Does your equity portfolio have core fitness?

Niall OSullivan , Global Solutions Chief Investment Officer and Rich Dell, Head of Equities

For even the longest-term investors, the upcoming new year provides a valuable opportunity to pause and reflect. Many of the investors we work with are currently looking to prepare for 2025 by conducting a deep review of their portfolios.

Active management in equity markets has been a particular area of focus. The challenge investors face is equity markets themselves sometimes defy conventional investment thinking. Over the past five years, many of the traditional principles deployed in building equity exposures have not delivered, which has had a knock-on effect on active management performance.

When returns are being driven by “core” parts of the market that conventional wisdom might warn you to avoid, tilting too far towards alpha generation can lead to missed returns.

Equity returns in unusual times

As we have noted, a number of cyclical factors have coincided in recent years that have challenged traditional equity investing principles and served to make alpha generation more challenging.

The levels of stimulus pumped into the global economy in the wake of the global financial crisis, and the extremely low interest rate environment that followed, had a significant impact on equity markets. The low cost of borrowing benefited future cash flows over current, and arguably buoyed companies that might otherwise have failed and weakened the link between company fundamentals and share prices.

The continued evolution of tech enabled platforms and the benefits of networks also saw market returns dominated by a small number of mega cap tech companies, the so-called ‘Magnificent Seven’. Then, as interest rates rose, artificial intelligence emerged as an equity market theme, boosting the Magnificent Seven further.

History shows, that the largest stocks seldom hold top positions in the index over the long term. However, the volume of sell-side coverage may have made it difficult to reach a differentiated view, and the sheer size of the companies has made some managers reluctant to hold large positions in these companies.

Finally, the significant macro events of the last five years, from the pandemic and reopening post-lockdowns, to rising geopolitical risks and supply side imbalances, have increased the variation in equity market returns. In these conditions, top-down positioning can outweigh stock fundamentals as a driver of returns, making alpha from stock selection more difficult to achieve.

Adapting your equity portfolio

There may be areas of the market that look particularly attractive through a traditional lens of valuation, quality, or growth. However, if you only allocate to those areas, you can easily miss a chunk of the benchmark. This can lead to missed returns, especially when benchmarks are very concentrated or risks are highly disparate, both of which have been the case in recent years. It is therefore important to ensure you can still capture the core to benefit from the returns driven by what might appear to be “unattractive” parts of the market.

Alongside this, clients we work with conduct regular “portfolio health assessments”, which include reviewing investment objectives against risk tolerance, time horizon and portfolio structure, ensuring diversification and reviewing manager research and selection frameworks, as well as ongoing risk monitoring and management.

Many of the cyclical headwinds to alpha generation will dissipate with time, but it is not possible to know exactly how the landscape will evolve. With this in mind, it is important to stay attuned to market dynamics and ensure that your portfolio’s ‘core’ remains strong.

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