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Stattman: Government Bonds Not Safe

Government bonds aren't the risk-free investments they once were, while stocks have better reward potential right now, says Dennis Stattman of BlackRock.

Liana Madura, assistant site editor, 07/06/2011

Dennis Stattman is a managing director and portfolio manager at BlackRock. He also is head of BlackRock's Global Allocation team and a member of the BlackRock Leadership Committee. As portfolio manager of BlackRock Global Allocation MDLOX, he talked to us about how he navigates the market amid the lingering the sovereign debt crises, the fund's universal appeal, and the positives and negatives of investing in stocks right now. He also told us his lessons learned in understanding the risks in BlackRock's equity portfolio versus its corporate bond portfolio.

1. How are you mitigating risk in your portfolio in the face of the growing global sovereign debt crisis?
We have been attuned to sovereign debt risks for the past several years, particularly given that enormous amounts of debt have been transferred from the private sector to the public sector as governments have had to enact massive intervention policies during the financial crisis.

As such, we have come to believe that government bonds are not the risk-free investments that many thought them to be. Consider also that we have been in a bull market for government bonds for well more than 20 years, which makes the sovereign sector considerably less attractive. The combination of high prices and low yields makes the entry point for government bonds rather unappealing.

As the sovereign crisis has been unfolding, we've aimed to mitigate risk in our portfolio by minimizing direct exposure to government bonds, particularly in those areas where we don't think our clients are being fairly compensated for the credit risks they are assuming. Additionally, with inflation risks growing stronger, government bonds are looking less attractive. Given the low level of government bond yields right now, inflation would not have to be much higher than where it is today for government bond returns to become negative on a real basis.

Global Allocation has been noticeably underweight government bonds for some time. We began moving out of government bonds in late 2008 and early 2009, when there was a massive demand for them during the financial crisis. Instead, we began favoring investments in such areas as equities and convertible bonds. We maintain that underweight in government bonds today, including underweight positions in U.S. Treasuries, European government bonds, and Japanese government bonds. Notably, we own no European peripheral debt today given the risks.

2. What has been your biggest mistake, and what are you are doing differently today to guard against repeating it?
What makes Global Allocation unique is its flexibility to invest across asset classes, regions, currencies, and risk profiles, resulting in a very diversified portfolio.

Looking back over Global Allocation's 22-year history, we take pride in the fact that we have experienced very few periods of protracted underperformance. In the fund's 22-year history, we have experienced only three calendar years of negative return, one being in 2008. The few occasions that the fund has lagged its benchmark have tended to occur during times of significant market dislocations and extreme volatility, when correlations among and between almost all asset classes spiked.

Our biggest mistake was made more than a dozen years ago when we failed to properly understand the similarity of risks in our equity portfolio and our corporate bond portfolio. So as markets weakened, we suffered losses in both the equity and corporate bond segments of our fund. Today, we have superior risk-analysis resources that look at our entire portfolio and actively monitor correlations of securities across all asset classes.

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