BlackRock Recommends Buying Cheap Volatility While Pimco Sells

Jun 26, 2014 2:38 pm ET

June 26 (Bloomberg) -- BlackRock Inc., the world’s biggest asset manager, is recommending that investors shield against a pick-up in volatility, putting it at odds with Bill Gross’s Pacific Investment Management Co.

BlackRock’s Chief Investment Strategist Russ Koesterich said that with the Chicago Board Options Exchange Volatility Index within a few points of its record low this month and with valuations “stretched across markets,” price swings are likely to return. Depending on the portfolio, one way to express that is to buy puts, derivative contracts that bet on a decline in the underlying security, he said.

“Volatility is cheap,” Koesterich said at a briefing outlining BlackRock’s mid-year investment outlook today in New York. While global central banks policies that support financial markets mean volatility should be muted, he said, “it’s not clear it should be this low.”

The Standard & Poor’s 500 Index, a benchmark for U.S. stocks, hasn’t risen or fallen more than 1 percent in 48 sessions, the longest streak since 1995. Pimco, which manages almost $2 trillion, sold insurance betting volatility will remain abnormally low, chief investment officer Bill Gross said last week.

Hedge funds and other speculators have pushed long and short positions in VIX futures to record highs, according to data compiled by Bloomberg. In listed contracts, demand for protection should the bull market falter has sent the price of bearish puts to a 15-year high relative to calls.

Eventual Recoil

A reversal of the Fed’s zero-interest rate policy would cause a spike in volatility, said BlackRock, which manages about $4.3 trillion in assets.

“The longer monetary policy smothers volatility and underwrites heady valuations, the bigger the eventual recoil,” BlackRock strategists including Koesterich wrote in the investment outlook.

That contrasts with Pimco’s view for the next three to five years, an era it calls the “new neutral” characterized by low interest rates and lower, more stable global growth. As “part and parcel” of that, Newport Beach, California-based Pimco’s sold “insurance, basically, against price movements” since May, Gross said. Pimco sees low volatility “for now,” with an eye on central banks including the Bank of England for policy shifts that would spark price movements, he said.

BlackRock echoed Pimco’s call for lower returns expectations. In the new neutral, stocks and bonds will hand investors annual returns of about 5 percent and 3 percent respectively, Pimco said in May. With the S&P at about its record high and the yield investors demand to hold speculative- grade bonds instead of government debt at about the least on record, investors should recalibrate with “lower return expectations, particularly for U.S. equities,” Koesterich said.

--With assistance from Callie Bost in New York.