As they took stock of the rising risks in the market last year, advisors increased their bond allocations in the fourth quarter to create much-needed ballast against equity volatility.
That was the finding of Natixis Investment Managers in its newly released Portfolio Clarity US Trends Report, which reviewed the state of moderate advisor-managed portfolios at the end of 2018. In spite of significant equity losses in Q4 2018, advisors dialled up allocations to US large-cap and growth stocks, but counterbalanced them with short-duration government bonds.
“The big takeaway for 2018 was the increase in volatility coupled with rising rates that pushed investors towards higher quality fixed income,” said Marina Gross, executive vice president of Natixis’ Portfolio Research and Consulting Group, which conducted the analysis. “
Moderate portfolios returned -5.1% for the calendar year after a sharp US equity-driven decline of -8.3% in the fourth quarter. Large-cap stocks saw an overall decline of 13.5%, while small-caps dropped by an even steeper 20%. Despite the plunge, US large-caps outpaced international equities for the year, performing ahead of emerging-market equities by 10% and international developed equities by 9.2%.
Aside from raising their allocations to US large-cap and growth stocks in the fourth quarter, advisors favoured emerging-market over developed equity; in spite of that increased allocation, emerging-market equities contributed less risk to diversified portfolios.
Looking at fixed income, the analysis found advisors shortened duration throughout the year; credit quality was at above-average levels and allocations to short and ultrashort bonds reached all-time highs. Short-term and ultrashort-term bond allocations made up 17% of the fixed-income bucket, while intermediate-term bond allocations were just under 30%. The 10-year Treasury yield started the year at 2.4% and climbed to 3.23% in November, after which it retreated as the year came to a close.
Taking in the prospects for rising interest rates and economic growth, advisors raised government bond holdings to 8%, on average, in the fourth quarter as ballast while staying exposed to higher-yielding fixed-income. The strategy, which resulted in reduced risk, worked well for top-quartile portfolios, among which fixed-income allocations contributed to better overall return, smaller drawdowns, and lower risk. All in all, top-quartile portfolios returned -3.1% for 2018, while bottom-quartile portfolios’ performance registered at -7%.
“We remain optimistic for equity performance over the remainder of this year, but we see controlled upside pressure on yields,” Gross said. “For this reason, extending duration, rather than running from it, might serve investors better over time.”
The US Portfolio Trends analysis also found 22% of advisors using minimum-volatility products in their portfolios following the 2018 uptick in equity volatility. Minimum-volatility product use was found mainly in the large-cap space, mostly with large blend, foreign large blend, and diversified emerging markets.
“As volatility continues, we expect this trend will also continue, amplified by investor concerns over late-cycle dynamics and increased sensitivities to systemic trading,” Gross said.
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