Portfolio Construction

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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.

Q1 2025 investment landscape

Post-election optimism in the U.S. gave way to investor concerns about the impact of the flurry of executive actions, including tariff hikes, deregulation announcements, cuts to government staffing and programs, and tighter immigration activities. The spike in uncertainty about the trajectory of U.S. policy provoked a sell-off in U.S. equity prices and the dollar. This has led to deteriorating business and consumer expectations despite the expansion and strong fundamentals of the U.S. economy. While the market losses so far have not been extreme in historical terms, and leverage has not been as stretched as in prior downturns, the scope of the tariffs took many by surprise and volatility has been heightened. While the tariff hikes pose a direct stagflationary risk to the U.S. economy, near-term recession risks are still relatively low, but growth risks have shifted decisively to the downside. Elevated policy uncertainty warrants a restraint on active risk. This could all lead to slowing versus stalling growth for the U.S.; however, the Fed could still cut rates if needed.

It is important to maintain a well-diversified portfolio and employ discipline to reach investment objectives and embrace volatility to create portfolio opportunities.

 

A common composition of an advisor-created portfolio


For illustrative purposes only.

Source: FI Portfolio solutions (4,003 Portfolio Reviews and Portfolio Quick Checks conducted between 1/1/25 and 3/31/25) and Morningstar.

Increasing popularity of ETFs

Driven by advantages like better tax efficiency, cost, and intraday liquidity, we are seeing an increase in ETF usage. On average, 51% of an advisor’s portfolio is allocated to ETFs, which shows the popularity of this investment vehicle, with the highest use of ETFs within the U.S. equity sleeve.

ETF allocations in a portfolio

Sixty percent of incoming portfolios reviewed by our team utilized ETFs for their U.S. equity exposure and 76% of portfolios had mutual funds. Within the international sleeve, 43% of portfolios utilized ETFs and 78% of portfolios used mutual funds. When it comes to fixed income, 47% of incoming portfolios had an allocation to ETFs and 82% utilized mutual funds.

Growth in active ETFs

Based on our research, in 2022, 13% of advisors had some allocation to active ETFs; however, by the end of 2024, that proportion increased to 36%. The average allocation to active ETFs amongst users was around 22%, largely seen in fixed income and then U.S. equity.

Compared to the previous quarter, active ETF allocations within U.S. equities grew from from 14% in Q4 2024 to 16% in Q1 2025. However, only 20% of portfolios utilized active ETFs for U.S. equity exposure, with the bulk (68%) using index ETFs with an average allocation of 30%.

We saw an overwhelming adoption of active funds when it came to fixed income and international with 92% of portfolios having some active fixed income fund exposure compared to 34% with index funds. In international, that breakdown was 82% and 42% respectively. While the exposure within the portfolio itself is roughly similar for international (13% active, 11% index), for fixed income, the active exposure was almost double (28% vs. 15%).

We observed the average portfolio has:

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

Domestic Equity
Domestic Equity

In Q1, the average equity sleeve of a portfolio was 70%, a slight increase compared to last quarter (68%). Eighty percent of the equity sleeve is allocated to U.S. equities versus 20% in international. U.S. allocation continues to remain high, compared to 73% in 2021. Within U.S. equity, the average portfolio has 64% allocation to large caps, 23% to mid caps and 13% to small caps. Growth exposure continued to drop, with portfolios having 28% exposure to growth funds, which is on par with 2021 levels. This allocation shift was toward the value style box, with 30% exposure to that category and a 43% exposure to core. There was a slight increase to cyclical sectors (30% to 32% in Q1).

Insights:

  • Dragged down by a reversal in growth stocks, U.S. equities stumbled out of the gate and finished the first quarter with moderate losses.
  • Stock prices of the largest U.S. companies by market capitalization—concentrated in the technology and communications sectors—reversed course in Q1 and underperformed relative to the broader stock market.
  • Valuations contracted during Q1, a sign that historically high valuation levels are making it harder to surpass investor expectations. So far, equity allocations have hovered at this peak with significant bias towards Growth/Technology creating a concentration risk. Index fund usage was on average 25% in 2023 and this has risen to 30% in Q1 2025, which could especially lead to this unintentional concentration.
Alternatives
Alternatives

In a higher inflation environment, the correlations of stocks 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. Given the uncertainty going forward, alternatives can provide an opportunity for diversification.

Insights:

  • In this quarter, 10% of incoming portfolios had allocation to liquid alternatives. The average weight of liquid alternatives in a portfolio nearly doubled since 2023 (now 8% vs. 5% in 2023). The most popular categories are hedged equity and market neutral products.
International Equity
International Equity

Twenty percent of the equity sleeve is allocated to non-U.S. equities, which remains consistent with what we saw last quarter. This represents a decrease from 27% in 2021. Advisors have 83% of their international sleeve in developed markets and 17% in emerging markets—which is a slight increase (2%) to developed compared to last quarter. International exposure, both EM and DM, are at its low and have been for a while now. Thirty-one percent of portfolios had no international equities exposure in Q1 2025 versus 24% in Q4 2024.

Insights:

  • Non-U.S. equities posted widespread gains during Q1, with Europe and developed-market equities spearheading the rally and benefiting from a weaker dollar. Non-U.S. developed equities also experienced a sharp reacceleration in earnings growth momentum.
  • Europe and Canada tend to be more rate sensitive, and households and businesses are likely to benefit from falling policy rates. In the eurozone, a renewed commitment to fiscal expansion through defense spending, especially in Germany, may spark an upturn in business sentiment.
  • China is seeing signs of improvement through both a pickup in industrial activity and regulatory policy easing.
  • Emerging-market valuations remained slightly above their long-term average, while non-U.S. DM PEs again finished below average. Non-U.S. equity valuations also remain more attractive when considering the market’s expectations for earnings growth over the next 12 months.
  • The U.S. announced a massive increase in tariffs across the world that, if fully implemented, would take rates to levels not seen in more than a century. The tariff hikes may provoke meaningful headwinds for countries with large trade surpluses with the U.S. Given the attraction valuation of non–U.S. equities, diversification to this asset class could be key for advisor portfolios in the coming months.
Fixed Income
Fixed Income

Fixed income allocations dropped to 25% of the portfolio. This is still near the lows of fixed income allocations 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 staying in cash positions. Investment-grade allocation is at 78% of the fixed income sleeve, and 22% to high yield. This is a 3% increase to high yield compared to last quarter.

Insights:

  • Yields fell and credit spreads widened during Q1. This supported gains across fixed income categories, with inflation-resistant TIPS and interest rate-sensitive longer duration bond categories leading the way.
  • High-yield spreads rose from their very subdued levels, as policy-related growth concerns weighed on risk assets. Overall, fixed income yields ended the quarter around their 50th percentile, suggesting valuations are roughly in-line with long-term averages and provide income in a balanced portfolio.
  • Amid a highly uncertain backdrop, the Fed kept its policy rate steady during Q1 after cutting rates by 100bps during 2024. Coming into 2025, the market expected an additional 150bps of easing, but stubborn inflation reduced market expectations to only two more cuts this year.
  • The elevated U.S. policy uncertainty underscores the importance of diversification in fixed income to hedge against growth risks.

All data points are based on Fidelity portfolio construction reviews and Portfolio Quick Checks (PQC), as of 3/31/25.

In conclusion

It is important to maintain a well-diversified portfolio and employ discipline to reach investment objectives and embrace volatility to create portfolio opportunities. Reach out to our portfolio construction guidance team 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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