info
On Christmas Day, the New York Stock Exchange and Capital Group’s U.S. offices will be closed.

In observance of the Christmas Day federal holiday, the New York Stock Exchange and Capital Group’s U.S. offices will close early on Tuesday, December 24 and will be closed on Wednesday, December 25. On December 24, the New York Stock Exchange (NYSE) will close at 1 p.m. (ET) and our service centers will close at 2 p.m. (ET)

Portfolio Construction

4 surprising risks in client portfolios

Mark Barile Casey Dregits Samir Mathur

Published onDecember 15, 2023

6 MIN ARTICLE

How are financial advisors allocating client portfolios in today’s uncertain environment? Our Portfolio Consulting and Analytics team meets with thousands of advisors every year to discuss portfolio challenges and recommend allocation changes based on client goals. We’ve identified the most common issues found in client portfolios and how we’ve worked with advisors to help reduce risks.

1. Market concentration has left investors under-diversified

 

Some advisors we work with are surprised to learn that today’s market concentration among top stocks in the S&P 500 Index is as high as it was during the dot-com bubble. (Often referred to as the Magnificent 7, this group includes mega-caps such as Amazon and Apple.) For comparison, exposure to information technology and communication services made up 25% of the S&P 500 Index at the peak of the tech bubble in March 2000. Currently, those sectors occupy 36% of the index’s total market capitalization. What’s more, the top five largest companies in the S&P 500 represented 24% of the index, as of September 30, 2023, but only 14% of recurring earnings (the amount of a company’s earnings expected to continue).

 

Meanwhile, key bond indices fell sharply in 2022 and mostly posted negative three-year average annual returns as of September 30, 2023. High yield, as measured by the Bloomberg U.S. Corporate High Yield 2% Issuer Capped Index, proved to be the main exception, with three-year average annual returns, as of September 30, 2023, at 1.75%. In general, many advisor portfolios appear to be unbalanced in this environment, with too much equity concentration risk and not enough fixed income diversification. Our analysis of advisor portfolios has shown that correlations between the fixed income sleeve of the average advisor portfolio versus the S&P 500 have climbed overall, with the three-year correlation jumping from 0.43 at the beginning of 2021 to 0.68 as of September 30, 2023.

 

Our takeaway: Bonds are one way to balance out heavy equity concentration. “We encourage advisors to think about the longer term role that fixed income can play in a balanced portfolio to provide a measure of protection against potential downside moves in equities,” says Mark Barile, manager of the Portfolio Consulting and Analytics team. This includes discussions about rolling correlations, scenario analysis and credit/curve positioning, among other factors, to assess fixed income allocations. Credit analysis is based on credit quality (whether bond holdings are BB/Ba-rated or below), curve positioning refers to duration (sensitivity to interest rates) and scenario analysis refers to how portfolios have held up during market corrections of 10% or more. “Advisors who have the discipline to stay diversified through these market conditions and use fixed income both as a ballast and to generate income are likely to benefit going forward,” adds Barile.

Market concentration now as high as during the dot-com bubble

This graph shows that in March 2000—the height of the dot-com bubble—the top five stocks in the S&P 500 Index made up 19% of the index while the top 10 stocks comprised 32% of the index. As of September 30, 2023, concentration was as high as it was during the dot-com bubble, with the top 10 stocks making up 32% of the S&P 500 Index, and the top five comprising 24%.

Source: Factset, September 30, 2023.

2. Portfolios hold more high yield than advisors realize

 

“Advisors are usually surprised by the amount of high yield, lower rated bonds in their portfolios,” says senior portfolio consultant Casey Dregits. They are also surprised, at times, by the risk these holdings can add. As of September 30, 2023, we found that the average advisor had a 17% allocation to high yield (or lower rated) investments versus 14% for the American Funds Moderate Growth and Income model (which typically aligns with a 60% equity/40% bond portfolio). In general, high yield, lower rated bonds usually have a lower sensitivity to interest rates and tend to fare better than other fixed income asset classes in a rising rate environment and in the face of higher inflation. Duration (interest rate sensitivity) in the average advisor portfolio was 4.55 years versus 6.28 years for the model, as of September 30, 2023.

More high yield than the model

This chart shows that the high yield (below investment grade) allocation was 17% of the average advisor versus 14% for the American Funds Moderate Growth and Income Model. The duration for the average advisor portfolio was 4.55 years versus 6.28 years for the model. The average three-year correlations for both the model and the average advisor portfolio were both 0.68.

Source: Capital Group, FactSet, and Morningstar as of September 30, 2023. The American Funds model portfolio represents the most recent available data, as of September 30, 2023, for the American Funds Moderate Growth and Income Model Portfolio. Average three-year correlation of the fixed income sleeve for each portfolio is relative to the S&P 500. Below investment grade/high yield refers to companies with a debt rating of BB/Ba and below or whose debt is not rated by agencies.

Our takeaway: Balancing core bond allocations with flexible exposure to higher yielding sectors can be useful in growth and income and income-oriented portfolios, according to Samir Mathur, chairman of Capital Group’s Portfolio Solutions Committee, which oversees model portfolios. “We recommend taking a flexible approach to high yield and duration rather than trying to make a call on interest rates,” adds Dregits. “Our team can make suggestions to advisors on where to focus core allocations in portfolios and how not to go to extreme ends in order to mitigate volatility,” Dregits says.

3. Portfolios have limited international diversification

 

Some advisors shy away from international stocks, especially given that non-U.S. equities lagged U.S. stocks over the last decade. For the 10-year period ending September 30, average annual returns for the S&P 500 Index were 11.91% versus 3.35% for the MSCI All Country World Index ex US (ACWI ex US). Many advisors who do invest internationally tend to favor emerging markets. For example, as of September 30, the average advisor portfolio allocated 11% to emerging markets versus 7% for the American Funds Moderate Growth and Income model. But the average advisor had a 20% exposure to developed international equity versus 25% for the model. This year, non-U.S. allocations in many of our model portfolios have increased further via shifts in underlying funds, according to Mathur. This includes increased non-U.S. allocations in the American Funds Moderate Growth and Income Model Portfolio in the 12 months ended September 30, 2023.

Equity allocations by domicile and revenue

This chart shows that the average advisor portfolio had a 70% exposure to U.S. stocks by domicile, a 20% exposure to developed international stocks and an 11% allocation to emerging markets equity as of September 30. By revenue, the average advisor portfolio had a 51% allocation to U.S. equity, a 20% allocation to developed market equity and a 29% exposure to emerging markets stocks. By contrast, the American Funds Moderate Growth and Income model had a 68% exposure to U.S. stocks by domicile, a 25% exposure to developed international stocks and a 7% allocation to emerging markets equity as of September 30. By revenue, the average model had a 49% allocation to U.S. equity, a 24% allocation to non-U.S. developed market equity and a 27% exposure to emerging markets stocks. Totals may not reconcile due to rounding.

Sources: Capital Group, FactSet, and Morningstar as of September 30, 2023. The American Funds model portfolio represents the most recent available data, as of September 30, 2023, for the American Funds Moderate Growth and Income Model Portfolio.  Totals may not reconcile due to rounding.

Our takeaway: Selecting strategies with an international focus can help provide non-U.S. diversification. “Our team often suggests international strategies that evaluate opportunities on a company-by-company basis,” Dregits says. “This includes developed market international companies that derive revenue from emerging markets.” Having a broader opportunity set to pick from is rarely a bad starting place.  “Whether it’s the prevalence of dividend payers, views on currency, or simply seeking to identify market leaders, international equity allocations can play a key role in portfolio diversification,” says Dregits. Flexible strategies that invest across regions and sectors can also help investors stay focused on their goals through market uncertainty, according to Mathur.

4. Advisors are underweight dividend payers

 

Many advisors are also surprised to learn they are underweight dividend payers, especially in an environment where dividend payers could be relatively well positioned to withstand market volatility. This may be due to holding more passive investments that seek to track the S&P 500 and have typically had less exposure to higher dividend payers than exchange-traded funds (ETFs) that take a more active approach to dividend payers. The average advisor had a 28% allocation to high dividend payers within portfolio holdings compared to 37% for the American Funds Moderate Growth and Income model, as of September 30. As a result, many portfolios may miss out on the benefits higher dividend payers have historically provided, such as an enhanced measure of downside protection in difficult markets.

Limited dividend exposure versus model portfolio

This chart shows that the average advisor portfolio had a 28% exposure to high-yielding stocks with a 2.7% or greater dividend yield versus a 37% allocation by the American Funds Moderate Growth and Income model portfolio. The average advisor had a 41% exposure to medium-yielding stocks with a dividend range between 0.70%-2.69%, while the model had a 45% exposure to medium dividend payers. The average advisor portfolio had a 32% exposure to low-yielding stocks with yields at 0.69% or less, whereas the average model had an 18% exposure to low dividend payers.

Source: Capital Group, FactSet, and Morningstar, as of September 30, 2023.  The American Funds model portfolio represents the most recent available data, as of September 30, 2023, for the American Funds Moderate Growth and Income Model Portfolio.

Our takeaway: Consider focusing on dividend payers with the potential for sustainable dividend growth. Currently, many dividend payers are at or near all-time attractive valuations and can provide equity diversification during this period of heavy equity market concentration and potentially over the long term. In addition, we also find that many advisors who are focused on tax efficiency for their clients are interested in ETFs that can access dividend opportunities. “We regularly analyze dividend exposure with advisors to suggest a range of options, depending on their needs. This includes active dividend ETFs, which have tended to provide more diversification than passive ETFs that seek to track the S&P 500, especially given heavy levels of concentration in the top 10 S&P stocks,” says Dregits.

Want to get another perspective on your client portfolios?

 

Many advisors we’ve worked with have told us that they like hearing an unbiased perspective on portfolios and talking through solutions with trusted partners. This is especially valuable through periods of market uncertainty. We are here to analyze portfolios along with you and talk through any challenges you may be facing. Here’s how you can request a portfolio consultation from one of our portfolio specialists to help you address your clients’ specific investment goals. Book a consultation here: Portfolio Consultation | Capital Group

Mark-Barile-bw-600x600

Mark Barile is senior manager of Capital Group's Portfolio Consulting and Analytics team. He has 18 years of investment industry experience (as of 12/31/2023). He holds a bachelor's degree in studio art from Trinity University. He also holds the Certified Investment Management Analyst® designation.

CADD

Casey Dregits is a senior portfolio consultant with 22 years of investment industry experience. He holds an MBA as well as bachelor’s degree in political science, history, and Germanic studies from Indiana University. He also holds the Chartered Financial Analyst® designation.

SKM

Samir Mathur is a solutions portfolio manager with 31 years of investment industry experience. He chairs Capital Group’s Portfolio Solutions and Global Solutions Committees. He also serves on the Target Date Solutions and Custom Solutions committees. He holds an MBA from University of California, Berkeley, a master’s degree in computer science from University of Southern California and a bachelor’s of technology degree from the Indian Institute of Technology, Delhi.

Related content

Stock market outlook: It’s time for diversification
As rate hikes near end, historic investor opportunity may begin
Cash on the sidelines? A conversation guide for deploying cash for long-term investing.

Model portfolios are only available through registered investment advisers. This content is intended for registered investment advisers and their clients.

 

Past results are not predictive of results in future periods.

 

The average advisor portfolio is representative of the aggregate exposures of 1,188 advisor portfolios analyzed by Capital Group’s Portfolio Consulting and Analytics team from 7/1/23 to 9/30/23. The American Funds model portfolio represents the most recent available data, as of 9/30/23, for the American Funds Moderate Growth and Income Model Portfolio.

 

Model portfolios are subject to the risks associated with the underlying funds in the model portfolio. Investors should carefully consider investment objectives, risks, fees and expenses of the funds in the model portfolio, which are contained in the fund prospectuses. Investing outside the United States involves risks, such as currency fluctuations, periods of illiquidity and price volatility. These risks may be heightened in connection with investments in developing countries. Small-company stocks entail additional risks, and they can fluctuate in price more than larger company stocks. The return of principal for bond funds and for funds with significant underlying bond holdings is not guaranteed. Fund shares are subject to the same interest rate, inflation and credit risks associated with the underlying bond holdings. Lower rated bonds are subject to greater fluctuations in value and risk of loss of income and principal than higher rated bonds. The use of derivatives involves a variety of risks, which may be different from, or greater than, the risks associated with investing in traditional securities, such as stocks and bonds. A nondiversified fund has the ability to invest a larger percentage of assets in securities of individual issuers than a diversified fund. As a result, a single issuer could adversely affect a nondiversified fund’s results more than if the fund invested a smaller percentage of assets in securities of that issuer. See the applicable prospectus for details.

 

Model portfolios are provided to financial intermediaries who may or may not recommend them to clients. The portfolios consist of an allocation of funds for investors to consider and are not intended to be investment recommendations. The portfolios are asset allocations designed for individuals with different time horizons, investment objectives and risk profiles. Allocations may change and may not achieve investment objectives. If a cash allocation is not reflected in a model, the intermediary may choose to add one. Capital Group does not have investment discretion or authority over investment allocations in client accounts. Rebalancing approaches may differ depending on where the account is held. Investors should talk to their financial professional for information on other investment alternatives that may be available. In making investment decisions, investors should consider their other assets, income and investments. Visit capitalgroup.com for current allocations.

 

Portfolios are managed, so holdings will change. Holdings are the weighted average of the underlying funds.  

 

Bond ratings are based on a model portfolio’s underlying funds’ holdings and investment policies. Bond ratings, which typically range from AAA/Aaa (highest) to D (lowest), are assigned by credit rating agencies such as Standard & Poor's, Moody's and/or Fitch, as an indication of an issuer's creditworthiness. For most American Funds and Capital Group ETFs, if agency ratings differ, a security will be considered to have received the highest of those ratings; and securities in the Unrated category have not been rated by a rating agency, however, the investment adviser performs its own credit analysis and assigns comparable ratings that are used for compliance with applicable investment policies. Please see each fund’s most recent prospectus for details.

 

The market indexes are unmanaged and, therefore, have no expenses. Investors cannot invest directly in an index.

 

The S&P 500 Index is a market capitalization-weighted index based on the results of approximately 500 widely held common stocks.

 

The S&P 500 Index is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Capital Group. Copyright © 2023 S&P Dow Jones Indices LLC, a division of S&P Global, and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part is prohibited without written permission of S&P Dow Jones Indices LLC.

 

MSCI All Country World ex USA Index is a free float-adjusted market capitalization-weighted index that is designed to measure equity market results in the global developed and emerging markets, excluding the United States. The index consists of more than 40 developed and emerging market country indexes. Results reflect dividends gross of withholding taxes through December 31, 2000, and dividends net of withholding taxes thereafter.

 

MSCI has not approved, reviewed or produced this report, makes no express or implied warranties or representations and is not liable whatsoever for any data in the report. You may not redistribute the MSCI data or use it as a basis for other indices or investment products.

 

Bloomberg U.S. Corporate High Yield 2% Issuer Capped Index covers the universe of fixed-rate, non-investment-grade debt. The index limits the maximum exposure of any one issuer to 2%.

 

BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). Bloomberg or Bloomberg’s licensors own all proprietary rights in the Bloomberg Indices. Neither Bloomberg nor Bloomberg’s licensors approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
This material does not constitute legal or tax advice. Investors should consult with their legal or tax advisors.
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and should not be considered advice, an endorsement or a recommendation.
All Capital Group trademarks mentioned are owned by The Capital Group Companies, Inc., an affiliated company or fund. All other company and product names mentioned are the property of their respective companies.
Use of this website is intended for U.S. residents only. Use of this website and materials is also subject to approval by your home office.
Capital Client Group, Inc.
This content, developed by Capital Group, home of American Funds, should not be used as a primary basis for investment decisions and is not intended to serve as impartial investment or fiduciary advice.