Portfolio Construction Pulse Spring 2023
A Risk Paradox Revealed?
A dismal year for stocks and bonds in 2022 prompted many financial professionals to reposition their client portfolios. In this edition of Portfolio Construction Pulse, data reviewed by our specialists suggests that some changes meant to reduce risk could actually increase overall portfolio risk, resulting in a potential risk paradox in 2023.
Our team of Portfolio Construction Specialists work closely with financial professionals every day, consulting with them to pursue the investment goals they've set for their model portfolios and their clients. Portfolio Construction Pulse details the current trends, challenges, and ideas arising from these conversations.
Access additional data on financial professional portfolio construction trends and observations, as well as how T. Rowe Price is positioning our multi-asset portfolios, by downloading the latest edition of Portfolio Construction Pulse.
As of December 31, 2022
Top-level allocation moves appeared to indicate risk avoidance as clients lowered exposure to both equities and fixed income in their portfolios, while adding to alternative investments and cash.
MODEL ALLOCATIONS (AVERAGE)
Data sourced from model portfolios submitted by financial professionals and reviewed by our Portfolio Construction Solutions team.
1 For financial professionals, Alts includes investment strategies in the following categories: Commodities, MLPs, Real Estate, Global Real Estate, Multistrategy, Options Trading, Long-Short Equity, Relative Value Arbitrage, Event Driven, Systematic Trend, Macro Trading, Derivative Income, and Equity Market Neutral. Alts play a defined role in T. Rowe Price multi-asset portfolios serving as an illiquid cash-plus alternative that is carved out of fixed income.
2 T. Rowe Price utilizes “Other Equity” to invest in outcome-oriented equities to address inflation. Financial professionals typically utilize Other Equity for specific allocations to sector-oriented exposure.
3 Diversifiers include fixed income strategies that offer diversification to traditional core fixed income. This includes: Bank Loan, Convertibles, Emerging Markets Bond, Emerging Markets Local-Currency Bond, High Yield Bond, High Yield Muni, Multisector Bond, Nontraditional Bond, Preferred Stock, and World Bond. For select T. Rowe Price multi-asset portfolios, the firm’s nontraditional bond fund is used as a liquid cash-plus alternative that is carved out of the cash position in fixed income allocations.
Clients moved away from growth-oriented stocks across all market capitalization ranges and sectors, and they increased allocations to value, small-cap, and mid-cap stocks. A bias for domestic stocks prevailed as exposure to international equities fell to the lowest level in three years. Emerging markets usage fell, likely due to concerns about China's regulatory environment and COVID reopening.
GROWTH ALLOCATIONS FALL, BUT MIND THE RISK4
Investors de-risked through lower growth exposure across market-cap ranges and sectors, but higher allocations to small-cap and mid-cap stocks added to overall equity risk. Domestic bias grew as international allocations fell to their lowest level in three years.
4 Based on Morningstar categories.
Reflecting concerns about inflation and rising interest rates, clients reduced intermediate core bond positions and increased exposure to alternative investments and cash. Importantly, average duration remained lower than the Bloomberg U.S. Aggregate Bond Index as clients allocated nearly 16% of total fixed income to short-term bonds and increased positions in shorter-duration credits like floating rate bank loans, and high yield.
CORE ALLOCATIONS FALL, AND DIVERSIFIERS RISE5
Inflation and interest rate concerns led to lower core bond allocations and increases to alternatives and cash. Duration stayed low amid higher positions in short-term debt, floating rate bank loans, and high yield bonds. Such positioning may reduce fixed income’s tendency to offset equity volatility during drawdowns and sell-offs.
5 Based on Morningstar categories.
6 Diversifiers include fixed income strategies that offer diversification to traditional core fixed income. This includes: Bank Loan, Convertibles, Emerging Markets Bond, Emerging Markets Local-Currency Bond, High Yield Bond, High Yield Muni, Multisector Bond, Nontraditional Bond, Preferred Stock, and World Bond. For select T. Rowe Price multi-asset portfolios, the firm’s nontraditional bond fund is used as a liquid cash-plus alternative that is carved out of the cash position in fixed income allocations.
Clients still looking to reduce portfolio risk in response to recession concerns could consider adding defensive equity strategies, such as dividend growth. On the fixed income side, high yield bonds could potentially offer equity-like returns with less downside risk than stocks.
Clients seeking to deploy cash positions back into the markets have options. A “bonds are back” approach could include allocating to ultra short-term debt if rising rates are still a concern, while increasing duration may be more appropriate for those wary of recession. An opportunistic approach also could seek to take advantage of favorable valuations by adding selectively to higher-quality small-cap, value, and international stocks.
Financial professionals should take a close look at their exposure to alternative investments, where increased exposure unintentionally may have added to overall portfolio risk. We suggest adjusting the sources and position sizes as options or replacing the positions where appropriate.
Portfolio Construction Solutions from
T. Rowe Price
We work with financial professionals to find practical solutions for critical investment and practice challenges. Used independently or in combination, each component of our integrated suite of Portfolio Construction Solutions provides access to T. Rowe Price’s world-class multi-asset expertise and global investment resources to address your portfolio construction needs.
Portfolio Construction Solutions discussed are available only to financial professionals and not the retail public. Art of Clean Up® and Asset Allocation Model Review are offered by T. Rowe Price Investment Services, Inc. Model Construction is offered by T. Rowe Price Associates, Inc.
Past performance cannot guarantee future results. All investments involve risk. The charts and tables are shown for illustrative purposes only.
This material has been prepared by T. Rowe Price Investment Services, Inc., for informational purposes only. Information and opinions are derived from proprietary and nonproprietary sources deemed to be reliable; the accuracy of those sources is not guaranteed.
Under no circumstances should this material, in whole or in part, be copied, redistributed, or shown to any person without prior consent from T. Rowe Price. This material is not intended to be investment advice or a recommendation to take any particular investment action. This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.
Copyright © 2022 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.
Consider the investment objectives, risks, and charges and expenses carefully before investing. For a prospectus or, if available, a summary prospectus containing this and other information, visit the fund’s website. Read it carefully.
© 2023 T. Rowe Price. All rights reserved. T. Rowe Price, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.