This publication recently interviewed Michael Fredericks, who is managing firector, is head of US retail Asset allocation for the BlackRock's Portfolio Strategies (MAPS) group.

This publication recently interviewed Michael Fredericks, who is managing director and head of US retail Asset allocation for lackRock's Portfolio Strategies (MAPS) group. He is responsible for the development and management of asset allocation strategies for retail clients.

Fredericks joined BlackRock in 2011 from JP Morgan Asset Management where he was an executive director and portfolio manager in the Global Multi-Asset Group, responsible for retail asset allocation solutions. Previously he was an equity analyst responsible for global consumer discretionary stocks at Nicholas Applegate Capital Management. He also performed investment manager due diligence at Callan Associates.  Given the global nature of the issues concerned, we hope readers of this, and its sister publications in other regions, finds the material of value.

First of all, can you give us a broad overview of how you invest and what your philosophy/approach is and how best to describe it?

At BlackRock, we believe the ability to be flexible and to look beyond traditional income-producing asset classes will be vital in the future as the backdrop shifts from one of historically low rates and reduced volatility to a more normalized investing environment. We believe a flexible, risk-aware strategy that incorporates alternative income sources can potentially increase income and diversification while decreasing volatility of the entire portfolio.

Our approach has been of tactical asset allocation (TAA) and this is an active-management strategy in which we continuously monitor and adjust portfolio asset class allocations to take advantage of risk, return and income opportunities. We believe taking a go-anywhere approach is critical to allowing an experienced manager to choose the best opportunities to balance income and risk. The flexibility of a go-anywhere tactical approach means that benchmark allocations are not weighing down the portfolio with low-yield, high-volatility asset classes. And one major advantage of TAA is that we will be able to take a more diversified approach to portfolio management in an effort to control the overall risk of the portfolio and target more consistent results.

How do you arrive at the approach you take to investing? Was it as a result of particular discussions, debates?

It is always important to keep the end client in mind when taking investment decisions. We are trying to deliver to our clients sustainable and attractive yield whilst mitigating as much of the risk as possible. This naturally leads us to take a conservative approach to asset allocation.

We have three portfolio managers managing the asset allocation, backed up by a team of 20 investment professionals. We dynamically mange the allocations between asset classes in real time to taking advantage of changes in the macro economic outlook to increase or decrease weights. We are not tied to a benchmark nor have strategic weights to particular asset classes allowing us the flexibility to achieve our investment goals. Individual security selection is managed by investment teams from the wider BlackRock organisation who have a deep understanding of each individual asset class. The benefit of this top down and bottom up combination is the ability to focus at a micro level and a macro level i.e. understanding the idiosyncrasies of individual companies across each geographic region, whilst keeping an overall view on markets and controlling risks at a portfolio level.

Asset allocation decisions are taken after weighing up various fundamental inputs, comprising of; valuations to assess underlying fundamental value, macro environment to capture changing economic conditions, market sentiment to assess investor behavior and other idiosyncratic factors such as geopolitical events.

Lots of fund managers say they have varied types of exposure to different assets, including alternatives. What is distinctive about how you do this at BlackRock? Can you also illustrate the benefits by any data, performances, back-testing?

We believe our strategy of diversifying an income-oriented portfolio by incorporating alternative asset classes that are less correlated to traditional stocks and bonds helps reduce some volatility. For investors who may have too high an allocation to cash or traditional bond strategies, we recommend our flexible income approach as a worthy complement to an overall portfolio. Of course, any portfolio reallocation should take place within the context of an investor’s goals, risk tolerance and time horizon.

Risk management has long been embedded in BlackRock’s culture. Our risk-management processes include daily risk reviews and stress tests, weekly portfolio construction discussions and monthly senior management reviews of performance and risk levels. Through this comprehensive approach, investment decisions in all of our client portfolios are made with an eye toward understanding how each decision might impact the portfolio’s overall risk profile. We have observed that conservative, income-oriented investors are typically more sensitive to market fluctuations, particularly short-term pullbacks that may cause their investments to experience sharp negative returns. For this reason, we place a particular emphasis on monitoring and managing short-term volatility in order for us to more effectively adapt to rapidly changing market conditions.

Examples of dynamic asset allocation and our risk first approach include:

-- Two years ago we generated most of our income from credit and in particular High Yield, today we generate most of our income from
equities and specifically from equity call overwriting (this strategy in itself accounting for almost a third of the total income);

-- Taking out equity protection and moving 10 per cent into cash before the “taper tantrum” in May of last year reduced losses
significantly.

You have exposure to alternatives via derivatives. Can you expand on this and explain? What sort of alternatives (hedge funds, private equity, property, commodities, metals, infrastructure, other)?

The derivative exposure that we currently have in the portfolio is used in two main ways.

Firstly we generate significant income from our covered call strategy. This involves simultaneously buying an equity and writing an out-of-the money call option on that equity. This strategy has the potential for capital growth from the equity and generates significant income through the option premium.

The second use of derivatives in the portfolio is to manage risk, typically controlling the duration (interest rate sensitivity) of the portfolio or the equity Beta (equity market sensitivity). Typical instruments used would include treasury futures, S&P500 Futures or options.

We do have exposure to “non-traditional” asset classes such as preferred stock and structured credit - asset classes typically not held by investors. These exposures are all obtained by holding a portfolio of actual securities as opposed to obtaining the exposure through derivatives.

What is the asset allocation split between the major asset classes at the moment?

(Answer based on data as of 31 July 2014)

Equity 36.1 per cent; fixed income 24.6 per cent; non-traditional assets 25.1 per cent cash and cash equivalents 14.3 per cent.

How much freedom do you have to change exposures? What sort of frequency of adjustment is allowed for, and why?

Through our strategy of diversifying an income-oriented portfolio by incorporating alternative asset classes that are less correlated to traditional stocks and bonds, we are able to retain a certain level of freedom in the way we manage our asset exposure. As olatility increases we may tactically reduce exposure to riskier assets and add more to positions that demonstrate lower risk profiles. Similarly, as volatility stabilizes, we may allocate to higher risk assets. In all cases we will remain diversified among stocks, bonds and alternative income sources to protect against volatility and to balance risk, return and income.

Our active-management strategy means that we are not beholden to any one particular kind of investment and has the flexibility to adapt to changing markets.

How much cash can you hold? Are you always fully invested? What is the rule of the fund?

Cash and cash equivalents are 14.3 per cent [of asset allocation]. There is no limit on the amount of cash that the fund can hold. Typically the fund will hold a cash balance of between 0 per cent and 20 per cent. Cash is generally held as a way of reducing overall portfolio risk, so during periods of market stress or predicted market stress then we will tend to increase this cash buffer. If we perceive the level of market risk to be low then we can, and are frequently, fully invested.

What sort of investors is this fund aimed at? Should wealth management clients be interested?

Multi-asset income funds are good for many different investors who need income to fund their lifestyle.  This includes a wide variety of investors from those who need to pay for their children’s education through to retirees wanting to maintain a desirable lifestyle. Indeed, low rates are making retirement, for some, too expensive, and leaving would-be retirees short of their income goals.

Many of today’s investors face the dilemma of having to guard against the corrosive effects of inflation in a low-return environment, yet they also need to be wary of taking on too much risk. We see a lot of conservative investors either sitting on the sidelines in cash waiting for markets to change or have retained their fixed income bias but have reduced the credit quality (and hence increased their risk) in order to maintain their income levels.

Having a fund that offers income but is also nimble enough to react to changing markets is an option for investors looking to increase the diversity of their portfolios and lessen interest rate and market risk, while at the same time lowering volatility. This is certainly a great option for wealth management clients.

Any further points you want to make about the economic outlook?

In the aggregate it does feel like things are getting a bit better in the US, whereas in Europe there has been some decent growth (albeit from a low base), but some of the data have been disappointing of late. We’re clearly in tapering mode - the Fed has set a target date of October to end its Quantitative Easing programme - and the question is when rates will rise.

We think rates are going to move higher sooner than the market is currently pricing in, but we don’t see a big risk to a sharp rise in 10-year Treasury yields. Meanwhile, mergers-and-acquisition activity has been off the charts, and usually you see a big spike in M&A somewhere near the end of the cycle.

It’s been eye-opening how many deals have been getting done, and that’s in part because funding is so cheap (i.e., interest rates are so low). Having said that, there are always things to worry about, be it policy issues or overseas unrest. It’s difficult to know how they will play out, and part of the reason we don’t take on a lot of risk is that these things can’t be predicted.