Portfolio Concepts
PC trends: Stay ahead of the curve
Our experienced team found three trends to watch for in client portfolios
The Capital Group Portfolio and Analytics team reviewed 3,304 portfolios in the first half of 2020.* In their analysis, they uncovered a variety of noteworthy and persistent portfolio construction trends. Understanding these patterns of investment behavior may provide insight into building effective, efficient portfolios that align with your clients’ real-world financial goals.
Some of our critical findings include:
Average advisor portfolio is 15% overweight U.S. equities relative to global market cap weighted index
Average allocation to U.S. equities
Average advisor portfolio has cut about a quarter of their allocation to value stocks
Average allocation to large-cap value stocks
Average fixed income allocation to spread categories has increased by about 66% in two years
The average fixed income allocation to spread categories
*The Capital Group Portfolio Consulting and Analytics team reviewed 3,304 portfolios over the first six months of 2020. The team aggregated the holdings and allocations data across all the portfolios mentioned above. This data was then used to determine a variety of characteristics, such as average fund category weightings, asset class weights and relative weights versus benchmarks. Spread categories include any fixed income category that maintains additional yield greater than a U.S. Treasury of comparable maturity.
GLOBAL FLEXIBILITY
Global flexibility remains key in building a diversified portfolio
Our team found that the typical portfolio reviewed had almost three times the amount of U.S. equity exposure compared to non-U.S., with an approximately 74% allocation to U.S. equity versus 26% to non-U.S. The average advisor portfolio is 15% overweight U.S. equities relative to the MSCI All Country World Index. By consistently favoring U.S. equities, advisors may lose out on the potential long-term opportunities with non-U.S. equities.
U.S. versus non-U.S. equity relative exposure
Source: Morningstar and Capital Group Portfolio Consulting and Analytics data as of 6/30/20.
As noted in the chart below, Standard & Poor's 500 Index (S&P 500) has outpaced international equities — proxied by MSCI World Index ex USA — for the past 10 years. However, MSCI World Index ex USA equities outpaced the S&P 500 for the 10 years prior from 2000 to 2009. In fact, since 1970, U.S. equities have lagged international equities about as often as they have led.
As history has shown, expressing large geographic bias in equity allocations can have long-term implications. Over a 10-year period, such a bias may cost a portfolio thousands of basis points in “missed” returns relative to a more balanced global equity allocation.
10-year annualized returns by index
Source: Return data by Morningstar. Indexes selected because they are representative of commonly used benchmarks for U.S. (S&P 500) , Global (MSCI World) and non-U.S. (MSCI World ex USA) equity markets.
Fund implementation
ANWFX (F-2)
The fund takes a flexible approach to global growth. It seeks to take advantage of evolving global trade patterns by predominantly investing in companies that have potential for growth in capital. It invests primarily in multinational companies with a meaningful share of their sales and operations outside of their home countries. This approach provides the strategy’s portfolio managers with geographic flexibility and the ability to navigate different markets.
SMCFX (F-2)
A pioneer in global small-cap investing, this strategy seeks growth of capital by investing in some of the fastest growing and most innovative companies in the world. It invests in companies with market capitalizations of up to $6 billion at the time of purchase. As one of our most research-intensive strategies, with a team of more than 100 portfolio managers and research analysts based in both developed and developing markets, it takes full advantage of our global presence and insights.
SECTORS AND STYLE
Advisors have been reducing allocations to value funds
According to our team’s analysis, advisors have been markedly reducing allocations to large-cap value equities over the past three years. By mid-2020, average allocations to large growth and blend categories were 35% and 41%, respectively, compared to value, which was 25%. This represents a reduction in relative allocation to large-cap value by a quarter from three years ago.
Average allocation style box
Source: Morningstar. Capital Group Portfolio Consulting and Analytics team. Values may not add up to 100% due to rounding.
This trend produced short-term gains in the current market, but may have long-term implications for client portfolios. To illustrate that point, growth stocks outpaced value in more than 50% of rolling one-, three- and five-year periods. However, over all three-, five-and 10-year rolling periods, the total return of value stocks exceeded that of growth by 24, 57, and 71 basis points annually, respectively.
Historical rolling monthly success
Source: Morningstar, based on Russell 1000 Growth Index and Russell 1000 Value Index, from 12/29/78–9/30/20. Analysis for rolling periods based on monthly observations.
Fund implementation
AMRFX (F-2)
Conservatively managed to reduce volatility and risk, this strategy has provided downside resilience during every S&P 500 decline of 15% or more since its inception in 1950.* It invests primarily in well-established companies with strong balance sheets and a history of consistent dividends. The portfolio does not invest in companies that derive the majority of their revenues from tobacco and/or alcohol.
*The fund has provided excess returns versus the S&P 500 TR Index during all 14 major market declines (15% or more) over its lifetime, dating back to 1950, as of April 30, 2020 (for all share classes at NAV).
WMFFX (F-2)
Washington Mutual Investors FundSM
A disciplined approach to investing that uses strict eligibility criteria to screen for companies across a broad array of industries with strong balance sheets and consistent dividends. This approach has enabled the strategy to outpace its index during almost every S&P 500 decline of 15% or more since its inception in 1952.† The strategy seeks to be fully invested and avoids companies that primarily derive revenue from alcohol or tobacco products.
†The fund has provided excess returns versus the S&P 500 TR Index during 13 of 14 major market declines (15% or more) over its lifetime, dating back to 1950, as of April 30, 2020 (for all share classes at NAV).
FIXED INCOME OUTCOMES
The importance of aligning bond investments with a portfolio’s investment objectives
Over the past two years, advisors have dramatically increased allocation to riskier fixed income categories, even as spreads compressed and yields marched lower.
Average allocation to spread categories, 2018–2020
This chart is based on data provided to the Capital Group Portfolio and Analytics team for analysis. The spread categories include any fixed income category that maintains additional yield greater than a U.S. Treasury of comparable maturity.
In times of equity market volatility, high yielding and lower quality fixed income tend to be highly correlated with equities, and may suffer from illiquidity. As highlighted in the chart below, returns to higher yielding, riskier “spread categories” like high-yield bonds, have lagged categories like intermediate core bond, which tend to be composed of higher quality bond investments.
12-month yield versus YTD return
A spread sector or spread category denotes any fixed income category that maintains additional yield greater than a U.S. Treasury of comparable maturity.
Morningstar categories included: High Yield Bond, Bank Loan, Multisector Bond, Emerging Markets Bond, Corporate Bond, Nontraditional Bond, Intermediate Core-Plus Bond, Intermediate Core Bond.
Fund implementation
ABNFX (F-2)
Taking a broadly diversified, high-quality approach, this core bond strategy has the ability to invest in every sector of the bond market, with a limited percentage of below-investment-grade holdings. This approach historically has helped to diversify equity risk in a portfolio.* The strategy draws on our experience in managing U.S. core bonds since 1973 and an 85-year heritage of investing in U.S. markets.
*Source: Capital Group, based on the fund’s 3-year correlation to the S&P 500 TR Index on a rolling monthly basis for the period from January 1, 2009, and ending December 31, 2019 (for all share classes at NAV).
ANBFX (F-2)
American Funds Strategic Bond FundSM
A core plus fund focused on total return consistent with preservation of capital. This strategy seeks higher returns than core bond funds with generally low equity correlation. It aims to drive returns primarily through interest rate, yield curve and inflation positioning, generally resulting in liquid investments with high credit quality. It has the flexibility to invest in extended bond sectors on an opportunistic basis, allowing it to shift credit and duration exposure and pursue opportunities.
What this means
The key is to work with your clients to understand their goals and time horizons and not be overly reactive to market volatility or headlines. Our objective-based, flexible approach may be well suited to helping you create portfolios to address your clients’ real-world needs.
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Portfolio Construction Concepts
PORTFOLIO CONSTRUCTION
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.
Investing outside the United States involves risks, such as currency fluctuations, periods of illiquidity and price volatility, as more fully described in the prospectus. 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 portfolios and for portfolios with significant underlying bond holdings is not guaranteed. Investments 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 cash securities, such as stocks and bonds.
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.
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MSCI All Country World 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. The index consists of more than 40 developed and emerging market country indexes. This index is unmanaged, and its results include reinvested dividend and/or distributions but do not reflect the effect of sales charges, commissions, account fees, expenses or taxes.
MSCI World Index measures stock market results in more than 20 developed markets. MSCI World Index results reflect net dividends.
MSCI World Index ex USA is a free float-adjusted market capitalization index that is designed to measure results of more than 20 developed equity markets, excluding the United States. Results reflect net dividends.
Russell 1000 Growth Index is a market capitalization-weighted index that represents the large-cap growth segment of the U.S. equity market and includes stocks from the Russell 1000 Index that have higher price-to-book ratios and higher expected growth values.
Russell 1000 Value Index is a market capitalization-weighted index that represents the large-cap value segment of the U.S. equity market and includes stocks from the Russell 1000 Index that have lower price-to-book ratios and lower expected growth values.
Standard & Poor’s 500 Composite Index is a market capitalization-weighted index based on the results of approximately 500 widely held common stocks. This index is unmanaged, and its results include reinvested dividend and/or distributions but do not reflect the effect of sales charges, commissions, account fees, expenses or taxes.
Large-value portfolios invest primarily in big U.S. companies that are less expensive or growing more slowly than other large-cap stocks. Stocks in the top 70% of the capitalization of the U.S. equity market are defined as large cap. Value is defined based on low valuations (low price ratios and high dividend yields) and slow growth (low growth rates for earnings, sales, book value and cash flow).
Large-blend portfolios are fairly representative of the overall U.S. stock market in size, growth rates and price. Stocks in the top 70% of the capitalization of the U.S. equity market are defined as large cap. The blend style is assigned to portfolios where neither growth nor value characteristics predominate. These portfolios tend to invest across the spectrum of U.S. industries, and owing to their broad exposure, the portfolios' returns are often similar to those of the S&P 500 Index.
Large-growth portfolios invest primarily in big U.S. companies that are projected to grow faster than other large-cap stocks. Stocks in the top 70% of the capitalization of the U.S. equity market are defined as large cap. Growth is defined based on fast growth (high growth rates for earnings, sales, book value and cash flow) and high valuations (high price ratios and low dividend yields). Most of these portfolios focus on companies in rapidly expanding industries.
Intermediate-term core bond portfolios invest primarily in investment-grade U.S. fixed income issues including government, corporate and securitized debt, and hold less than 5% in below-investment-grade exposures. Their durations (a measure of interest-rate sensitivity) typically range between 75% and 125% of the three-year average of the effective duration of the Morningstar Core Bond Index.
Intermediate-term core-plus bond portfolios invest primarily in investment-grade U.S. fixed income issues including government, corporate and securitized debt, but generally have greater flexibility than core offerings to hold non-core sectors such as corporate high yield, bank loan, emerging markets debt and non-U.S. currency exposures. Their durations (a measure of interest-rate sensitivity) typically range between 75% and 125% of the three-year average of the effective duration of the Morningstar Core Bond Index.
Bank-loan portfolios primarily invest in floating-rate bank loans and floating-rate below-investment-grade securities instead of bonds. In exchange for their credit risk, these loans offer high interest payments that typically float above a common short-term benchmark such as the London Interbank Offered Rate, or LIBOR.
Corporate bond portfolios concentrate on investment-grade bonds issued by corporations in U.S. dollars, which tend to have more credit risk than government or agency-backed bonds. These portfolios hold more than 65% of their assets in corporate debt, less than 40% of their assets in non-U.S. debt, less than 35% in below-investment-grade debt and durations that typically range between 75% and 150% of the three-year average of the effective duration of the Morningstar Core Bond Index.
High-yield bond portfolios concentrate on lower quality bonds, which are riskier than those of higher quality companies. These portfolios generally offer higher yields than other types of portfolios, but they are also more vulnerable to economic and credit risk. These portfolios primarily invest in U.S. high-income debt securities where at least 65% or more of bond assets are not rated or are rated by a major agency such as Standard & Poor's or Moody's at the level of BB (considered speculative for taxable bonds) and below.
Multisector-bond portfolios seek income by diversifying their assets among several fixed income sectors, usually U.S. government obligations, U.S. corporate bonds, foreign bonds and high-yield U.S. debt securities. These portfolios typically hold 35% to 65% of bond assets in securities that are not rated or are rated by a major agency such as Standard & Poor's or Moody's at the level of BB (considered speculative for taxable bonds) and below.
Emerging markets bond portfolios invest more than 65% of their assets in foreign bonds from developing countries. The largest portion of the emerging markets bond market comes from Latin America, followed by Eastern Europe. Africa, the Middle East and Asia make up the rest.
Inclusion in nontraditional bond is informed by a balance of factors determined by Morningstar analysts. Those typically include a mix of: absolute return mandates; goals of producing returns not correlated with the overall bond market; performance benchmarks based on ultrashort-term interest rates such as Fed funds, T-bills or LIBOR; the ability to use a broad range of derivatives to take long and short market and security-level positions; and few or very limited portfolio constraints on exposure to credit, sectors, currency or interest-rate sensitivity. Funds in this group typically have the flexibility to manage duration exposure over a wide range of years and to take it to zero or a negative value.
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