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Russ Koesterich
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Russ Koesterich, CFA, Managing Director, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a founding member of the Blackrock Investment Institute, delivering BlackRock's insights on global investment issues. Mr. Koesterich's service with the... More
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BlackRock
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The Blog
My book:
The Ten Trillion Dollar Gamble: The Coming Deficit Debacle and How to Invest Now: How Deficit Economics Will Change our Global Financial Climate
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  • Insight for Income Investors – Focus on Total Return
    Taken from iSharesblog.com

    In the current low interest rate environment, some investors are searching for income by taking unintended bets with their portfolios, embracing instruments and financial strategies which are often inappropriate, misunderstood, or just plain destructive to value.  As a result, they may be inadvertently introducing under-appreciated risks and unnecessary volatility without a commensurate increase in return.

    So how should one invest for income in today’s low yield environment?  When it comes to income, we would emphasize the following portfolio construction guideline: Focus on the level of desired return.  The desired return, rather than where it comes from (i.e.  income or capital gains), should determine the composition of the portfolio.

    This guideline is based on our analysis of a series of hypothetical portfolios designed to generate a range of target returns by combining investments that provide different levels of income.  We started with a simple portfolio of around 70% fixed-income and 30% equities, no preference for income, and a modest annual return of around 6%.  We then compared this portfolio with others that had increasing preferences for income.

    The result: portfolios with a low preference for income over capital gains were not materially less efficient – in other words, the returns they generated relative to their level of risk were not substantially different than the initial portfolio.  In contrast, as our hypothetical investor started to demonstrate a much stronger preference for income, the portfolio became materially more risky per unit of desired return.

    The explanation for this result is simple: as the preference for income increases, assets that generate low levels of income are ‘pushed out’ of the portfolio — even if they provide diversification benefits.  As the investor forgoes the diversification benefit of holding asset classes with low income components (such as growth equities, for example), the portfolio becomes more risky per unit of total return.  Indeed, the cost of the preference for income is the additional risk that must be taken in the portfolio as a result of this reduced diversification benefit.

    In light of these findings, what practical steps should investors take in building portfolios and thinking about income?  First, begin with an explicit return target.  This will help frame the significance of the income versus efficiency trade-off.  Second, leave income producing investments in more conservative portfolios.  If investors insist on both return and income they may have to accept a pick-up in volatility.

    Potential iShares Solutions

    Dividend stocksDVY – iShares Dow Jones Select Dividend Index Fund (click here for fund details)
    Preferred stocksPFF – iShares S&P U.S. Preferred Stock Index Fund (click here for fund details)
    US long term TreasuriesTLT – iShares Barclays 20+ Year Treasury Bond Fund (click here for fund details)
    US Short Term TreasuriesSHY – iShares Barclays 1-3 Year Treasury Bond Fund (click here for fund details)
    US Large CapIWB – iShares Russell 1000 Index Fund (click here for fund details)
    US Small CapIWM – iShares Russell 2000 Index Fund (click here for fund details)

    Listen to the full March Market Perspectives by Russ Koesterich here.

    Source: BlackRock

    The author is long DVY, PFF, and IWM.

    In addition to the normal risks associated with investing, investments in smaller companies typically exhibit higher volatility.  Bonds and bond funds will decrease in value as interest rates rise.

     

    The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy.

     

    The iShares Funds are not sponsored, endorsed, issued, sold or promoted by Dow Jones & Company, Inc., Russell Investment Group or Standard & Poor’s, nor are they sponsored, endorsed or issued by Barclays Capital. None of these companies makes any representation regarding the advisability of investing in the Funds. Neither SEI nor BlackRock Institutional Trust Company, N.A., nor any of their affiliates, are affiliated with the companies listed above.

    Carefully consider the iShares Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses, which may be obtained by calling 1-800-iShares (1-800-474-2737), or by clicking the Prospectuses link. Read the prospectus carefully before investing.

    Investing involves risk, including possible loss of principal.

    The iShares Funds (“Funds”) are distributed by SEI Investments Distribution Co. (“SEI”). BlackRock Fund Advisors (“BFA”) serves as the investment advisor to the Funds. The iShares Blog contributors are affiliated with BlackRock Fund Distribution Company (“BFDC”), which assists in the marketing of the Funds. BFA and BFDC are affiliates of BlackRock Institutional Trust Company, N.A. (“BlackRock”), none of which is affiliated with SEI.

    The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications or other transactions costs, which may significantly affect the economic consequences of a given strategy.

    The information provided is not intended to be tax advice. Investors should be urged to consult their tax professionals or financial advisors for more information regarding their specific tax situations.

    Neither BlackRock Institutional Trust Company, N.A., and its affiliates nor SEI and its affiliates provide tax advice. Please note that (i) any discussion of U.S. tax matters contained in this communication cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein; and (iii) you should seek advice based on your particular circumstances from an independent tax advisor.

    This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular.

    Mar 24 7:50 PM | Link | Comment!
  • iShares Bi-Weekly Strategy Update | 3.21.2011

    Taken from iSharesblog.com

    Last week, world equity markets suffered their sharpest correction since August of 2010. Continuing unrest in the Middle East and lingering sovereign debt issues in Europe are contributing to the spike in volatility, but last week’s sell-off was primarily driven by the unprecedented destruction wrought by the earthquake in Japan and related concerns over the safety of its nuclear power plants. While the humanitarian cost is incalculable, we do not believe that the events in Japan are likely to meaningfully detract from global growth, or change the market dynamics favoring equities. In fact given the recent flight to safety and accompanying drop in nominal bond yields, we would be even more inclined to reiterate our preference for equities over bonds.

    Japan: Both Local and Global Economies Likely to Prove Resilient

     

    Japan will recover. In fact, the experience of the 1995 Kobe earthquake suggests that economic recovery may be swifter than anticipated. That said, lingering concerns over demographics, politics, and deflation are likely to continue to put long-term pressure on Japanese equities.

    The full humanitarian costs of the recent earthquake and tsunami will not be known for months. In addition, a more significant nuclear event at the Fukushima Dai-ichi plant adds another unpredictable element to the disaster. However from an economic standpoint, absent a ‘Chernobyl’ type meltdown which at this point seems highly unlikely, the economic impact of the earthquake is likely to prove modest. The area primarily impacted by the quake accounts for a relatively small portion of Japan’s economy, and Japan’s overall share of the global economy has contracted sharply after several decades of economic stagnation. Back in the 1990’s Japan accounted for approximately 18% of global economic activity. Today Japan contributes less than 9% to the global economy, suggesting that the impact to global economic growth is likely to be limited.

    Given the potential for resilience, and the extraordinary efforts by the Bank of Japan to inject liquidity into the monetary system, is Japan a buy? The market is certainly cheap. Japan trades at its book value, versus the global average of 1.7x book-value for the MSCI All Country World Index. Despite its modest valuation and the prospects for a quick recovery, we believe a bounce in the Japanese markets is likely to be short-lived. The long-term issues that have resulted in what are now several lost decades are likely to persist. Namely, Japan is still facing the world’s most challenging demographics, entrenched deflation, and a political system still mired in inertia; none of which support a long-term improvement in Japanese equities.

     

    US Treasury Market: “I can’t eat an iPad”

    Broad inflation in the US is unlikely to prove a threat in 2011. However, other measures of inflation are rising, particularly expectations of future inflation. The recent rise in inflation expectations reflects the sharp spike in oil prices as well as continued skepticism towards Fed policy.  Rising inflation expectations imply that the real return on Treasury notes and bonds is likely to be well below the long-term average. In other words Treasuries appear particularly expensive at the same time that structural deficits will necessitate more and more supply. As a result, we would prefer municipal and corporate bonds over Treasuries.

    At a recent town hall meeting in Queens, New York Fed President William Dudley was reminded that economists don’t always reside in the same world as everyone else. The event was reminiscent of the early tea party events – just substitute “quantitative easing” for “ObamaCare” and “rising food and energy prices” for “rising healthcare costs.” While extolling the virtues of falling technology prices, a member of the audience responded, “I can’t eat an iPad.”

    The Fed tends to focus on core inflation – a measure of inflation which excludes food and energy prices – but with food and gasoline prices rising most people have a somewhat different view of inflation. And while the benefits of cheaper technology are manifest, Mr. Dudley was reminded that most people are more concerned with eating and putting gasoline in their cars.

    The impact of the recent spike in energy is not just evident in town-hall meetings; these concerns are becoming more pervasive in a way that should start to alarm the Fed, or at the very least bond investors. The University of Michigan tracks many measures of consumer sentiment, including consumer expectations of inflation. In February, the survey indicated that expectations for US inflation over the next year rose to 4.6%, the highest level since August of 2008 and well above the twenty-year average of 2.9%. While the one-year expectations tend to be volatile, even the more stable measure of inflation expectations- the five-year measure – spiked higher. February’s reading indicates that the survey respondents expect US CPI to average 3.2% over the next five years, a level well above the Fed’s implicit inflation target of around 2%.

    Rising inflation expectations are good to a point, particularly to the extent they indicate a waning fear of deflation. This was, after all, one of the stated goals of QE2. However, there can be too much of a good thing. If higher inflation expectations prove more than a passing response to an oil spike, they will eventually push consumers towards looking for higher wages, a much more serious problem. While higher wages are unlikely in the near term due to an anemic labor market, a long-term rise in inflation expectations would be a negative for bond holders.

    Source Bloomberg 2/28/11

    Rising inflation expectations are also evident among professional investors. The embedded inflation rate on 10 year TIPS is now close to 2.50%, the highest since December 2009. This suggests that investors expect inflation of approximately 2.50% over the next decade, a level well above the long-term average of 2.00% that has persisted since the inception of TIPS market in the late 1990s.

    Higher inflation expectations, coupled with falling nominal yields – the latter mostly a function of the recent flight to safety – mean that investors can expect a lower real or inflation adjusted return on the 10 year Treasury. Ironically, investors are accepting more expensive Treasuries with lower returns at precisely the moment that supply is surging due to higher deficits. Investors are fleeing to Treasuries as a safe-haven bid in a time of uncertainty, but do Treasuries still offer such a bastion of strength?

    While nobody believes the Treasury will fail to meet its obligations, by most standards the credit risk of the United States has deteriorated. At the same time, investors are being asked to accept historically low real returns for owning US Treasuries. With a real yield of less than 1% before taxes, it would appear that both the municipal and corporate bonds currently offer investors better value.

    Source: Bloomberg

    In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Bonds and bond funds will decrease in value as interest rates rise.

    iPad is a registered trademarks of Apple Inc. Neither BlackRock nor SEI is affiliated with Apple Inc.

    Carefully consider the iShares Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses, which may be obtained by calling 1-800-iShares (1-800-474-2737), or by clicking the Prospectuses link. Read the prospectus carefully before investing.

    Investing involves risk, including possible loss of principal.

    The iShares Funds (“Funds”) are distributed by SEI Investments Distribution Co. (“SEI”). BlackRock Fund Advisors (“BFA”) serves as the investment advisor to the Funds. The iShares Blog contributors are affiliated with BlackRock Fund Distribution Company (“BFDC”), which assists in the marketing of the Funds. BFA and BFDC are affiliates of BlackRock Institutional Trust Company, N.A. (“BlackRock”), none of which is affiliated with SEI.

    The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications or other transactions costs, which may significantly affect the economic consequences of a given strategy.

    The information provided is not intended to be tax advice. Investors should be urged to consult their tax professionals or financial advisors for more information regarding their specific tax situations.

    Neither BlackRock Institutional Trust Company, N.A., and its affiliates nor SEI and its affiliates provide tax advice. Please note that (i) any discussion of U.S. tax matters contained in this communication cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein; and (iii) you should seek advice based on your particular circumstances from an independent tax advisor.

    This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular.

    Mar 21 7:22 PM | Link | Comment!
  • Monday Market Calls | 3.14.2011
    Taken from iSharesblog.com

    Call #1: Underweight European equity market (with emphasis on banks)

    Last week Moody’s downgraded Spain’s debt, cutting it to Aa2.  The downgrade was likely based on the additional cost of shoring up Spain’s banking industry.  Despite the back-up in yields, there is good news for Spain in that the interest rates it’s paying on debt remain within budgeted levels, and the Treasury has completed roughly a quarter of its planned financing for the year.  In addition, there is evidence of real reform including an overhaul of the labor laws and pensions, increased job creation, and the introduction of core capital requirements for savings banks.  Also, unlike smaller countries, Spain is still able to access debt markets – last Tuesday it raised 4 billion Euros.

    Despite cutting its rating, Moody’s reiterated that debt sustainability in Spain is not under threat.  That said there is a growing likelihood of defaults in Greece and Ireland.  Currently, Credit Default Swaps for Greece are signaling a 60% chance of default within the next five years.  So while the Euro will survive, sovereign debt issues are likely to linger.  The net impact is likely to be a haircut for holders of peripheral European sovereign debt, i.e. European banks.  As such, we remain underweight this sector.

    Call #2: Overweight developed (with preference for large/mega cap) vs. emerging markets

    Year-to-date, emerging markets are down roughly 1.5% while developed market mega caps are up roughly 5%.  Our view is reinforced by the recent market volatility and growing unrest in the Middle East.  In this type of environment, large, quality companies are likely to prove more resilient.

    There have been some noticeable improvements in the inflationary environment in emerging markets, most notably a sharp deceleration in the growth of the Chinese money supply (an important criterion for the Chinese monetary authorities) and continued monetary tightening in Brazil.  But higher oil prices will exacerbate inflationary pressures in emerging markets, particularly food prices which are largely driven by energy costs.  We continue to watch emerging markets for evidence of progress on inflation, return of risk appetite, and cheaper valuation.  Until then, we stay underweight emerging markets and overweight developed markets.

    Potential iShares solutions

    Underweight European banksEUFN – iShares MSCI Europe Financials Sector Index Fund (click here for fund details)
    Overweight developed market mega capOEF – iShares S&P 100 Index Fund  (click here for fund details) 

     

    IOO – iShares S&P Global 100 Index Fund (click here for fund details)

    Underweight emerging marketsEEM – iShares MSCI Emerging Markets Index Fund (click here for fund details)

    Source: Bloomberg

    Index returns are for illustrative purposes only and do not represent actual iShares Fund performance. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results. For actual iShares Fund performance, please visit www.iShares.com.

     

    In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.

    The iShares Funds are not sponsored, endorsed, issued, sold or promoted by MSCI Inc. or Standard & Poor’s. Neither of these companies makes any representation regarding the advisability of investing in the Funds. Neither SEI, nor BlackRock are affiliated with the companies listed above.

    Carefully consider the iShares Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses, which may be obtained by calling 1-800-iShares (1-800-474-2737), or by clicking the Prospectuses link. Read the prospectus carefully before investing.

    Investing involves risk, including possible loss of principal.

    The iShares Funds (“Funds”) are distributed by SEI Investments Distribution Co. (“SEI”). BlackRock Fund Advisors (“BFA”) serves as the investment advisor to the Funds. The iShares Blog contributors are affiliated with BlackRock Fund Distribution Company (“BFDC”), which assists in the marketing of the Funds. BFA and BFDC are affiliates of BlackRock Institutional Trust Company, N.A. (“BlackRock”), none of which is affiliated with SEI.

    The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications or other transactions costs, which may significantly affect the economic consequences of a given strategy.

    The information provided is not intended to be tax advice. Investors should be urged to consult their tax professionals or financial advisors for more information regarding their specific tax situations.

    Neither BlackRock Institutional Trust Company, N.A., and its affiliates nor SEI and its affiliates provide tax advice. Please note that (i) any discussion of U.S. tax matters contained in this communication cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein; and (iii) you should seek advice based on your particular circumstances from an independent tax advisor.

    This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular.

    Mar 15 1:26 PM | Link | Comment!
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