5 top allocation moves in advisor model portfolios

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DAVID REILLY: Hello, and welcome to our Peer Trends discussion. I'm David Reilly, here with my colleague, Connor Reardon. We work on the Portfolio Analysis and Consulting Group. Every quarter, we capture the asset allocation and implementation trends we are seeing in financial advisor portfolios.

To remind listeners, our portfolio consultants work with financial advisors throughout the country, across channels from advisors working at independent broker dealers, traditional wirehouse BDs, to registered investment advisors. We interact with about 300 to 400 advisors every six months, and it's the model portfolios from those advisors that make their way into our peer group and form the basis for these trends.

So in the next few minutes, Connor and I will cover the five themes that we see in advisor portfolios.

CONNOR REARDON: Thanks for the introduction, Dave. One thing I think is unique about what we do here at Natixis is, not only are we engaging with top financial advisors across the country, but since we also manage real-client assets, we're eating our own cooking. We don't look to force our views, but rather, share our insights with how advisors are positioned going forward. And when we share our insights with advisors, it lines up with what we're doing in the models that we manage.

For example, we'll soon delve into one useful framework that shows how sensitive portfolios might be relative to inflation and the business cycle.

DAVID REILLY: That's right, Connor. In fact, in many of the reviews that we did last year, we saw that advisors were leaning into a stagflationary positioning, which we thought was a low probability outcome. We'll get to that shortly.

Let's turn to the key themes and takeaways from our latest Winter Peer Trends Report. So 2024 was a strong year. Within equities, it was led by large caps, US equities, and that's something that, of course, everyone likely knows. On the bond side, short duration fixed income was the winner, since short-term interest rates were higher due to the Fed rate hikes from 2022 and in 2023.

If we calculate the performance of the representative model from our moderate peer group, it shows that a return of 12.2% in 2024, outperforming a global 60 over 40 passive portfolio. However, that lagged in all US equivalents 60/40 model, as most non-US equity exposure would have been a drag last year on relative performance versus the US equities.

CONNOR REARDON: Turning to fixed income, intermediate-term interest rates using the 10-year treasury, essentially, moved sideways in the first half of the year, then lowered as we moved into the summer. Having duration during that period would have helped, but then in the fall of last year, we saw this treasury yield back up meaningfully by about 100 basis points, from 3.6% in September before the election, to about 4.6% at the end of the year.

During that period, portfolios that were positioned with lower duration being closer to cash would have performed better. In terms of credit or corporate bonds, 2024 was a year for carry, meaning that the return in corporate bonds was primarily made up of coupon, rather than price movement.

There were no real credit events last year, and spreads remained relatively tight. In 2025, we do expect credit conditions to remain solid. That said, we still think it makes sense to move up in quality this year, as the nominal level of interest rates are fairly attractive.

DAVID REILLY: Connor, to your point, the peer group data shows that portfolios were and still are positioned with less duration in their models compared to the benchmark Bloomberg aggregate bond index. That tells me they remain worried about inflation.

So we see that in fixed income, but you know what, we also see that in their equity exposures. For one, advisors continue to own explicit inflation hedging sector products, for example, real estate and commodity funds. This also shows up within cyclicality and inflation framework that we mentioned earlier.

We like to think of this framework as simply a more nuanced way of understanding equity exposure than a traditional style-box framework.

CONNOR REARDON: Advisors often ask questions along the lines of is it better to shift away from the growth side of the style box later on in the cycle, as that tends to be higher risk? Or is it true that many of the large growth names have a high degree of quality, which expects to perform best in later business cycles?

Is value too defensive positioning early in a cycle, or is there a subcategory of cyclical managers in the large cap value space that would do best during those periods?

DAVID REILLY: Yeah, we found this framework to be really useful the last few years, as the market has grappled with the direction of inflation and the business cycle. Connor, can you describe this framework in a bit more detail?

CONNOR REARDON: Yeah, absolutely. So we looked at the past returns of all 74 S&P industries relative to economic indicators to develop a sensitivity score. Running two plus decades of industry returns, along with the Citi Economic Surprise Index and the Citi Inflation Surprise Index. We then had two factors against which we could score the industries. Plotted on an x, y-axes, a clear picture takes hold where the quadrants each describe a distinct economic outcome.

DAVID REILLY: Thanks, Connor. That's really good to describe what that framework is. Now, turning to the returns in the model portfolios for the peer group, this framework showed that portfolios which were positioned to anticipate lower inflation performed the best, while those hedging inflation lagged within the peer group.

The industries that tend to do better when inflation came in lower than expected tended to outperform last year. This includes the quadrants describing both soft landing, also correlating to higher economic growth, and hard landing with lower growth.

CONNOR REARDON: Let's shift to another theme we're seeing. This one is in fixed income. Advisors are increasing their exposure to core plus strategies for flexibility, and their seeking yield through multi-sector and nontraditional bond strategies. We think this makes a lot of sense, given how tight credit spreads are right now. In other words, there's a risk to trading in and out of the high-yield bond category when you could just have a manager that employs a flexible strategy designed to add risk after spreads widen or to increase duration after yields back up.

DAVID REILLY: The last theme to highlight really relates to alternatives. And while it's a shrinking sleeve in the peer group, we see that advisor models continue to include some alternative products. The mix of alternatives focuses more recently on high equity beta categories, like derivative income and option-based products.

There's a clear preference for participating in the equity bull market, while giving clients an option, protected downside, and/or an attractive, predictable yield. This should serve to help those portfolios in what might be another volatile 2025.

CONNOR REARDON: If I could summarize these five key trends and advisor models, it would be, first, we had a strong year driven by US large caps and short duration fixed income. Second, the inflation concern among advisors is down, but it's not out. Third, models with more inflation hedging equity exposures performed worse than those expecting an inflation fade. Fourth, a fixed income trend we think makes sense is seeking flexibility in core plus, multisector, and nontraditional bonds. And lastly, the composition of alternatives has shifted to higher equity beta strategies.

DAVID REILLY: That concludes our discussion on some of the latest peer trends. For more of our research and investment insights, please visit our website at im.natixis.com. And as always, feel free to reach out to us with any questions, comments, or for customized insights tailored to your specific portfolio. On behalf of the portfolio analysis and consulting team at Natixis Investment Manager Solutions, thank you for your continued partnership, and thanks for listening.