Here's What Drove Strong Portfolio Performance in First Half

And can that be repeated? The best performing portfolios were overweight equities, including international stocks, leaving them with a higher risk profile

International equities, including emerging markets, actively managed stock funds and growth stocks were key drivers of the relatively strong performance of investment portfolios in the first half of 2017, according to the latest Natixis Portfolio Trends Report.

(Related: Advisors Focus on Markets and Downside Protection: Fidelity)

The average moderate-risk model portfolio gained 6.8% in the first half, outperforming the traditional 60/40 portfolio split between the S&P 500 index and Bloomberg Barclays U.S. Aggregate Bond Index by 0.30%, and portfolios favoring active managers outperformed by 0.26%.

(Related:Are Stocks Overvalued or Poised for More Gains?)

A 13% allocation to international equities drove 31% of portfolio returns, and the top quartile of moderate-risk portfolios outperformed bottom-quartile portfolios by more than 3%, due in large part to the higher level of active management among top quartile performers.

“High exposure to U.S., international and emerging market equity was the key to success in the first half of 2017 coupled with lower allocations to fixed income and alternatives,” according to the report. Commodities were the only asset class that lost money in the first half. 

“The portfolios that fared best were overweight equities and geographically diversified, but that leaves them now with a high degree of market risk,” says Marina Gross, executive vice president of Natixis’ Portfolio Research and Consulting Group.

She expects the general trends of the first half will continue in the second half though returns won’t be as strong. “I have a hard time expecting the S&P 500 will add another 10% and emerging market stocks another 20%.”

Gross suggests that investors remain in equities but be prepared for a potentially material rise in volatility and offset some market risk by adding alternative investments.

(Related: Why Gold Is Trouncing Stocks This Year)

“We don’t know when the tide will turn,” says Gross. “We’re talking with our clients about diversifying, not dismantling,” says Gross, and adding alternatives such as precious metals, real estate and managed futures for more aggressive long-term portfolios and long/short fixed income strategies, options and market neutral strategies for more moderate portfolios.

Geopolitical risks and Fed policy behoove "some risk mitigation and diversification in portfolios," says Gross. 

She also suggests that U.S. based investors keep an eye on the U.S. dollar because gains in the greenback will reduce returns for non-dollar-denominate foreign assets. (A weaker dollar helped boost gains in international equities during the first half.)

In recent months Natixis stopped adding to allocations in foreign stocks and increased U.S. equity exposure in model portfolios. (In the latest quarter U.S. corporate earnings growth were the strongest in nearly six years.)

Natixis is also keeping a close eye on the default rates in high yield, whose spreads to investment-grade bonds have narrowed.

In addition to strong performance, portfolios in the first half saw average fees falling to 84 basis points, down from 65 basis points three years ago, due to declining fees for active management and growing use of cheaper passive products, according to the Natixis report.

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