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Trends in portfolio construction

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

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2024: A year of economic strength and anticipation

The U.S. economy remained robust throughout 2024, with investors eyeing potential policy shifts post-November elections. The global business cycle continued its expansion, characterized by monetary easing and stable earnings projections.

Federal reserve policy and market performance

In Q4, the Federal Reserve cut its policy rate, signaling that further easing hinges on progress toward its inflation target, which has been elusive recently. U.S. growth stocks led the charge with double-digit returns, and most asset categories closed the year favorably. This can be attributed to strong earnings growth and valuation expansion, trends that may extend to small and mid cap categories in 2025.

Economic outlook for 2025

The U.S. economy shows muted recession risk in the near term, yet a transition to a disinflationary mid-cycle environment remains uncertain. The U.S. and global economies face policy crosswinds in 2025, with potential trade policy headwinds and monetary easing tailwinds. Pro-growth policies could bolster U.S. economic resilience and exceptionalism, though market volatility is expected.

 

A common composition of an advisor-created portfolio


 

For illustrative purposes only.

Source: FI portfolio solutions (3,733 Portfolio Reviews and Portfolio Quick Checks conducted between 10/1/24 and 12/31/24) and Morningstar.

Increasing popularity of ETFs

The advantages of ETFs, such as better tax efficiency, cost savings, and intraday liquidity, have driven their increased usage. On average, 53% of an advisor’s portfolio is now allocated to ETFs, demonstrating their popularity.

ETF usage in portfolios

U.S. Equity: 67% of incoming portfolios utilized ETFs for U.S. equity exposure, while 79% also included mutual funds.

International: 47% of portfolios utilized ETFs, up from 35% last quarter.

Fixed Income: 57% of incoming portfolios have some allocation to ETFs.

Growth in active ETFs

In 2022, only 13% of advisors had allocations to active ETFs. By the end of 2024, this number surged to 40%, with an average allocation of around 21%. This increase is most notable in the Fixed Income asset class, followed by U.S. equity.

Adoption of strategic beta products

Strategic beta products also saw widespread adoption in 2024, with 54% of incoming portfolios having some exposure to these products.

We observed the average portfolio has:

13
holdings
6
different asset managers
47
bps of underlying blended fees

Domestic Equity
Domestic Equity

Advisors didn’t modify their overall equity exposures much in 2024. In Q4, the average equity sleeve of a portfolio was 68%, consistent with the last two quarters. Seventy-nine percent of the equity sleeve was allocated to U.S. equities versus 21% in international. U.S. allocation continues to remain high as we move into 2025, compared to 73% in 2021. Within U.S. equity, the average portfolio had a 66% allocation to large caps, 22% to mid caps and 12% to small caps. This is a 4% increase in large caps compared to the previous quarter and a 3% decrease in small caps – reversing the trend of declining large cap exposure between Q2 and Q3. Growth exposure continued to drop, with portfolios having 29% exposure to growth funds, which was on par with 2021 levels. This allocation shift was toward the blend style box, with 43% exposure to that category and a 28% exposure to value. Fifty-four percent of U.S. equity exposure was active, 46% was in index funds.

Insights:

  • U.S. stocks added to their gains and finished the year with stellar double-digit returns, and most asset categories finished in positive territory for the full year.
  • Stock prices of the largest U.S. companies by market capitalization—concentrated in the technology and communications sectors—finished Q4 and 2024 with another dominant performance relative to smaller stocks. With valuations near historically high levels, earnings growth may be the key determinant for stock performance in the year ahead.
  • Consensus expectations for 2025 U.S. stock market results appear to be optimistic relative to non-U.S. equities and other assets. However, upside surprises for asset prices often become more difficult amid elevated expectations.
  • So far, equity allocations have hovered at this peak with significant bias toward Growth/Technology creating a concentration risk. Index fund usage was on average 25% in 2023, and this has risen to 30% in 2024, which could especially lead to this unintentional concentration.
Alternatives
Alternatives

In a higher inflation environment, the correlations of stocks and investment-grade bond turned positive, where the performance of stocks and bonds moved in the same direction. This lack of diversification between stocks and bonds led to advisors looking at alternatives as an option. Given the uncertainty going forward, alternatives may provide a good investment opportunity. Assets such as bitcoin may garner additional interest going into 2025 given policy tailwinds from the new administration.

Insights:

  • In Q4, 17% of incoming portfolios had an allocation to Liquid Alternatives. The average weight of alternatives in a portfolio was around 9%, compared to 5% in 2023. The most popular categories were hedged equity and market-neutral products.
  • The traditional 60/40 failed to perform during the downtown of 2022, which has led more and more advisors to consider alternatives to diversify sources of alpha.
International Equity
International Equity

Looking at Q4, 21% of the equity sleeve was allocated to non-U.S. equities, which remained consistent to what we saw in 2023. This represents a decrease from 27% in 2021. Advisors had 81% of their international sleeve in developed markets (DM) and 19% in emerging markets (EM). International exposure, both DM and EM, is at its lowest and has been for a while now. Twenty-four percent of advisor portfolios in Q4 had no international exposure, compared to 30% in Q2. This shows an increase in recognition of the return and diversification potential offered by expanding the opportunity set in equities. Sixty-four percent of the international sleeve utilizes active funds, while 36% is in index funds.

Insights:

  • Non-U.S. equities suffered Q4 losses amid the rise in political uncertainty and a rising dollar, registering only modest 2024 gains.
  • The global cycle faces policy crosswinds in 2025, including a potential headwind from trade policy and a tailwind from monetary easing. Most major developed market (DM) central banks continued to cut their policy rates during Q4, with expectations for more cuts in Europe and Canada in 2025 than in the United States. The prospect of higher U.S. tariff rates poses a risk for major exporters, particularly countries that have meaningful goods trade surpluses with the United States.
  • Year-over-year growth trended upward for EM after a prolonged slump. Non-U.S. developed markets saw a reversal, with earnings growth decelerating and ending the year in negative territory.
  • China’s cyclical trends are mixed with some hints of improvement against a backdrop of structural challenges. Industrial production reaccelerated in the second half of 2024, and property markets showed some signs of stabilization. However, structural imbalances within the Chinese economy remain headwinds.
  • While it remains uncertain whether new policy measures will spark an economic reacceleration, this could provide an opportunity for advisors to participate by selecting good companies with strong fundamental support.
Fixed Income
Fixed Income

Fixed income allocations remained consistent at 27% of the portfolio in Q4. This is still near the lows of fixed income allocations that we have observed in the last two years. Advisors have been reallocating from fixed income to equities to take on risk and participate in the market as well as stayed in cash positions. Investment-grade allocation was at 81% of the fixed income sleeve, and 19% to high yield. Seventy-five percent of the fixed income sleeve was in active products and 25% in index funds.

Insights:

  • Despite rising Treasury yields, most fixed income asset classes provided positive returns for 2024 as credit spreads tightened and higher coupons provided positive income.
  • Most fixed income categories ended the year with yields near their long-term historical averages and credit spreads toward the lowest end of their historical ranges. Overall, fixed income yields suggest valuations that are roughly in line with long-term averages and better than the past decade.
  • The Federal Reserve cut rates by 25 bps twice during Q4, easing a total of 100 bps during 2024. Coming into the year, the market expected 150 bps of easing, but stubborn inflation kept the Fed from easing more aggressively, and the market expects only one or two more cuts in 2025.
  • It is difficult to time rate moves, so it is important to align fixed income duration to portfolio objectives. Money market assets have increased since the first Fed cut. This may indicate a barbell to equities and cash, which offers less diversification than a more broadly diversified portfolio. 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 12/31/24.

In conclusion

Monetary policy is focused on both mandates of inflation and labor, which will drive the market in the coming months. It makes the Fed more comfortable, which makes investors more comfortable. Please reach out to our portfolio construction guidance team and services to help you build 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.

Views expressed are as of the date indicated, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.

Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

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