Portfolio Construction
Portfolio Construction Pulse Summer 2023
The Shifting Sands of Sentiment
At the onset of 2023, clients were positioned for inflation and rising rates, but many were exposed to higher risk. Sentiment was decidedly cautious with the threat of recession a key concern. So far, we have avoided recession, but the implications of an inverted yield curve remain to be seen. Capital markets have posted positive results for the first half of the year but are not out of the woods yet. Over the last year, the Portfolio Construction Solutions team observed a steady decline in portfolio risk. Higher use of hedged equity strategies in place of traditional equities and higher cash allocations lent to this more conservative posture. Portfolios continued to be more exposed to cyclical areas of the equity market emphasizing value-oriented strategies. In fixed income, durations trended lower. Meanwhile, many clients inquired about adding risk and putting cash back to work in client portfolios.
Positioning Highlights
As of June 30, 2023
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, alternatives 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. Alternatives 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.
Equities
INTERNATIONAL ALLOCATIONS RECEDED, WHILE VALUE GAINED3
International equity continued to fall out of favor, declining from 24.9% to 20.2% over the last three years. Reduced allocations to emerging markets and global growth strategies were the primary drivers.
Value allocations rose from 25.8% to 37.1% over the last three years, and growth allocations fell. While style bets are a popular tactical approach, our analysis suggests that a balanced approach incorporating value, blend, and growth showed better returns, more efficient performance, and improved long-term return consistency.
FINANCIAL PROFESSIONAL MODEL PORTFOLIOS: Equity Allocations
3 Based on Morningstar categories.
4 As percentage of total equity.
5 Includes both small-cap and mid-cap equities.
6 As percentage of U.S. equity.
Fixed Income
DURATION TRENDED LOWER, WHILE HIGH YIELD EXPOSURE ROSE7
Combined exposure in cash and short-term rose from 23.7% to 30.7% since June 2021, contributing to lower duration. However, our analysis suggests that higher duration instruments like core bonds, for example, historically outperformed shorter duration as the Fed rate cycle transitions from hikes to a pause. Consider adopting a more balanced approach in fixed income.
Allocations to diversifiers remained largely stable, but there was a notable rise in high yield. Clients seeking yield or those concerned that equities have limited short-term upside potential may find better return opportunities in high yield bonds.
FINANCIAL PROFESSIONAL MODEL PORTFOLIOS: Fixed Income Allocations
FINANCIAL PROFESSIONAL MODEL PORTFOLIOS: Diversifiers9,10
7 Based on Morningstar categories.
8 As percentage of total fixed income.
9 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.
10 As percentage of diversifiers.
Outlook
In times of shifting sentiment, consider adopting a more balanced approach to growth and value style allocations and adding diversification. Within equities, this may include adding back to growth in light of the move to value. While equity valuations are elevated, earnings expectations appear to be improving and momentum around artificial intelligence could provide a structural tailwind to growth.
Clients still desiring downside protection could add diversification by adding 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 may entail modestly extending duration to gain potential safeguard.
Clients concerned about the potential stickiness of inflation may wish to add inflation-sensitive equities alongside their core equity positions utilizing real asset strategies.
Clients seeking to deploy cash positions 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). For equities, clients could also seek to take advantage of favorable valuations by adding selectively to higher-quality small-cap stocks or by using cash to balance out exposure between growth and value.
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.
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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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