Barometer: Analyzing Q3 portfolio trends Barometer: Analyzing Q3 portfolio trends http://www.federatedhermes.com/us/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedhermes.com/us/daf\images\insights\article\barometer-change-small.jpg November 11 2025 November 12 2025

Barometer: Analyzing Q3 portfolio trends

Optimism holds, reinforced by caution
Published November 12 2025
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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. Moderate-risk portfolios have a mix of 50/50 to 70/30 equity/fixed income allocations, which includes the classic 60/40 split.

The analysis also includes the measurement of cross correlations, the correlation between every pair of investments in a portfolio. Cross-correlation analysis can help advisors determine how effective their portfolio diversification strategies are. A low correlation score — portfolio holdings with low cross correlations — is indicative of a portfolio with the potential to be more resilient in different market environments. 

In this latest of their quarterly updates, our Portfolio Construction Solutions team examines how advisors have adapted their sector and asset allocations 

Risk on or off?

The noise-to-news ratio remained high during the third quarter, as many issues of concern to investors in the second quarter carried over. The familiar litany of 'concerns' includes inflation, market concentration, valuation, interest rates and tariffs. To which, perhaps, you can add China, credit concerns and the price of gold. There seemed to be an ever-expanding list, none of which halted the rise of markets in the US or globally during the quarter. 

In our examination of third-quarter portfolios, three things stood out to us:

  • Cross-asset correlations continued to decline, a trend briefly interrupted by tariff uncertainty earlier in the year. This can be partly attributed to 2022, a year of high correlations, falling off the measurement period.
  • Large cap equity allocations declined meaningfully in 3Q25, from 67% to 63%.
  • Fixed income durations fell from 4.89 to 4.23 years.

Portfolio dynamics: Markets do their jobs

One of the goals of portfolio construction is to lower overall portfolio volatility and increase portfolio efficiency by combining assets with low correlation to each other. Portfolio cross-asset correlations in our analysis have declined over the last one and three-quarters years, from 0.69 to 0.50, as international equities and fixed income returns diverged from broader US market movements. From this, one could infer that both advisors and markets are correctly doing their jobs. 

Global equity: Allocations still favor US, while global market performance holds

Strong global performance was apparently not sufficient motivation for advisors to shift the US/non-US mix meaningfully. The MSCI EAFE index is up 25.7% through 9/30/25 vs. 14.1% for the S&P 500. Domestic equity allocations remained relatively stable in 3Q25 at 82.0%, and developed international equity allocations remained steady at 15.1%, a slight decline from the previous quarter. The relative stability, despite strong performance, suggests that advisors maintained a cautious stance amid global uncertainties. If strong returns persist, we could see classic return-chasing behavior among investors.

Caution was evident, as well, in emerging markets allocations, often an indicator of risk-on/off trades. These reached their lowest recorded level in 1Q25 since the inception of our trends analysis, at 2.2%. This level rebounded in 2Q25 to 3.0% and then leveled off at 2.9% in 3Q25 despite the strong performance for the MSCI Emerging Markets Index throughout the year, up 28.2% through 9/30/25.

Style, capitalization and sectors: A reallocation out of large caps 

While we saw global equity allocations shift at the margins, large cap allocations declined meaningfully in the third quarter, as advisors positioned for a market broadening, the presumed result of the widely anticipated interest rate cutting cycle by the Federal Reserve. The most notable decrease came from large cap value allocations, which fell two percentage points quarter-over-quarter, while large blend and large growth allocations each decreased by one percentage point. 

One beneficiary of this decrease appears to be mid-cap stocks, whose allocations in model portfolios increased by 2% to 25%, while maintaining a modest value tilt.

Small-cap allocations remained range-bound between 10% and 12%. In 1Q25, investor enthusiasm around re-shoring — driven by tariff implementations by the Trump Administration — boosted sentiment for smaller-cap companies. However, that excitement faded in 2Q25 as tariffs appeared to serve more as a bargaining tool amid ongoing trade negotiations. Advisor sentiment toward small caps was reinvigorated in 3Q25, following dovish commentary from the Federal Reserve.

Changes in equity sectors were minimal in 3Q25, except for reductions in value-oriented sectors such as financials and healthcare. We interpret advisor allocations to these sectors as a byproduct of reduced exposure to the large value segment, rather than a targeted sector rotation. 

More notable was what didn’t happen. In the past, we have observed clients actively buying the dip in technology stocks. However, this behavior did not persist in 2025. While most advisors have firm views on technology stocks, positive and negative, we observed technology allocations in advisor models level off in the summer of 2025.

Fixed Income: Durations shorten

Over the last year duration positioning in moderate model portfolios has been markedly shorter than both the benchmark index fund portfolio and our internal PRISM® committee allocations. This could be explained by several factors, but perhaps most easily by the fact that clients and their advisors felt that there was insufficient compensation for going too far out on the curve, as shorter-term yields continued to remain attractive relative to duration risk. 

We saw a marked drop in portfolio duration this past quarter, as the average duration decreased sharply from 4.89 to 4.26 years, following the first notable uptick in duration in 2Q25 since the second quarter of 2024. The reduction in portfolio duration appears to be driven in part by advisors reallocating into shorter-duration products, rather than signaling a broad call to shorten duration. This shift reflects a tactical move toward the front end of the curve, where advisors see more compelling opportunities than in cash and core/core plus.

The road ahead

The current portfolio positioning appears to reflect the underlying caution that is supporting a record-setting market. Shifting out of large cap, stability in non-US exposure, wariness toward technology and lower durations seem to be indications that advisors and their clients are taking prudent steps in portfolio construction, given an equity market that has risen over 20% annually over the last three years.

For more from the Portfolio Construction Solutions Team, please read their white paper on a simple approach to constructing a strategic fixed income sleeve.

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DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Diversification and asset allocation do not assure a profit nor protect against loss.

Effective Duration: A measure of a security’s price sensitivity to changes in interest rates. One of the methods of calculating the risk associated with interest rate changes on securities such as bonds.

Prices of emerging market securities can be significantly more volatile than the prices of securities in developed countries, and currency risk and political risks are accentuated in emerging markets.

Mid-capitalization companies often have narrower markets and limited managerial and financial resources compared to larger and more established companies.

Growth stocks tend to have higher valuations and thus are typically more volatile than value stocks. Growth stocks also may not pay dividends or may pay lower dividends than value stocks.

International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards.

Large-cap companies may have fewer opportunities to expand the market for their products or services, may focus their competitive efforts on maintaining or expanding their market share, and may be less capable of responding quickly to competitive challenges. The above factors could result in the share price of large-cap companies lagging the overall stock market or growth in the general economy, and, as a result, could have a negative effect on the fund's portfolio, performance and share price.

MSCI Europe, Australasia and Far East Index (EAFE) is a market capitalization-weighted equity index comprising 21 of the 48 countries in the MSCI universe and representing the developed world outside of North America. Each MSCI country index is created separately, then aggregated, without change, into regional MSCI indices. EAFE performance data is calculated in U.S. dollars and in local currency.

The MSCI Emerging Markets Index was created by Morgan Stanley Capital International (MSCI) to measure equity market performance in global emerging markets.

Small company stocks may be less liquid and subject to greater price volatility than large capitalization stocks.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Stocks are subject to risks and fluctuate in value.

Value stocks tend to have higher dividends and thus have a higher income-related component in their total return than growth stocks. Value stocks also may lag growth stocks in performance at times, particularly in late stages of a market advance.

PRISM® is a registered trademark of FII Holdings, Inc., a subsidiary of Federated Hermes, Inc.

The value of investments and income from them may go down as well as up, and you may not get back the original amount invested. Past performance is not a reliable indicator of future results. 

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