Portfolio Construction

Portfolio Construction Pulse

Financial Professional Portfolio Construction data, trends, and observations to inform your investment decisions.

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. 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 June 30, 2022
Overall Model
Transcript

Portfolio Construction is a key area of focus for financial professionals. T. Rowe Price’s Portfolio Construction Solutions Team works with financial professionals every day, consulting with them on their model portfolios and helping them enhance their investment practice. Portfolio Construction Pulse delivers the data trends and observations from those consultations. Jason, you are the director of Product Management for the Portfolio Construction Solutions Suite.

I have to ask you, I'm sure there's other financial professionals that would be interested in knowing what are some of the most noteworthy trends that the team has seen based on their consultations with other financial professionals.

As you would expect, the team has been in a lot of conversations this year with financial professionals around their portfolio positioning in light of the current economic environment. Inflation concerns, rising interest rates, the slowdown in the economy, and what are the impact that all of these factors have on their portfolios and how they're positioned. When we look at the data on financial professional portfolios, risk remains high. Beta is at 1.06 on the average portfolio. There's a lot of movement out of growth into value, out of growth, into blend, in particular, large growth, large, large blend and large value, movement into shorter duration, fixed income strategies, inflation protected, fixed income strategies. And then we're seeing increased use in alternatives.

Jason. Oh, that's extremely interesting. Based on the consultation that the team is having, what are some of the things that the team is offering up as considerations for financial professionals to focus on and watch out for?

Sure, sure. So as I mentioned, we're seeing higher levels of risk in the financial professional models. And in many cases, this is not intentional risk. This is not the advisor making an intentional bet in the portfolio to generate returns. Three takeaways to consider: In equities, if you're looking to pare your growth exposure, move into a blend value strategy. A strong consideration here is considering a blend strategy that is investing in dividend growers. Dividend growers have historically been a way to mitigate risk in volatile and down markets. For fixed income, implementation is key. If you're looking to implement a shorter duration strategy, inflation protected type of strategy, making sure that you're implementing that strategy in a way that doesn't introduce unintended risks into the portfolio. So, you're looking to lower interest rate risk. Don't introduce an additional risk. Finally, with alternatives, we found that looking at correlations are really important, making sure that if you're looking, you're going to add an alternative strategy into the model that it's performing the role that you intended to perform in the model. As an example, we had a case this year where an alternative strategy was funded out of the fixed income allocation, and the strategy actually had fairly high correlation to equity. And so the overall impact of the portfolio was higher equity risk, which of course was not the intent. So just making sure you're really paying close attention to these these factors when you're implementing these types of strategies is really important.

If a financial professional is interested in working with the Portfolio Construction Solutions team, what's the best way for someone to go about doing so.

To schedule a Portfolio Construction Solutions consultation, simply reach out to your T. Rowe Price Investment Consultant.

  • Volatility, lack of appetite for international equity, and perennial concerns over fixed income were key areas of discussion with clients. Conversations through the year also shifted from inflation to recession worries.
  • Overall, risk in client model portfolios remained at relatively higher levels with an average 5-year beta of 1.06.
  • Trends showed continued emphasis on U.S. equities, especially large-cap value.
  • Fixed income trends reflected concerns over rising rates with increased use of shorter duration strategies.
  • Alternative investments continued to see increased use in client model portfolios. However, they are not necessarily providing lower correlations to equity and may be contributing to higher risk levels.

Financial Professional Model Allocations (Average)

The following section provides a current snapshot of the average allocations, portfolio statistics, and strategy usage from the financial professional models our Portfolio Construction Solutions team has reviewed and analyzed.

Financial Professional Model Allocations (Average)

As of June 30, 2022.

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, Equity Market Neutral. Alts play a defined role in T. Rowe Price Multi Asset portfolios serving as a cash-plus alternative that is carved out of fixed income.

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.

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.

SOURCE: CIP Database.

Equity
Transcript

Jordan:

T. Rowe Price’s Portfolio Construction Solutions team partners with financial professionals every day. As the team assists financial professionals with reviewing their model portfolios, understanding their goals and objectives, and ultimately providing perspectives that help those financial professionals achieve those goals and objectives. Portfolio Construction Pulse delivers the proprietary data, trends, and observations sourced from those Portfolio Construction Solutions consultations. Jason, what are some of the most noteworthy trends that the team has seen when it comes to the equity portfolio, specifically?

Jason:

Well, the largest trend we've seen in equities this year has been this shift from growth to value. That shift has been occurring across the cap spectrum, so large to small cap into large value. We're also seeing in the industry data that there's been a significant amount of flow going into large cap blend funds. On the international front, a lot of headwinds. You have the war in Europe, you have continued lockdowns in China, a strengthening dollar. All of these things have kept financial professionals from adding more to their international equity allocations despite compelling valuations.

Jordan:

For the financial professionals that are interested in knowing, what we’re, the conversations that the team is having with other financial professionals, from an equity perspective, what's the team saying that other financial professionals should be on the lookout for? Where should they be focused?

Jason:

Let me address that question in two parts. One focused on U.S. equity and one focused on international equity. Within U.S. equities, market declines in the first half of the year have modestly improved valuations. However, a lot of risk still remains. One way to potentially address that risk is by looking at blend strategies that are investing in dividend growers. Dividend growers historically have been a way to mitigate risk in volatile markets.

Jordan:

So, some potential downside protection being offered there.

Jason:

Yes, exactly.

Jordan:

Got it. So, what about international equity?

Jason:

We've spent a lot of time this year in our conversations with financial professionals talking about not just the overall international equity allocation, but the breakdown or the diversification within that international allocation. So, you know, as I mentioned earlier, a heavy tilt towards growth within these allocations. So, we are looking at what's your growth versus value, what’s your sector allocation, what’s your country or regional allocation, and just making sure that you have the diversification within that portion of your portfolio.

Jordan:

So, while the overall allocation international is obviously important, what types of exposure within international is really a focus for the consultations that the team is having today with financial professionals?

Jason:

Very much, yes.

Jordan:

So how does that 24% average international allocation compare with T. Rowe Price’s strategic target?

Jason:

It's below our strategic target. So, T. Rowe’s strategic target is at 30% of total equity. So, the average financial professional sits below that and has been for some time.

Jordan:

Interesting. Somewhat of a trend. For those financial professionals that would like to schedule a portfolio construction solutions consultation to evaluate either only their equity portfolios or their overall model portfolios, what's the best way for them to do so?

Jason:

Sure. You just simply get in contact with your T. Rowe Price Investment Consultant.

Jordan:

Thank you so much, Jason.

  • Exposure in U.S. large value increased by 2% and continued to be the largest change in allocations over the past year. Year-over-year position changes in client model portfolios as well as industry cashflow trends pointed to a broader move away from growth across U.S. large, mid, and small-cap equities. Similar style trends were observed in international equity.
  • At 24.2% of total equity, the allocation to international remained below our strategic target of 30%. This trend has continued for at least a year. Within international equity, client model portfolios are more heavily tilted to growth than in the U.S., which poses a diversification risk.

Equity Statistics4
Equity Statistics
Equity Statistics

As of June 30, 2022.

Based on Morningstar categories.

Fixed Income
Transcript

Jordan:

T. Rowe Price’s Portfolio Construction Solutions team partners with financial professionals every day across the country. Through these consultations, the team is taking the time to understand what the financial professionals’ goals and objectives are, reviewing their model portfolios, providing perspectives that ultimately help the financial professional achieve those goals and objectives. Portfolio Construction Pulse delivers the proprietary data, trends, and observations sourced from those consultations.

Jason, let's focus on fixed income for a minute. Based off all the consultations that the team is having with financial professionals, based off all those model portfolios that the team is receiving for analysis and review, what do you think is the most noteworthy trends that other financial professionals would want to know about?

Jason:

In fixed income we're seeing movement into shorter duration strategies such as bank loan. We're seeing increased use of inflation-protected bond strategies, as well as long-term government bond strategies. We look at the average financial professional model from the models that we review and collect, and we've also noticed that from the beginning of the year through June 30th, the average duration has ticked up slightly from 4.6 years to 4.8 years.

Jordan:

So, it's interesting that the team has seen duration increase in these model portfolios even just a little bit. Does the team have a perspective on what financial professionals should be focused on or keeping an eye out for within their fixed income portfolios specifically given the current market conditions?

Jason:

Sure. We would say that the key is whether the financial professional is looking to shorten duration or increase duration, it's really about diversifying your duration. And understanding the role that fixed income is playing in the model. Understanding the fit of each of the strategies that you're using and whether or not they're playing the role that you're intending them to play. How is the fixed income diversified by sector, by region, country, by credit risk? So, all of these things are factored into what to do with the fixed income portion of your portfolio. In fact, that's often the question that we get. “What do I do with the fixed income portion of my portfolio?” And so, we would say that, diversify your duration. If you're looking to shorten duration, we can work with advisors that are doing that. And the goal is really to make sure that you're addressing one risk, interest rate risk, but you don't introduce an additional risk at the same time.

Jordan:

Mitigating unintentional consequences of those decisions. Makes total sense. So for financial professionals that are interested in a Portfolio Construction Solutions consultation, what's the best way for them to get in touch and schedule a Portfolio Construction Solutions consultation?

Jason:

Sure. To schedule a Portfolio Construction Solutions consultation, simply reach out to your T. Rowe Price Investment Consultant.

  • Financial professionals continued to look for solutions to navigate the current interest rate environment and central bank policy shifts as well as a changing economic landscape.
  • Average model duration rose to 4.8 years from 4.6 years in December 2021 and counter to other portfolio trends. Financial professionals allocated more to shorter duration strategies like short-term bond and bank loans and away from intermediate-term fixed income. A number of factors may be contributing to this phenomenon. For example, clients turned to inflation-protected bond strategies to help contend with higher inflation and rising rates. However, they tended to allocate to longer duration rather than shorter duration TIPs. In several cases, this was leading to higher-than-expected portfolio duration.

Fixed Income Statistics5
Fixed Income Statistics
Fixed Income Statistics

As of June 30, 2022.

Based on Morningstar categories.

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.

What to Watch

Are you positioned for: (1) Volatility, (2) Diversified International, and (3) Addressing Fixed Income Concerns?

  • Market declines in the first half of 2022 modestly improved equity valuations. However, earnings growth in the second half could be challenged by slowing economies. Higher input costs also could cut into profit margins. One way to address potential volatility is by taking a balanced approach to equity incorporating blend strategies that offer more defensive features.
  • Despite compelling relative valuations, the war in Europe, the continued lockdowns in China, and now the strengthening dollar have kept financial professionals from adding more to their international equity positions. However, financial professionals should evaluate the diversification of their international equity allocations and seek a broad, balanced approach that encompasses style and region exposures.
  • While the Fed and other major central banks are tightening, not all countries are at the same point in their monetary cycles. By taking advantage of divergence, investors may be able to address fixed income concerns by diversifying their interest rate exposure using global bond strategies and managers who actively manage duration. Additionally, higher interest rates and wider credit spreads (the additional yield over comparable U.S. Treasuries for bonds with credit risk) potentially create income opportunities for investors with the appropriate time horizon that could be addressed through shorter duration credit strategies like high yield or bank loans.

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.

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.

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202210-2450363

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