Portfolio Construction
Portfolio Construction Pulse: U.S. exceptionalism drives advisor allocations
Advisors tended to position capital where it performed best in 2024. The S&P 500 Index was a standout performer as themes involving U.S. exceptionalism and artificial intelligence (AI) drove many allocation decisions. In fact, the S&P 500’s 25% annual return was over 21 percentage points higher than the MSCI EAFE Index, a common measure of international equities. Perhaps not surprisingly, we observed large shifts toward U.S. stocks in moderate allocation models, with a reduction in international exposure. We also saw a shift toward large-cap blend equity strategies at the expense of large-cap value, small-cap, and mid-cap holdings. Policy priorities are top of mind for advisors as they rethink their fixed income allocations. Advisors tended to adjust with more flexible mandates and also moved cash from the sidelines into shorterduration mandates. We expect 2025 to be a year of transition, marked by a broadening of investment opportunities combined with potential risks.
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Positioning Highlights
As of December 31, 2024
Asset Allocation: Pivoting in the face of policy changes
- Advisors pivoted away from performance-challenged areas and meaningfully increased their large-cap U.S. exposure. Inflation hedges were reduced, with commodity-related holdings dropping. Within fixed income, advisors moved to more flexible multi-sector and ultrashort mandates, while they cut back from coreplus and cash holdings. In the face of greater uncertainty around policies and interest rates, we saw an uptick in flexible strategy usage. This includes multi-sector bond within fixed income and both defined outcome and multi-strategy funds within alternative allocations.
Equities: U.S. exceptionalism gathers steam
- U.S.: Earnings growth, fiscal spending, solid economic growth, and AI-led capital spending and innovation continued to fuel performance and interest in U.S. stocks. Large-caps gained 3.6% in advisor models, led by largecap blend stocks. Large- and mid-cap value lost share in models.
- Sectors: At a high level, we saw reduced interest in sector-specific allocations. Inflation hedges were reduced, with natural resources and energy allocations losing share. Better-performing sectors, including technology, industrials, financials, and communications, saw increased chance of usage in models.
- International: International stocks fell further out of favor. We saw a 1.8% drop in share in moderate allocation models, with international accounting for 19.9% of total equity. Large-cap value saw the largest drop, while small- and mid-cap strategies also decreased. Allocations to global growth mandates increased by 0.9%, while emerging markets saw the largest gains with a 2.2% increase in allocation.
Fixed Income: Policy uncertainty leads to a shift to multi-sector and ultrashort allocations
- The Federal Reserve closed the year with a market-moving meeting on December 18, 2024, lowering expectations for the number of interest rate cuts in 2025. The fed funds rate finished the year at 4.5% after 100 basis points of interest rate cuts. (A basis point is equal to 1/100 of a percentage point.)
- While there was notable progress on the inflation front in 2024, inflation closed the year at 3.3% on the core consumer price index (CPI) and 2.7% for headline CPI. There was also greater advisor concern around deficit spending levels.
- Policy uncertainty surrounding the economy, interest rates, and elections drove advisor use of flexible multi-sector mandates, with the category increasing by 2.0%. Coreplus mandates were cut by 1.6%, and cash dropped by1.4%. Some of of this money found its way into ultrashort mandates, which gained 1.0% of share in advisor models.
- Duration extended in typical advisor models, finishing the year at 4.84 versus 4.67 at the end of 2023.
Alternatives: Inflation hedges reduced while defined outcome gains favor
- Allocations to inflation hedges fell as inflation returned to more normal levels between 2 and 3%. Real assets saw the largest drop within alternatives, led by a 4% cut to natural resources and a 1.4% reduction in commodity allocations. The one bright spot within this category was infrastructure.
- Exposure to systematic trend-following strategies fell by 4.7% as their potential for negative equity correlation was out of favor.
- The hedged category continued to gain share, but in this edition of Portfolio Construction Pulse, the newly created defined outcome category was the biggest gainer. These products typically provide for more limited downside exposure in exchange for limited equity upside.
Outlook
Investment opportunities broaden:
- Performance definitively favored U.S. large-cap equities at the expense of more diversified equity portfolios. While small- and mid-cap stocks began to perform, a correction in December led to another year of underperformance. The gap between U.S. and international equities was particularly wide at over 21 percentage points.
- We look for a broadening in the investment opportunity set against the backdrop of elevated starting valuations. A strong economy and increased earnings estimates support the theme of broadening investment opportunities highlighted in our global market outlook. Areas of opportunity include industrials, financials, and energy investment at the sector level and value and small- and mid-cap equities at the portfolio level.
U.S. exceptionalism expands:
- U.S. economic outperformance has been notable with AI-related capital spending and innovation, fiscal spending, and monetary policy supporting robust gross domestic product growth and fueling increased equity earnings. Service sectors continued to strengthen into the year’s end. This strength is particularly noteworthy given the divergence with other developed economies as well the challenges in China.
- The labor market has normalized, and our economist is looking for job creation to slow into 2025. Key risks to the outlook include tariff policy, a reversal in inflation progress toward 2%, and fiscal spending levels that upset fixed income markets.
Focus on fixed income:
- Fixed income has proven challenging; however, we saw very solid credit performance in 2024 with high yield corporate bonds and bank loans both up 8.1% on the year. The Bloomberg U.S. Aggregate Index was more muted with a modest 1.4% return.
- Advisors positioned away from core-plus with a 1.6% reduction. They also put cash to work with a 1.4% cut and partially allocated this to ultrashort positions, which gained 1.0%. Flexible multi-sector mandates were the biggest addition with a 2.0% gain.
- Despite tight spreads, T. Rowe Price continues to favor high yield bonds and bank loans given the robust economic backdrop combined with attractive yields. Our multi-asset team also continues to be moderately underweight duration. Policy priorities and their impacts will be closely followed. Tariff policies, a slowing in Federal Reserve rate cuts, and fiscal deficits are just a few areas likely to receive greater scrutiny in 2025.
MODEL STATISTICS (Average)
Data sourced from model portfolios submitted by financial professionals and reviewed by our portfolio construction specialists.
AVERAGE ALLOCATION: 12-Month Change
Average statistics based on moderate-risk models submitted for the 3-year period ended December 31, 2024.
*Beta is calculated relative to the Morningstar Moderate Target Risk Index.
| Fixed Income Duration | 2022 | 2023 | 2024 |
|---|---|---|---|
| Advisor Models | 4.62 | 4.67 | 4.84 |
| Benchmark* | 6.12 | 6.20 | 6.02 |
| Advisor’s Relative Duration Weight (%) | 75% | 75% | 80% |
Average statistics based on moderate-risk models submitted for the 3-year period ended December 31, 2024.
*Benchmark = Bloomberg U.S. Aggregate Bond Index
RANGE OF MODEL-WEIGHTED NET EXPENSE RATIO (2024)
Source: T. Rowe Price Client Investment Platform (CIP) database.
MODEL STATISTICS (Average)
Data sourced from model portfolios submitted by financial professionals and reviewed by our portfolio construction specialists.
FINANCIAL PROFESSIONAL MODEL PORTFOLIOS: Average Allocations 2022–2024
1 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.
2 For financial professionals, alternatives includes investment strategies in the following categories: Commodities, master limited partnerships, real estate, global real estate, multi-strategy, 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.
Source: T. Rowe Price Client Investment Platform (CIP) database.
Equities
ALLOCATIONS FOLLOWED RETURNS, CONTRARIAN POSITIONS SHRANK3
- U.S. equity allocations increased 2% as advisors moved assets to where performance was most attractive. Large-cap allocations rose sharply, with advisors moving to blend at the expense of large-cap value.
- Performance-challenged positions decreased. International allocations declined 1.8% to 19.9% of total equities. Smalland mid-cap stocks were reduced by 3.5%, while receding inflation concerns drove sharp drops in natural resources and energy holdings.
| EQUITY4 | Financial Professional Model Portfolios | T. Rowe Price Multi-Asset Strategic Design | Difference |
|---|---|---|---|
| U.S. Large-Cap | 58.1% | 52.5% | 5.6% |
| U.S. Small-Cap5 | 18.4 | 13.5 | 4.9 |
| Dev. Ex-U.S. Large-Cap | 12.1 | 21.0 | -8.9 |
| Dev. Ex-U.S. Small-Cap | 0.4 | 4.0 | -3.6 |
| Emerging Markets Equity | 3.3 | 4.0 | -0.7 |
| World Stock | 3.9 | 0.0 | 3.9 |
| Regional Stock | 0.2 | 0.0 | 0.2 |
| Other Equity | 3.6 | 5.0 | -1.4 |
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.
Source: T. Rowe Price Client Investment Platform (CIP) database.
Fixed Income
FLEXIBLE MANDATES GAINED SHARE AND CASH CAME OFF THE SIDELINES
- Advisors redeployed cash but were still wary of core fixed income allocations, with allocations to the core-plus category falling 1.6%.
- The flexibility offered by multi-sector mandates led to a 2.0% allocation gain. The cash-plus nature of ultrashort also proved attractive as advisors stepped out from cash holdings.
| Fixed Income7,8 | Financial Professional Model Portfolios | T. Rowe Price Multi-Asset Strategic Design | Difference |
|---|---|---|---|
| U.S. Core | 65.4% | 55.0% | 10.4 |
| Developed Ex-U.S. IG (Hedged) | 1.0 | 15.0 | -14.0 |
| Multi-sector Bond | 15.0 | 0.0 | 15.0 |
| U.S. Treasury Long | 1.5 | 10.0 | -8.5 |
| Global High Yield | 7.9 | 7.0 | 0.9 |
| Floating Rate Loans | 1.9 | 3.0 | -1.1 |
| Emerging Markets | 0.7 | 10.0 | -9.3 |
| Nontraditional Bonds | 4.5 | 0.0 | 4.5 |
| Other Diversifiers | 2.3 | 0.0 | 2.3 |
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, multi-sector 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.
Source: T. Rowe Price Client Investment Platform (CIP) database.
Alternatives
DEFINED OUTCOME GAINED SHARE, WHILE INFLATION HEDGES DECLINED11
- The newly created category of defined outcome gained the greatest share within alternatives. Advisors also sharply increased their allocation to multi-strategy funds.
- Advisors reduced allocations to real assets and potential inflation hedges. Allocations to trend-following strategies were also reduced.
FINANCIAL PROFESSIONAL MODEL PORTFOLIOS: Alternative Allocations12
FINANCIAL PROFESSIONAL MODEL PORTFOLIOS: Alternative Allocations11
11 For financial professionals, alternatives includes investment strategies in the following categories: Commodities, master limited partnerships, real estate, global real estate, multi-strategy, 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.8 As percentage of total fixed income.
12 As percentage of total alternatives.
Source: T. Rowe Price Client Investment Platform (CIP) database.
ETFs
ACTIVE ETFs CONTINUED TO SEE GREATER ADOPTION
- The use of exchange-traded funds (ETFs) continued to increase sharply with the vehicle making up 30.5% of holdings, up from 22.5% last year. Active ETF adoption continued to grow with a spike from 17.9% to 23.3% of total ETF usage.
- With high usage of passive and strategic beta in the mid- and small-cap space, we see an opportunity for active ETFs to gain share.
FINANCIAL PROFESSIONAL MODEL PORTFOLIOS: ETF Usage
FINANCIAL PROFESSIONAL MODEL PORTFOLIOS: Active ETFs
| Top 5 Equity ETF Categories | Chance of Usage |
|---|---|
| Large Blend | 48.9% |
| Large Value | 42.1 |
| Large Growth | 39.7 |
| Mid-Cap Blend | 21.4 |
| Small Value | 16.8 |
| Top 5 Fixed Income ETF Categories | Chance of Usage |
|---|---|
| Intermediate Core Bond | 8.7% |
| Long Government | 6.6 |
| Muni National Intermediate | 6.1 |
| Intermediate Core-Plus Bond | 5.8 |
| Short-Term Bond | 4.9 |
Source: T. Rowe Price Client Investment Platform (CIP) database.
Active/Passive/Strategic Beta*
STRATEGIC BETA INCREASED IN SMALL- AND MID-CAPS, OPENS THE DOOR FOR ACTIVE
- Areas that have tended to see high passive usage include long-term fixed income, where we tend to see high-quality pure duration, and sector equity funds used for tactical positioning.
- The areas that showed at least a double-digit uptick in passive usage include large-cap growth, sector equity, and midcap blend. At T. Rowe Price, we see an opportunity to gain potential alpha with active solutions in these equity areas, particularly in the mid-cap space.
| % Passive | % Strategic Beta | % Active | |
|---|---|---|---|
| U.S. Equity | 18.3% | 24.3% | 57.5% |
| US Large Cup | 20.5 | 24.5 | 55.0 |
| Large Value | 0.2 | 34.6 | 65.3 |
| Large Blend | 42.2 | 18.7 | 39.1 |
| Large Growth | 13.1 | 21.6 | 65.3 |
| U.S. Mid-Cap | 10.8 | 25.5 | 63.7 |
| Mid-Cap Value | 0.0 | 42.5 | 57.5 |
| Mid-Cap Blend | 35.9 | 31.5 | 32.6 |
| Mid-Cap Growth | 0.0 | 4.7 | 95.3 |
| U.S. Small-Cap | 11.6 | 20.6 | 67.9 |
| Small Value | 0.2 | 40.1 | 59.7 |
| Small Blend | 27.9 | 8.1 | 64.0 |
| Small Growth | 0.0 | 13.1 | 86.9 |
| Sector Equity | 50.9 | 3.5 | 45.6 |
| International Equity | 15.5 | 8.6 | 75.9 |
| Foreign Large-Cap | 15.5 | 11.1 | 73.5 |
| Foreign SMID | 4.4 | 0.0 | 95.6 |
| Diversified Emerging Markets | 21.5 | 1.5 | 76.9 |
| Fixed Income | 17.7 | 0.2 | 82.1 |
| Short-Term Bond | 12.0 | 0.0 | 88.0 |
| Intermediate Core Bond | 21.4 | 0.0 | 78.6 |
| Intermediate Core-Plus Bond | 3.1 | 0.0 | 96.9 |
| Global Bond–USD Hedged | 6.7 | 0.0 | 93.3 |
| Multi-sector Bond | 0.0 | 0.1 | 99.9 |
| High Yield Bond | 7.8 | 1.4 | 90.7 |
| Bank Loan | 1.6 | 0.0 | 98.4 |
| Long-Term Fixed | 76.5 | 0.0 | 23.5 |
| Allocation | 0.0 | 0.0 | 100.0 |
| Alternatives | 7.3 | 1.3 | 91.4 |
| TOTAL | 16.7% | 11.1% | 72.2% |
* According to Morningstar, actively managed strategies rely on analytical research, judgment, and experience for investment decisions; passively managed strategies track an index; and strategic beta strategies track an index with modifications to allow for varying position sizes, the exclusion of securities, or the use of leverage.
Source: T. Rowe Price Client Investment Platform (CIP) database; includes moderate-risk models provided over the last three years as of December 31, 2024.
ALLOCATION MIX: Active, Passive, and Strategic Beta
| Top 5 Passive | % Passive |
|---|---|
| Long-Term Fixed | 76.5% |
| Sector Equity | 50.9 |
| Large Blend | 42.2 |
| Mid-Cap Blend | 35.9 |
| Small Blend | 27.9 |
| Top 5 Strategic Beta | % Strategic Beta |
|---|---|
| Mid-Cap Value | 42.5% |
| Small Value | 40.1 |
| Large Value | 34.6 |
| Mid-Cap Blend | 31.5 |
| Large Growth | 21.6 |
| Top 5 Increase Passive | % Increase |
|---|---|
| Diversified Emerging Markets | 9.6% |
| Large Blend | 9.3 |
| Large Growth | 6.0 |
| Global Bond–USD Hedged | 5.3 |
| Intermediate Core Bond | 4.3 |
| Top 5 Increase Strategic Beta | % Increase |
|---|---|
| Mid-Cap Blend | 10.6% |
| Mid-Cap Value | 8.5 |
| Large Growth | 8.1 |
| Small Blend | 5.5 |
| Small Growth | 3.8 |
* According to Morningstar, actively managed strategies rely on analytical research, judgment, and experience for investment decisions; passively managed strategies track an index; and strategic beta strategies track an index with modifications to allow for varying position sizes, the exclusion of securities, or the use of leverage.
Source: T. Rowe Price Client Investment Platform (CIP) database; includes moderate-risk models provided over the last three years as of December 31, 2024.
FINANCIAL PROFESSIONAL MODEL PORTFOLIOS: Active ETFs
Source: T. Rowe Price Client Investment Platform (CIP) database; includes moderate-risk models provided over the last three years as of December 31, 2024.
IMPORTANT INFORMATION
Risk Considerations
Funds that invest in growth stocks are subject to the volatility inherent in common stock investing, and their share price may fluctuate more than that of a fund investing in income-oriented stocks.
The value approach to investing carries the risk that the market will not recognize a security’s intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced.
Mid-caps generally have been more volatile than stocks of large, well-established companies.
Small-cap stocks have generally been more volatile in price than large-cap stocks.
International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets.
The fund’s investments in bank loans may at times become difficult to value and highly illiquid; they are subject to credit risk, such as nonpayment of principal or interest, and risks of bankruptcy and insolvency.
ETFs are bought and sold at market prices, not net asset value (NAV). Investors generally incur the cost of the spread between the prices at which shares are bought and sold. Buying and selling shares may result in brokerage commissions, which will reduce returns.
Past performance cannot guarantee future results. All investments involve risk. The charts and tables are shown for illustrative purposes only.
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