Barometer: Analyzing Q2 portfolio trends

Our First Quarter Trends Report measurement window closed shortly before President Trump's April 2 “Liberation Day” tariff announcement, just as anticipation for that announcement was building. Instead of easing market uncertainty, the announcement triggered a multi-day global sell-off and has remained a central driver of market activity this year, as questions persist over the impact of the administration’s trade policy.

Uncertainty, meet Diversification

Following the "Liberation Day" announcement, we witnessed a steep decline in portfolio correlations, as international equities and fixed income assets began to decouple from broader US market trends. This shift contrasts with the elevated cross-asset correlations observed in prior quarters, which were driven by systemic risk and synchronized investor behavior. Significant volatility marked the first four months of the year, particularly in US growth stocks, which struggled before staging a strong rebound in May and June. The “Liberation Day” tariff announcement and escalating trade tensions at the start of Q2 introduced fresh uncertainty, prompting advisors to shift towards a risk-off approach. As a result, the typical co-movement between asset classes and sub-asset classes weakened, enhancing potential diversification benefits.

Another notable trend was how sensitivity to the broad-market S&P 500 declined noticeably in Q2 2025 across moderate portfolios, driven by a general decline in beta from within sub-asset classes outside of domestic large cap equity. This reduction coincided with widening credit spreads following the tariff announcement in early April. Since the inception of our trends analysis, the second quarter’s portfolio beta of 0.52 was the lowest on record.

In our last report, we wondered aloud how much of the Q1 allocations were due to tariff anticipation versus other factors. Entering the quarter, the 17.2% strategic allocation to non-US developed market equities in the average advisor portfolio was well below what our in-house allocation team (PRISM^®) and many other models recommended. While many investors were unlikely anticipating a 7% decline in the dollar's value in Q2, a 17.2% allocation should have been sufficient to achieve much of the diversification benefit of holding non-US assets. A higher exposure to non-US dollar assets would have benefited portfolios further during the decline in the dollar. By quarter’s end, non-US assets represented 18.3% of equity portfolios.

Global equity: Still favoring the US

Again, global equity markets saw increased idiosyncratic risk as investors first tried to understand Trump's tariff proposal and then its impact on the markets. In a quarter that saw the S&P 500 decline over 10% and then rebound by over 25%, US equity allocations reverted towards longer-term averages, finishing Q2 with an average allocation of 81.8% within moderate portfolios, versus 82.8% the prior quarter. Many factors may have contributed to the decline in domestic equity allocations, but the weakening US dollar boosted non-US assets, and those allocations increased by comparison. 

Emerging Markets allocations also ticked higher in Q2 after reaching their lowest recorded level since the inception of our trends analysis in Q1 2025. This is likely a combination of a weak dollar, an oversold asset class and a fundamentally sound backdrop for many EM countries.

In Q2 2025, allocations to Europe held steady compared to Q1, while allocations to Asia-Pacific rebounded significantly following a sharp drop in the first quarter. Asia-Pacific allocations ended the quarter in line with longer-term averages.

Equity style and capitalization: Cool on large cap growth

Equity style and capitalization are measured at the individual security level using actual fund holdings, which provides a more holistic view than fund category or "style pure" analysis. What we saw in these areas was likely a conjunction of short-term and long-term trends. 

Despite what was ultimately a strong quarter, advisors are apparently wary of the large cap growth story, which has seen risk concentrate in an ever-smaller group of companies. The average large cap growth allocation stabilized at 17%, following three consecutive quarters of decline, indicating that advisors may be diversifying their risk exposure away from some of those larger names. Many may already have rebalanced in prior quarters due to real or perceived market volatility, a sense that those stocks were overvalued or just general profit-taking. Meanwhile, having performed well through the first five months of the year, allocations to large cap value saw a notable increase, rising from 19% to 22%. Large blend allocations edged down slightly by one percentage point to 28%.

Because our analysis looks at portfolios at the holdings level, exposure to mid-cap —which has a fluid definition — can come from small cap managers holding on to winners or large cap funds seeking value, in addition to mid-cap funds. Mid-cap model portfolio allocations remained at 23% for the third consecutive quarter, while remaining relatively balanced between value and growth. 

Small cap allocations have remained rangebound between 10% and 12%. In Q1 2025, investors anticipated re-shoring due to tariff implementation from the Trump Administration, but re-shoring excitement subsided as tariffs appeared to be a bargaining chip and investor enthusiasm cooled as negotiations went on.

Equity Sectors: No chips and dip

Changes in equity sectors were minimal in Q2. In the past, we've observed clients buying the dip in Information Technology stocks – but this trend did not hold in either Q1 or Q2. We believe this may be because President Trump's tariffs and company-specific comments may have introduced unforeseen headwinds for mega-cap technology companies. Despite a 23% rally in the S&P Information Technology sector during Q2, few advisors increased their exposure to the space within their model portfolios. We view this as another indication that advisors may be seeking to diversify away from the heavy concentration of technology stocks in many major indexes.

Meanwhile, Health Care and Energy posted the weakest performance among S&P 500 sectors, yet these areas' allocations remained unchanged. Advisor allocations to Financials continued to rise in Q2 and we see this as a side-effect of increases to the Large Value segment, rather than a deliberate sector shift. Volatility and uncertainty dominated the first half of Q2, while the second half was marked by cautious positioning amid unresolved macro risks.

Fixed Income: Moving out the yield curve

While duration positioning in moderate risk model portfolios held steady throughout 2024 and into early 2025, the second quarter marked the first notable uptick in duration since the same period a year earlier. Lengthening portfolio duration is a risk diversifier, and appears to reflect advisors' response to heightened equity market volatility, geopolitical uncertainty, and increasingly attractive yields on the long end of the curve in the face of potential Fed rate cuts. We saw the increase in duration as the result of a broader move toward higher-quality fixed income exposures within portfolios.

Investment-grade credit allocations also ticked higher in the quarter, coinciding with a sharp intra-quarter widening, and subsequent re-tightening, of high yield spreads. Throughout 2024, spreads ground lower, bottoming at 2.54% in November and finishing 2024 at 2.96% on December 31, 2024. By March 31, 2025, these spreads had widened to 3.68%. As "Liberation Day" tariffs were announced, spreads had widened to 4.86% by April 7, before cascading to 3.05% by June 30, 2025.

The road ahead

Uncertainty comes with the territory. But what's clear is that markets have entered a new phase, and investors are actively adjusting. Managing risk exposures becomes crucial in times of uncertainty—but recognizing and addressing unintended risks is even more critical. Throughout the year, we've seen how diversified asset exposure can enhance portfolio resilience, even amid unexpected volatility.

For more from the Portfolio Construction Solutions Team, please read the white paper on dividend strategies and portfolio construction.

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.