy, we believe that the U.S. economy will likely avoid recession in 2H’23 and possibly the entirety of 2024. Many U.S. consumers, corporations, and municipalities have been able to withstand the impact higher short-term interest rates because they successfully locked in low, long-term fixed rate borrowing costs during the pandemic. In addition, with over $3 trillion in fiscal stimulus still yet to be spent and with significant excess savings remaining on household balance sheets, the lagged effect of massive fiscal spending is acting to materially off-set the lagged effect of restrictive monetary policy. With U.S. services spending still below its historical trend, U.S. inventory restocking likely to be a tailwind for economic growth, and inflation still annualizing at 3%, our view is U.S. nominal GDP may remain as high as 5% for the remainder of 2023, supporting earnings growth and taking some pressure off corporate profit margins. That said, this dynamic also implies stickier inflation and greater difficulty to generate slack in the system. As such, it is prudent to take the Fed at their word on the potential for additional rate hikes. We believe that inflation is likely to gradually come down over the coming quarters (albeit not to the equilibrium experienced in prior cycles) as supply shocks wear-off, restrictive monetary policy works to contain cyclical parts of the economy and the extended use of technology help push prices down. In this environment, we have increased our equity exposure to a moderate overweight, with an emphasis on stable growth and quality. We are constructive on fixed income as shortterm U.S. interest rates are at elevated levels relative to recent history, though maintain an underweight to duration as U.S. recession risk has receded. Most of our fixed income exposure is in a diversified basket of corporate credit, securitized assets, and emerging market sovereigns. In-line with the fund’s risk aware mandate, we hold exposure to an array of portfolio hedges.

Global markets were generally negative in May, as concerns about a potential U.S. debt default and possible credit downgrade, coupled with softer-than-expected Chinese growth, weighed on risk appetite. Global equities, as measured by the MSCI World Index, fell -1.0% in May, led lower by Chinese and European shares. Emerging market stocks, which possess a significant amount of both direct and indirect exposure to China, also struggled. However, in the U.S., large-cap stocks, as measured by the S&P 500 Index, experienced modest advances, powered by gains in some of the country’s largest software and semiconductor stocks, due to optimism related to advances in artificial intelligence (AI).

Global bonds fell in May, as investors evaluated the most recent U.S. inflation prints and concluded that the Fed might still have more work to do to contain price pressures. Although goods inflation in the U.S. continues to show signs of receding, services inflation remains stubbornly high. Duration sensitive long-maturity bonds, including 10-year U.S. Treasuries, were among the fixed income sector’s worst performers during the month, while overseas sovereigns were further weighed down by an appreciating U.S. dollar.

In May, we added to equities in recognition of a resilient US economy, continued strength across corporate earnings and a nominal GDP environment, that while decelerating, has proven to hold up better than expected at the beginning of the year. That said, we maintain a small underweight vs. our benchmark given near-term volatility caused by uncertainty around persistent inflation, tightening credit conditions and elevated valuations.

Within sector positioning, our overweights are concentrated in “stable” or “high quality” growth companies that can generate earnings consistency and are aligned with long-term structural trends. This would include industries such as medical devices and managed care that benefit from aging demographics, software and AI positioned to grow from R&D, digital infrastructure, and innovation, luxury goods manufacturers that benefit from a resilient consumer and defense companies that are in demand in a deglobalizing world.

We modestly added to exposure to gold-related securities (~1%), primarily through call options on gold ETFs. We felt the additional gold exposure had the potential to provide a small hedge to elevated equity volatility caused by concerns about the health of the banking sector. Gold prices could experience further support if real interest rates begin to plateau/decline after several quarters of sharp increases.

Underweight the U.S. Dollar (58% vs. 60% benchmark), as we believe that the U.S. Federal Reserve is approaching the end of a historic tightening cycle. Going forward, we believe there is room for the dollar to retrace some of its historic gains from 2021 and 2022 as central banks outside the U.S. continue to finish their own rate hike campaigns even after the Fed reaches its terminal level. As a result, we are overweight the Japanese Yen and Euro, as well as Mexican peso and Brazilian real.

Global markets generally posted sizeable gains in March after experiencing significant volatility mid-month, as investors shrugged off the first two major banking collapses in the U.S. since the 2008 Financial Crisis. Silicon Valley Bank (SVB) and Signature Bank were placed under the control of the FDIC after severe deposit flight quickly jeopardized their ability to continue operations. The FDIC’s rapid decision to guarantee all deposits at both banks along with the Federal Reserve’s commitment to provide substantial short-term funding availability to all banks, helped mitigate the risks of a full-blown banking crisis, but could not fully prevent investor angst from spreading overseas. Rapid deposit flight forced the Swiss National Bank to quickly arrange a forced merger between the nation’s second largest financial institution, Credit Suisse with UBS. Global equities, as measured by the MSCI World Index, rose +3.1% in March as a confluence of factors, including a sharp decline in real interest rates, swift U.S. regulatory action to backstop the banking system, and moderating February inflation data, combined to boost investor confidence. Global bonds rallied sharply over the month, as significant risks across the banking sector led investors to conclude that lending would be sharply curtailed, and as a result, a U.S. recession was now considerably more likely.

Despite the likelihood of significant contagion risk in the banking sector has probably been avoided, we are mindful that the deposit flight experienced by many U.S. regional banks is likely to weigh on future credit formation and increase the headwinds on an economy that is already decelerating. In addition, U.S. equity valuations are not inexpensive relative to their own histories and short-term U.S. interest rates remain elevated. In this environment, we remain underweight equities, though have become more constructive on non-US exposure. We are leaning into idiosyncratic risks with an emphasis on quality and pricing power in our core holdings, notably companies we believe are more likely to deliver consistent cash flows during a period of decelerating economic growth. We are more constructive on fixed income as short-term U.S. interest rates are at elevated levels relative to recent history. We have increased exposure to duration, taking it closer to neutral vs. the benchmark, reflective of the view that are approaching the peak of the U.S. Fed Funds rate. In-line with the fund’s risk aware mandate, we look to balance exposure to risk assets with a diversified allocation to portfolio hedges, with a reliance on high quality carry via income yielding assets coupled with derivatives and cash.

Global markets relinquished large portions of their January gains following the release of several key pieces of U.S. economic data during February that came in higher than expected, notably U.S. non-farm payroll figures, producer price data, and PCE Deflator data (the Fed’s preferred inflation gauge). In each instance, these higher-than-expected economic statistics sent both stocks and bonds lower, as investors anticipated that the U.S. Federal Reserve would need to further tighten monetary policy to contain inflation. Global stocks, as measured by the MSCI World Index, fell -2.4% as investors braced for a “higher for longer” interest rate environment. Emerging market stocks were particularly hard hit due to a rebound in the U.S. dollar.

Global bonds performed poorly in February, as the higher-than-expected U.S. jobs and inflation data highlighted above stoked concerns about the likelihood of tighter U.S. monetary policy. Duration-sensitive long-maturity bonds, such as 10-year U.S. Treasuries and developed market International Sovereign bonds, fared particularly badly as investors concluded that the world’s major central banks are likely to keep short-term rates elevated for a protracted period. Looking ahead, we believe that stronger-than-expected economic data is indicative that the U.S. will likely avoid a deep recession. While a positive nominal U.S. GDP may spare corporate earnings from significant revisions, stubbornly high inflation will continue to be a headwind for equities as the Fed will likely maintain restrictive monetary policy for the near-term. In this environment, we remain underweight equities, though have become more constructive on non-US exposure. We are leaning into idiosyncratic risks with an emphasis on quality and pricing power in our core holdings, notably companies we believe are more likely to deliver consistent cash flows during a period of decelerating economic growth. We are much more constructive on fixed income as short-term U.S. interest rates are at their highest levels in a generation. While we believe the bulk of the U.S. interest rate hikes have occurred, we see continued tightening from central banks (albeit at smaller increments), and thus maintain a partial underweight to duration (notably via Japanese rates). In-line with the fund’s risk aware mandate, we look to balance exposure to risk assets with a diversified allocation to portfolio hedges, with a reliance on high quality carry via income yielding assets coupled with derivatives and cash.

Global stocks declined in December, ending 2022 on a down note and putting to rest the worst calendar year for equities since 2008’s Global Financial Crisis. Global bond performance for the month was mixed. Shorter-dated bond prices were mostly stable during December, but longer-maturity bond prices were negatively impacted by data indicating continued strength in the U.S. labor market. Mid-month, the U.S. Federal Reserve approved an interest rate increase of +0.50% and signalled its intent to lift rates through the spring to combat inflation. Although the Fed’s decision marked a deceleration from four consecutive increases of +0.75% beginning back in mid-June, investor concerns about the potential negative impacts that addition rate increases could have on the economy – and corporate profits – weighed on equity performance. In addition, the Bank of Japan’s decision to alter its policy of “yield curve control” (YCC) also weighed on global risk assets, as the consequences of the shift encouraged Japanese investors to sell their foreign securities holdings (including U.S. Treasuries) and repatriate capital back home, further draining liquidity from global capital markets.

Looking ahead, we continue to make a case that despite the challenges faced in 2022, people underestimate how adaptive, innovative, and flexible the US economy can be. As a result, we believe that the U.S. will likely avoid a material economic contraction in 2023 (and may avoid a recession altogether), as the strength of the U.S. labor market should provide structural support for overall consumption. Across asset classes, within the Global Allocation Fund, we maintain a neutral view on equities in the short-term as we except U.S. Federal Reserve (Fed) policy to remain restrictive in the coming months. In this environment, we remain patient and are leaning into idiosyncratic risks with an emphasis on quality and pricing power in our core holdings, notably companies we believe are more likely to deliver consistent cash flows during a period of decelerating economic growth. Our preferred exposures reflect a bias in favor of quality, GARP (growth at a reasonable price) and select areas of resources where we anticipate supply to remain constrained for the foreseeable future. We are much more constructive on fixed income as we believe the historic back-up in yields YTD represents a generational inflection point and continue to look for ways to build carry into the portfolio, notably via high quality investment grade credit and agency mortgages. While we believe the bulk of the U.S. interest rate hikes have occurred, we see continued tightening from central banks (albeit at smaller increments), and thus maintain a partial underweight to duration (notably via non-US rates). In-line with the fund’s risk aware mandate, we look to balance exposure to risk assets with a diversified allocation to portfolio hedges, with a reliance on high quality carry via income yielding assets within the portfolio coupled with a balance in cash, the U.S. dollar, and derivatives. Total equity exposure decreased, driven largely by market movement, as equities were down amidst investor concern that future rate increases could have corporate earnings and risk assets. Our core positioning remained stable, as we believe equities will remain volatile, but range bound in the coming months.