Portfolio Construction
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.
Positioning Highlights
As of December 31, 2022
Asset Allocation
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.
Equities
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.
Fixed Income
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.
Outlook
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.
IMPORTANT INFORMATION
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.
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