Portfolio Construction Pulse Summer 2023

Hi, I’m John Escario, an investment specialist in the Portfolio Construction Solutions group here at T. Rowe Price.

Today, we’re discussing the Summer 2023 edition of Portfolio Construction Pulse – The Shifting Sands of Sentiment – a biannual survey of financial professional model portfolios based on thousands of client interactions in our proprietary database.

There’s a lot more to unpack in the Pulse report, but today, we’ll stick to three important topics:

• High-level asset allocation positioning in client portfolios
• A closer look at equity and fixed income asset class exposures
• And finally, we’ll look at some potential investment approaches to portfolio construction to prepare for the months ahead.

First, let’s look at the asset allocation level.

At the onset of 2023, investor sentiment was decidedly cautious with the threat of recession a key concern. At the same time, many portfolios were positioned for inflation and rising rates, suggesting a potential paradox that exposed portfolios to greater risk than expected.

Over the past year, overall portfolio risk has declined – 5-year portfolio beta (a common measure of portfolio volatility) fell from 1.05 to 1.00 in the year ended June 30. Clients lowered equity and fixed income positions to reduce overall portfolio risk and, in the case of cash, to capture higher yields.

We’ve also seen more interest in alternative investments, with many clients moving toward hedged equity strategies, which seek to limit downside risk but consequently limit upside opportunity. While allocations to real asset alternatives – which include natural resources, energy, real estate and the like, fell overall, the likelihood of inclusion in portfolios increased, indicating wider use and a desire for protection should inflation prove stickier than expected.

Now, let’s focus a little deeper on equity and fixed income allocations.

• Clients increased exposure to cyclical areas of the market, moving into value strategies and out of growth across all market capitalizations.
• As already noted, clients added to existing allocations and increased the use of cyclical, real asset-oriented sectors like energy and natural resources.
• Exposure to international equities continued to decline, particularly in the global large-cap growth and emerging markets categories.

In fixed income:

• With short-term interest rates above 5%, clients took advantage of the rise in yields and added nearly 7% to shorter duration strategies (particularly cash) over the past year, which reduced overall duration (a measure of a bond portfolio’s sensitive to interest rates).
• Additionally, this trend and a reduction in bank loan exposure contributed to improved credit quality.
• Interestingly, there was a notable rise in high yield exposures, suggesting that some clients seeking yield or those concerned that equities have limited short-term upside potential may find better return opportunities in high yield strategies. 

Finally, let’s look at some potential approaches to portfolio construction.  

Increasingly, our clients have inquired about adding risk and putting cash back to work in client portfolios. In times of shifting sentiment, we suggest adopting a more balanced approach to growth and value style allocations and adding diversification.  

Within equities:

• This could include adding back to growth strategies. Equity valuations remain elevated, but earnings expectations appear to be improving and momentum around artificial intelligence could provide a structural tailwind to growth. 
• Clients still looking for downside protection could add diversification through defensive equity strategies, such as dividend growth.

Within fixed income:

• Certain low to uncorrelated options in the nontraditional bond space may offer an alternative means of diversification, while a more traditional approach could entail modestly extending duration.

Additionally:

• Clients concerned about the potential stickiness of inflation could consider inflation-sensitive equities, such as real-asset strategies, alongside their core equity positions.
• Investors looking to deploy cash back into the markets have options. Those seeking to take advantage of attractive yields could consider high yield bonds (outside of a scenario involving a deep global recession). Within equities, investor could also look at high quality small cap strategies with favorable valuations or use cash to balance out exposure between growth and value equity exposures.

If you have questions about your portfolio positioning, we encourage you to view the full Portfolio Construction Pulse – The Shifting Sands of Sentiment – now available on the T. Rowe Price website or contact your T. Rowe Price Sales representative and set up a consultation with one of our Portfolio Construction Specialists. We’re here to help.

Thank you.