Portfolio Construction
Jan Gundersen
Mark Barile
Capital Group’s proprietary review of more than 1,300 advisor portfolios points to several key trends in late 2024. While it appears from fund flows that advisors are looking to “de-risk” portfolios, Capital Group still identified four potentially hidden risks in advisor portfolios:
- Potential elevated exposure to equity volatility
- Significant allocations to low- and non-dividend-paying stocks
- Relatively high exposure to emerging markets equity
- Relatively low duration in fixed income portfolios
Capital Group’s Portfolio Consulting and Analytics team reviews advisor portfolios in consultation with advisors, and from these consultations develops valuable, timely insights into the way advisors as a group are constructing portfolios.
“Our ongoing work consulting on portfolios with thousands of advisors gives us a unique capability to spot trends in advisor portfolios,” said Mark Barile, senior manager of the Capital Group Portfolio Consulting and Analytics team. “In our analysis in late 2024 we noticed four potentially hidden risks advisors may not be aware of, and in light of that we strongly encourage advisors to take a clear-eyed look at what they own.”
Risk 1: Equity concentration and volatility
Sources: Capital Group, FactSet, Morningstar
The average advisor portfolio is representative of the aggregate exposures of 1,390 advisor portfolios analyzed by Capital Group’s Portfolio Consulting and Analytics team from 7/1/24 through 9/30/24.
High volatility is defined as standard deviation of 10 or higher relative to the S&P 500.
The American Funds model portfolio exposure is represented by a monthly average exposure for the American Funds® Moderate Growth and Income Model Portfolio from 7/1/24 through 9/30/24. This model aligns closely with the broad asset allocation of the average advisor allocation with 67% equity and 28% fixed income.
Equity markets have recently seen historically high concentration in a handful of growth stocks – the “Magnificent Seven” stocks (The largest holdings in the S&P Index as of 12-31-2023; Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla) best symbolize this trend. The risks of concentration have been well documented during this bull market, and fund flows indicate investors are trying to de-risk portfolios by moving money out of growth strategies and into blend strategies. Still, our analysis indicates advisors remain heavily exposed to high equity volatility. In relation to the American Funds® Moderate Growth and Income Model Portfolio, the average advisor portfolio has roughly double the exposure to high equity volatility.
“This is where advisors really have to dig into their clients’ portfolios, looking to identify hidden sources of concentration and volatility, and assessing where there may be room to diversify their growth allocations,” said Jan Gundersen, senior investment director on portfolio solutions and services at Capital Group.
Risk 2: Exposure to non-dividend payers
Sources: Capital Group, FactSet, Morningstar
The average advisor portfolio is representative of the aggregate exposures of 1,390 advisor portfolios analyzed by Capital Group’s Portfolio Consulting and Analytics team from 7/1/24 through 9/30/24.
The American Funds model portfolio exposure is represented by a monthly average exposure for the American Funds® Moderate Growth and Income Model Portfolio from 7/1/24 through 9/30/24. This model aligns closely with the broad asset allocation of the average advisor allocation with 67% equity and 28% fixed income. Low dividend payers include companies that pay 0% to 0.69% dividends.
Capital Group also found the average advisor portfolio has significant allocations to low- and non-dividend paying stocks, continuing a trend we have seen throughout the recent bull market led by growth stocks. Dividend-focused investing can help reduce volatility, and dividend-paying stocks should be a staple within most portfolios, especially for clients who are closer to retirement. Advisors seeking to de-risk portfolios and dampen volatility should consider increasing exposure to dividend payers and growers.
Risk 3: Exposure to emerging markets equity
Sources: Capital Group, FactSet, Morningstar
The average advisor portfolio is representative of the aggregate exposures of 1,390 advisor portfolios analyzed by Capital Group’s Portfolio Consulting and Analytics team from 7/1/24 through 9/30/24.
The American Funds model portfolio exposure is represented by a monthly average exposure for the American Funds® Moderate Growth and Income Model Portfolio from 7/1/24 through 9/30/24. This model aligns closely with the broad asset allocation of the average advisor allocation with 67% equity and 28% fixed income.
A third area of potentially unintended risk involves international investing. Our analysis shows many advisors have higher allocations to emerging market equity than the American Funds model, which can mean higher portfolio volatility. We encourage investors to look closely at international and global allocations and to assess the balance of emerging markets and developed market equity. One way to accomplish this is through active global ETFs, which have the flexibility to take advantage of opportunities around the globe in real time.
“The strong rally in U.S. equities has to some degree overshadowed international and global strategies,” said Gundersen. “This is definitely an area where we encourage advisors to take a closer look at exactly what they own. They should consider their global portfolio not just from a domicile perspective — where companies are based — but from a revenue perspective, that is, where the companies derive revenue.”
Risk 4: Advisor fixed income portfolios are relatively short duration
Data from the Capital Group Portfolio Consulting and Analytics team based on analysis of 1,390 advisor portfolios from 7/1/24 to 9/30/24. American Funds model portfolio represents the most recent available data, as of 9/30/24, for the American Funds® Moderate Growth and Income Model Portfolio. This model aligns closely to the broad asset allocation of the average advisor allocation with 67% equity and 28% fixed income.
Another potential hidden risk in bond portfolios involves duration, which measures how sensitive a fixed-income portfolio is to changes in interest rates. While many advisors have started to extend duration in their portfolios, duration for the average advisor portfolio remains lower than the American Funds® Moderate Growth and Income Model Portfolio. In fact, that gap is growing – six months ago, our Portfolio Insights report showed average advisor portfolio duration at 4.5 years, while the American Funds® Moderate Growth and Income Model Portfolio was at 5.29. That gap of .79 years has now grown to 1.61 years.
“With the Federal Reserve having pivoted to interest rate cuts, more duration could provide additional upside as yields fall,” Gundersen said. “Added high-quality duration also has the potential to enhance diversification from equities in future bouts of volatility.”
Our study of advisor portfolios is also informed by our analysis of industry-wide trends in flows into and out of Morningstar’s mutual fund and ETF investment categories. Based on those trends, asset allocators appear to favor blend strategies, a sign they lack conviction in growth or value going forward. In the 12 months ending September 30, 2024, investors piled more than $218 billion into large blend strategies while pulling out more than $71 billion from large growth and large value strategies.
“The momentum into blend strategies while reducing growth exposure suggests some desire to de-risk and diversify higher volatility equities,” said Barile. “We caution advisors who are focused on reducing risk and volatility that shifting into passive strategies can create unintended risks to core allocations. This echoes our takeaway advice to advisors: Know what you own.”
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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.