Making Sense: Q1 Portfolio Positioning

Making Sense

Q1 Investment Philosophy and Positioning

Recorded: January 23, 2025

Amy: Hi. I'm Amy Thomas, a strategist here at First Citizens Bank. On January 23, 2025, Phil Neuhart, Director of Market and Economic Research, and Thomas O'Keefe, Managing Director of the Capital Management Group, discussed the investment philosophy driving our portfolio strategy for Q1.

As always, the information you're about to hear are the views and opinions of only the authors at the time of recording and should be considered as educational purposes only. None of this information should be considered as tax, legal or investment advice.

Phil: Thomas, thank you so much for joining us today. We plan to have a quarterly discussion on the Capital Management Group's allocations going forward. But given this is our first time sitting down together, why don't you take a moment to outline your role at First Citizens Wealth?

Thomas: Yeah, great. Thanks for having me, Phil. It's great to be here. So I'm a managing director within our Capital Management Group. I come to us—to First Citizens—from Silicon Valley Bank through the acquisition in 2023, and I'm generally responsible for high-level investment strategy, communications and partnerships.

As a quick refresher to our listeners, the Capital Management Group here at First Citizens sits within our wealth management group, and we're responsible really for allocating and investing client assets. We've got over 30 folks spread out across the country, all of which are here to help drive successful outcomes for our clients.

Phil: That's great information, Thomas, and we're certainly happy to have you on the team. So now let's turn to positioning. From a portfolio allocation perspective, what do you see as our key under- and overweights?

Thomas: Yeah, absolutely. First as a backdrop, our allocation process we run at a minimum four times each year. Now, certainly, we can do that more frequently if the particular environment situation commands that we should do that. But, generally, we're looking at our portfolios—and our allocations within those portfolios—on a quarterly basis.

Now the process is really foundationally data-driven, which really means that the team is collecting massive amounts of data, and then it is analyzing that data with the goal of really trying to find predictive value of that historical data for potential future returns.

Now, currently, we have our largest overweights in US growth—this is across all capitalizations —and international small cap, which is a satellite holding for us. We also have a very small overweight in long-duration Treasuries. This sits within our risk-managing sleeve. Our largest underweights are in US value and in emerging markets.

Phil: So let's dig into some of those specific positions. You mentioned being both overweight developed-international equity, while underweight emerging-market equity. Would you mind digging into some of the reasons for those allocation decisions?

Thomas: Yeah, that international equity overweight is primarily due to the international small-cap allocation that I mentioned earlier.

Really, we live in an environment where valuations are high across all asset classes—historically high. But what we found through our data is that the international small-cap space presents a more interesting and attractive relative price opportunity for us that hopefully will suggest elevated forward-expected returns.

We also see in some of the other data some potential reversion to the mean scenarios, where there could be a reversal in price based off of the history of what that particular asset class has done.

In emerging markets specifically, we see a very different story. We see valuations are quite elevated, especially compared to its own history, and we think these high valuations are actually weighing down our future expectations.

There's also some strong macro headwinds, and this shouldn't be a surprise to anybody out there. We see those headwinds in places like global trade, economic fundamentals, some governmental instabilities and generally the index has a very large concentration to China.

These are all things that we think are potentially changing with the new administration, but we continue to monitor as a headwind at this point. All of this can put downward pressure on what our models think the forward-looking returns could be for these particular asset classes.

Phil: That makes a lot of sense, Thomas. Now let's turn to the US. Over the past 2 years, there has been a lot of focus on the dominance of large-cap growth, particularly the Magnificent Seven. You pointed out the continued overweight to large-cap growth equity. What are some of the underlying fundamentals driving that decision?

Thomas: Yeah, let let's first put some perspective on what you just said. The US large-cap growth asset class has dominated over the past 5-plus years. In Q4 of 2024, it was the only positive performing asset class in December. And in the full year for 2024, it gained 35%.

The next best performing asset class—mid-cap growth—underperformed that by 13%. So just to put into perspective how incredible the US large-cap growth space has been and how well it has performed.

That recent run-up obviously should create some concern around valuations and how high those valuations are within that particular segment. What we have found through our data is that US large-cap growth actually happens to be less sensitive to valuation in its expected future returns than all other asset classes.

What this really means is that those high prices that we see have had less of an impact on the returns that we expect going forward. It also means that corporate and economic fundamentals have a higher impact on those particular returns.

So for now the fundamental backdrop for US growth equities is solid. I'm not saying it's great. I'm not saying it's poor. What I'm saying is it's solid, which means that this is a particularly good thing from a data perspective.

We would start to get particularly concerned if we saw elevated positive data coming through. This is where we start to want to go into our "sell high, buy low" mentality, and we would start to then potentially think about an underweight to that asset class. We don't believe that we're there yet.

It's also important to note that we never actually look at an asset class in isolation. We're currently underweight US value, but we're overweight international developed. Both of these asset classes actually have very similar characteristics, but the difference being that international developed equities have a much lower valuation multiple, than does US value.

So the reason why this is important is because our US growth overweight is actually balanced out a bit by our overweight to international developed equities.

Phil: So let's turn away from the return generating portion of portfolios to the risk-managing allocation. Would you mind speaking to the small allocation to longer duration Treasuries in addition to our core allocation to aggregate bonds?

Thomas: Yeah, absolutely. Like you said, Phil, we take a very core approach to our risk-managing sleeve, which is why we start with our aggregate bond position. We see an opportunity within the current environment to extend the duration of that particular portfolio.

Now the yield curve began to steepen at the end of 2024, which I'm sure most of you saw, and this was providing a very strong real yield—relative to long-term inflation expectations. So now you might be asking yourself, in 2024, in the current yield environment that we had, we probably—that position detracted from our overall performance, and you'd be correct.

Being longer duration did not actually add a lot of value in 2024. But we still see a lot of opportunity going forward, in the long-duration position, particularly around a high real yield—so think the interest earned on those bonds—and also the potential for lower absolute yields. So as rates decrease, we should be getting higher prices on those particular bonds. So we think that there is a real yield and a price-appreciation potential for this particular longer-duration position.

We do though acknowledge that there could be some volatility in the short run. It is very hard to predict timing on this, but we think over time, this will be a good positioning for our overall client portfolios.

Phil: For sure. Thomas, thank you so much for your time today. This was great. I look forward to doing this on a quarterly basis going forward, so until next time.

Thomas: Thanks for having me.

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Authors

Phillip Neuhart | SVP, Director of Market & Economic Research

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

Phillip.Neuhart@FirstCitizens.com | 919-716-2403

Thomas O'Keefe, CFA, CAIA | Managing Director

Capital Management Group | First Citizens Bank

222 Second Street | San Francisco, CA 94105

TO'Keefe@SVB.com | 408-761-6592

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