Natixis Global Asset Management’s year-end review of financial advisors’ moderate-risk model portfolios showed that markets rewarded a completely different set of asset allocations in the second half of 2016 than in the first half.
The volatile first six months of the year, concluding with the U.K.’s Brexit referendum, favored portfolio diversification, but U.S. investors who owned more higher-risk assets ultimately outperformed their peers during 2016.
The fourth quarter 2016 U.S. Trends Report, produced by Natixis Portfolio Clarity, was based on the asset allocations and performance of 286 moderate-risk model portfolios U.S. financial advisors submitted to the consultant team for review during the second half of 2016. These portfolios were among a broader sample of 2,495 portfolios submitted from January 2013 through December 2016.
The analysis found that the average portfolio gained 4.3% in the first half, when the best-performing portfolios were diversified with holdings that helped offset equity market volatility, including precious metals, international government bonds, emerging market debt and commodities.
In contrast, the average portfolio rose 3.8% in the second half when the best performers had larger allocations to U.S. high-yield debt and equities — especially small caps — and less exposure to interest-rate-sensitive bonds.
As well, there was a wider performance variation between portfolios in the second half than the first half. The best-performing quartile outperformed the bottom quartile by 4.1%
“The dichotomy we saw in the markets in 2016 illustrates why durable portfolios are so important,” David Giunta, chief executive for the U.S. and Canada at Natixis, said in a statement. “Investors should build portfolios geared toward their long-term goals and risk tolerance so they are prepared when volatility strikes.”
Active Management Outperforms
According to the Natixis report, investors steadily increased their fixed income allocations in 2016 to 31% at year-end, up 2.7% year over year and the highest level since the second quarter of 2013.
Investment in categories less sensitive to interest rates — mainly multi-sector bonds, high-yield debt and bank loans — drove the increase as investors positioned their holdings in anticipation of rising interest rates.
The shift to a rising-rate environment early in the second half favored active managers in the intermediate-term bond fund category, Natixis said. Some 90% of actively managed funds in the category outperformed comparable index funds by an average of 1.15% since midyear.
In the previous three-year period, index funds in the category bettered active strategies by a total of 0.14%, on average, and received 130% of net fund inflows.
Active management’s “comeback” notwithstanding, one observer says it never went away.
Whereas fixed income allocations increased in 2016, all other asset classes were relatively flat or fell compared with year-end 2015:
- Equities: 52%, down from 52.9%
- Asset allocation funds: 7.2%, down from 7.6%
- Alternative assets: 5.5%, down from 6.9%
- Real estate and commodities: 2.1%, up slightly from 1.8%
- Cash: 2.2%, down slightly from 2.5%
Although allocations to alternative investment funds were down last year compared with 2015, they rebounded by 0.5% from the end of the third quarter. Natixis said this illustrated two continuing trends.
For one, allocations within the alternatives category continue to shift from return generation to risk reduction.
At the end of December, 70% of alternative allocations in the moderate model portfolios were in risk-mitigating strategies — managed futures, market neutral, option writing and longshort credit — compared with 30% four years ago.
For another, option-writing funds were the fastest-growing alternative category, accounting for 31% of alternative allocations, as advisors sought bond alternatives.
“Investors concerned about potential volatility brought on by rising rates, valuations, central banks and geopolitical risk would do well to remember the lessons of a year ago,” Marina Gross, executive vice president of Natixis’ portfolio research and consulting group, said in the statement.
“Though a rising tide lifted many investors in the second half of 2016, the heightened volatility of the first half is much more typical and favors broad diversification.”