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Trends in portfolio construction

Stay up to date on the latest portfolio trends with our Portfolio Construction team’s insights, which are fueled by nearly 12,000 portfolio reviews annually.

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The resilient economy backed by the solid consumer backdrop continues to be strong, showing hints of stabilization and even reacceleration in some areas. Expectations of monetary easing have contributed to improving global financial conditions and manufacturing activity. With the Fed signaling that there are potential rate cuts to be seen in 2024, the market continues to enjoy favorable momentum. However, core US inflation pressures appear persistent, with recent inflation prints being higher than expected. Moreover, Q1 GDP came in at 1.6%, less than what was expected. The important drivers of inflation like shelter are trending down, which is good news, but investors are dialing back expectations for the magnitude and number of rate cuts for the year. The last mile of disinflation toward the Fed’s target may be difficult without greater economic slowing. As the markets reprice risk from the lower probability of near-term recession to a soft landing, it is important to maintain a well-diversified portfolio as upside surprises may be more difficult amid low market volatility and higher valuations.

A common composition of an advisor-created portfolio

 

Source: FI portfolio solutions (3,147 Portfolio Reviews and Portfolio Quick Checks conducted between 1/1/24 and 3/31/24) and Morningstar.

To monitor key trends in advisors’ strategic allocations and rebalances, we have reviewed over 3,000 professionally managed investment portfolios in Q1 of 2024 through our proprietary portfolio construction capabilities. Our analysis uncovers key themes playing out within each asset class that we believe will continue to be top of mind in 2024.

Average ETF usage in advisor portfolios

 

We are seeing the highest level of ETF usage in two years driven by advantages like better tax efficiency, cost, and intraday liquidity. In 2022, 52% of advisors had some ETF allocation and that has risen to 59% in Q1 of 2024. The average portfolio in 2024 has 13 positions of which 5 are ETFs (38%). This is an 11% increase from 2023 as interest continues to build in the wide variety of ETF products available. As ETF usage gains steam, the binary lines are blurred. While index funds continue to be the most popular product among advisors, there is increased interest in active ETFs. In 2022, 13% of advisors had some allocation to active ETFs and that proportion has increased to 25% in 2024. The average allocation to active ETFs among users is around 17%, showing increased adoption year over year.

We observed the average portfolio has:

14
holdings
6
different asset managers
53
bps of underlying blended fees

Domestic Equity
Domestic Equity

Growth Allocations in Equity Sleeve

 

In Q1, the average equity sleeve of a portfolio was 70%, which is a marked uptick from 66% in Q4 of last year. This is the highest level of equity allocation we have seen in the average advisor’s portfolio in the last two years. Seventy-nine percent of the equity sleeve is allocated to U.S. equities versus 21% in international. U.S. allocation continues to remain high as we move into 2024, compared to 73% in 2021 —  with advisors paying more attention to the prevailing socio-political climate and inflation in the rest of the world. Within U.S. equity, the average portfolio has 66% allocation to large caps, 22% to mid caps and 12% to small caps – which is largely unchanged from previous quarters. Advisors slightly increased their allocations to sensitive sectors (communication services and technology) along with growth allocations. As such, we see that risk and returns were proportional — portfolios with higher equities and growth and tech exposure benefitted in Q1.

Insights:

  • The global stock rally continued in Q1, once again led by large cap US growth stocks.
  • Growth allocations reached 40% of the equity sleeve, a high in the last two years. Thirty-seven percent of the equity sleeve is in core and 23% in value.
  • A continued rally in the stock prices of the largest U.S. companies by market capitalization once again drove the U.S. equity market’s gain. The share prices of these companies have more than doubled since the beginning of 2023. The bulk of the large stock gains were propelled by an expansion in valuation multiples. We do note that the market does seem to be broadening away from the mega-cap stocks, which is positive in general.
  • A primary reason for the domestic bias could be the double-digit earnings growth rebound expected in 2024 and beyond. Profit margins stabilized toward the end of 2023 and advisors expect them to expand this year.
Alternatives
Alternatives

In a higher inflation environment, the correlations of stock and investment-grade bonds turned positive, where the performance of stocks and bonds moved in the same direction. This lack of diversification between stocks and bonds led advisors to look at alternatives as an option.

Insights:

  • Nineteen percent of incoming portfolios had an allocation to alternatives, which is an increase of 3% compared to 2023. The average weight of alternatives in a portfolio is 7%, compared to 5% last year.
  • The traditional 60/40 under performed during the downtown of 2022, which has led more and more advisors to consider alternatives to diversify sources of alpha.
International Equity
International Equity

In Q1 2024, 22% of the equity sleeve was allocated to non-U.S. equities, which remains consistent to what we saw in 2023. This does represent a decrease from 27% in 2021. Advisors have 82% of their international sleeve in developed markets and 18% in emerging markets, consistent to the breakdown over the last two years. Global disinflation trends continue but the progress remains uneven across different geographies.

Insights:

  • Non-U.S. stocks outside of Latin America rose, with Japan leading the way. The global monetary tightening cycle appears to be over, but the pace and magnitude of easing remains uncertain. China remained an outlier, as it continued to ease policy in hopes of reaccelerating from its growth slump.
  • Global earnings growth, which has been decelerating since 2021, showed signs of stabilizing. Emerging markets trailing valuations are slightly above their long-term average, while DM finished below.
  • As inflation fell below or closer to target rates, some EM central banks began to cut interest rates. This could prove to be a good opportunity for advisors to take a look at their EM allocations.
Fixed Income
Fixed Income

Fixed income allocations in Q1 dropped to 29%, the lowest in two years. This is 3% lesser compared to Q4 2023. Advisors have remained consistent quarter over quarter in 2023 with an average allocation around 33% in the face of uncertainty in the economic conditions ahead. However, this year, inflation and recession concerns seem to have been put on the backburner. Worth noting, is that advisors continue to improve the quality of their fixed income sleeve. Eighty-three percent of the sleeve is allocated to investment grade, which is a two-year high. Advisors are increasing equity to take on risk but using the bond side as more of a hedge.

Insights:

  • The rise in Treasury yields weighed on bond prices. Riskier credit categories, such as leveraged loans and high-yield bonds, posted Q1 gains, but more interest-rate sensitive fixed-income categories registered modest losses.
  • It is difficult to time rate moves so it is important to align fixed income duration to portfolio objectives. Both a soft landing and recession are good scenarios to own bonds in, as the diversification provides protection in the event of slower than expected growth.
  • Advisors should consider moving from money market to bonds to lock in higher rates for a longer term as curve steepening happens very fast.

All data points are based on Fidelity portfolio construction reviews and Portfolio Quick Checks (PQC), as of 3/31/24.


In conclusion

Inflation coming down is the main driver of market recovery. It makes the Fed more comfortable, which makes investors more comfortable. Contact Fidelity's portfolio construction guidance team to help you build strategic portfolios for this new market environment.

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Diversification does not ensure a profit or guarantee against a loss.

Past performance is no guarantee of future results.

ETFs are subject to market fluctuation, the risks of their underlying investments, management fees, and other expenses.

Stock markets, especially non-U.S. markets, are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. Foreign securities are subject to interest rate, currency exchange rate, economic, and political risks, all of which are magnified in emerging markets. The securities of smaller, less well-known companies can be more volatile than those of larger companies.

Although bonds generally present less short-term risk and volatility than stocks, bonds do contain interest rate risk (as interest rates rise, bond prices usually fall, and vice versa) and the risk of default, or the risk that an issuer will be unable to make income or principal payments.

Additionally, bonds and short-term investments entail greater inflation risk—or the risk that the return of an investment will not keep up with increases in the prices of goods and services—than stocks. Increases in real interest rates can cause the price of inflation-protected debt securities to decrease.

Alternative investments are investment products other than the traditional investments of stocks, bonds, mutual funds, or ETFs. Examples of alternative investments are limited partnerships, limited liability companies, hedge funds, private equity, private debt, commodities, real estate, and promissory notes. Some of the risks associated with alternative investments are: Alternative investments maybe relatively illiquid. It may be difficult to determine the current market value of the asset. There may be limited historical risk and return data. A high degree of investment analysis maybe required before buying. Costs of purchase and sale may be relatively high.

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