Barometer: Analyzing Q1 portfolio trends

The first quarter's portfolio trends report was a cliffhanger, as it ended two days before President Donald Trump's “Liberation Day” tariff announcement. While some allocation shifts appeared to anticipate tariffs, we must wait until June 30 to see the evidence of more permanent positioning. Much of the quarter was clouded by the uncertainty of the who, when and how much surrounding these levies, questions that remain largely unresolved.

During this period, we observed heightened correlations among asset classes, attributable to systemic risk and investor behavior, as market participants sold off assets simultaneously. This behavior increases the interconnectedness among asset classes and can reduce portfolio diversification benefits. The first quarter reminded us of the importance of diversifiers, particularly alternatives. Against this backdrop of rising correlations, we view asset classes with diversification properties as being even more attractive. 

Equities: US still in favor

We saw domestic US equity allocations among the group of surveyed portfolios remain elevated relative to historical levels, comprising 82.8% of the total equity portion of the portfolios in our survey. This increase was primarily funded by reallocations from emerging markets, as the onset of the trade war caused significant disruption for asset allocators.

Determining the "correct" international equity portfolio allocation remains an ongoing exercise, with strong opinions on all sides. For some, their baseline exposure aligns with global passive indexes, while others prefer a zero exposure to non-US equity. Our survey suggests that others arrive at an allocation subjectively, based on client preferences and comfort levels.

Non-US equity: Finding its footing

Despite strong performance in the asset class, allocations to developed international equity declined slightly, led by international large value. At the start of 2025, allocators reduced their exposure to international equity as they anticipated rising tariffs-related volatility. In the same vein, emerging markets allocations reached their lowest recorded level in recent periods at 2.2% despite positive returns for EM indexes for the quarter.

Historically, changes in international equity regions have primarily occurred in Asia-Pacific, Europe and North America (ex-US) within our analyzed portfolios. In the period, European allocations increased, supported by positive performance and a declining dollar, while Asia-Pacific allocations experienced a sharp decline.

Changes within style and capitalization allocations

Allocations to large-cap growth declined by two percentage points in the first quarter, as large-cap growth stocks were hardest hit by tariff threats.. Similarly, allocations to large-cap value equity decreased by one percentage point, while large blend (core equity) allocations increased by one percentage point. Each of these changes in allocation aligned with market performance over the quarter.

On the one hand, mid-cap allocations in model portfolios remained elevated, with no changes observed over the quarter. On the other, small-cap allocations saw a significant increase across all styles, as investors seemed to anticipate the next phase of the “Trump trade” and a renewed emphasis on reshoring.

Tech took a hit

In recent quarters, we observed investors buying the dip in technology stocks. However, this trend was not apparent last quarter, as allocations to technology (the largest sector in many growth indexes) declined 1.7 percentage points. This will be something to monitor. 

Conversely, allocations to financials, the largest sector in many value indexes, increased from 14.4% to 16.2%, driven by the relative attractiveness and strong performance of this segment in the quarter. Improved lending margins, defensive sector rotation amid market volatility, and economic resilience reflected in a stable labor market were among the factors that supported this trend. Additionally, persistent inflation and renewed geopolitical tensions caused a flight to value. Industrials were also beneficiaries of this.

Fixed Income: Duration remained stable

Duration positioning in moderate risk model portfolios remained stable throughout 2024 and into 2025. Despite the Federal Reserve cutting rates by 100 basis points in 2024, model portfolio durations increased by only 0.05 years in the first quarter of 2025. This slight change occurred as the Fed paused rate adjustments, awaiting further clarity on the impacts on jobs and inflation of tariffs, federal spending cutbacks and immigration policy.

Allocations to investment grade credit decreased in the period. In contrast, high-yield allocations rose, coinciding with a widening of high-yield bond spreads. Our survey suggests that investors viewed this as an opportunity to add to the asset class. 

High-yield spreads versus equivalent Treasury bonds had gradually decreased throughout 2024, bottoming at 2.54% in November and finishing the year at 2.96% on December 31. By March 31 of this year, spreads had widened to 3.68%.

Sector positioning adjusted to the new landscape

Fixed-income sector allocations saw incremental change from the fourth quarter of 2024 to last quarter within model portfolios. US Treasury, asset-backed security (ABS) and corporate bond allocations increased, while cash equivalents and "Other" sectors decreased. Specifically, positioning of US Treasuries rose from 23.6% to 24.8% among our surveyed portfolios, corporate bonds from 27.3% to 28.8% and ABS from 9.1% to 11.0%. At the same time, cash equivalents dropped from 7.0% to 6.6%, and Other sectors fell from 5.2% to 4.0%.

The Federated Hermes Portfolio Construction Solutions team regularly analyzes a group of advisor-built, moderate-risk model portfolios. This information provides a barometer of market sentiment and serves as a benchmark for allocation comparisons. These portfolios have a mix of 50/50 to 70/30 equity/fixed income allocations, which includes the classic 60/40 split.