Performance Commentary

Highlights

• Portfolios with higher allocations to domestic, large-cap, and growth equities significantly outperformed their peers over the past year.
• A strategic focus on domestic large-cap equities and municipal bonds drove superior performance over the past three years.
• Strong U.S. market performance led portfolios emphasizing domestic large-cap equities to consistently outperform over the past seven years.
• Longer-duration bonds enhanced fixed-income performance over the past year.
• High-yield bonds drove fixed-income outperformance over seven years.

Backdrop

The S&P 500 Index rose by 5.89% in the third quarter of 2024, hitting new all-time highs after a brief summer sell-off in risk assets. Value stocks led the index higher, with small-capitalization companies outgaining their large-cap counterparts. The shift in leadership is a healthy development and a key sign of broadening participation beyond the Magnificent Seven stocks. Additionally, economic data is signaling a soft landing. The Federal Reserve Open Market Committee (FOMC) lowered the federal funds rate by 50 basis points at their September meeting, bringing the target range to 4.75% – 5.00%. Jerome Powell, the Chairman of the Federal Reserve, emphasized the balance of the institution’s dual mandate as inflation readings approach their target 2% level and the labor market remains generally stable as pandemic-era tightness abates without spiking unemployment.

The recalibration of monetary policy is met with data supporting that a soft landing is in sight, such as the most recent U.S. GDP report from the Bureau of Economic Analysis that topped economists’ estimates. To achieve the soft landing, the FOMC wants to ease financial conditions to ensure the labor market does not weaken further while stimulating economic growth. Market participants are pricing in another 50 basis points of cuts across the final two Fed meetings of 2024.

International equities outperformed domestic equities in the third quarter of 2024. The MSCI EAFE Index returned 7.37% in the quarter, while the MSCI Emerging Markets Index returned 8.86%. China’s economic woes of a struggling real estate market, dismal stock market performance, high youth unemployment rates among recent graduates, and fears of deflation led to an unprecedented all-in government response. The comprehensive plan was met with investor enthusiasm to end the quarter.

In fixed-income markets, the third quarter brought a tailwind following the long-anticipated FOMC decision to cut the federal funds target rate. Bond prices rallied into quarter-end and delivered a strong total return for the period as the Bloomberg U.S. Aggregate Bond Index posted a 5.20% gain. The U.S. 10-year Treasury finished the quarter more than 60 basis points lower at 3.81%. Investment grade outperformed high-yield credit in the third quarter.

Large-Cap Domestic Growth Drives One-Year Performance for TD Automated Investing, Betterment Climate Impact SRI, and Merrill Guided Investing SRI

Over the past year, TD Automated Investing, Betterment Climate Impact, and Merrill Guided Investing have emerged as top performers in terms of overall portfolio returns, as allocations to large caps, domestic, and growth equities have all played large roles.

Growth stocks played a pivotal role during the period, with the Russell 3000 Growth Index delivering a remarkable 41.46% return, significantly outpacing the Russell 3000 Value Index’s 27.62% gain. Betterment’s climate impact strategy and Merrill Guided Investing maintained slightly above-average allocations to growth stocks, with exposures of 30% and 29%, respectively, while TD Automated Investing held an average weight of 27%. SoFi emerged as a top performer in the equity category, benefiting from its high allocation to growth stocks; its portfolio has 41% allocated to growth compared to an average of 27% for the robos we track. These strategic allocations allowed them to capitalize on the robust performance of growth sectors during this period.

Large-cap stocks significantly outperformed small-cap stocks. The Russell 1000 Index, representing large-cap equities, returned an impressive 35.66%, overshadowing the Russell 2000 Index’s 26.74% return for small-cap stocks. Betterment stood out with an 84% allocation to large-cap equities, substantially higher than the average robo-advisor allocation of 69%. TD Automated Investing also exceeded the average with a 78% allocation, while Merrill matched the average at 69%. This emphasis on large-cap stocks allowed these portfolios to capitalize on the strong performance of market leaders.

Domestic equities outperformed international markets, with the S&P 500 returning 36.33%, outpacing the MSCI EAFE Index’s 25.46% return. Merrill and TD Automated Investing had substantial domestic equity exposures of 75% and 73%, respectively, both surpassing the average robo-advisor allocation of 67%. This strategic positioning in domestic markets contributed significantly to their overall performance. Betterment, with a 61% allocation to domestic equities, also benefited, although its exposure was slightly below the average.

On the fixed income front, longer-duration bonds yielded better returns than their shorter-duration counterparts. The Bloomberg Long Term US Treasury Index returned 15.43%, compared to a 5.67% return for the Bloomberg Short Term Treasury Index. Citi Wealth Builder and Edelman Financial Engines, two of the best performing fixed income portfolios, excelled by maintaining higher portfolio durations of 6.27 and 6.73, respectively. Their emphasis on longer-duration bonds enabled them to outperform in the fixed income category.

Domestic Equities and Municipal Bonds Drive Three-Year Performance for Zacks Advantage, Wealthfront, and Fidelity Go

Over the past three years, Zacks Advantage, Wealthfront, and Fidelity Go have led in performance. Their success is largely attributed to strategic allocations favoring domestic large-cap equities and municipal bonds, aligning with market trends that favored these asset classes.

In the equities sector, domestic stocks significantly outperformed international markets. The S&P 500 Index delivered an impressive annualized return of 11.88%, surpassing the MSCI EAFE Index’s 6.11% for developed international markets and the MSCI Emerging Markets Index’s 0.76%. Zacks Advantage stood out with an 83% allocation to domestic equities, well above the average robo-advisor allocation of 67%. Wealthfront and Fidelity Go also exceeded the average with domestic equity exposures of 75% and 71%, respectively. This emphasis on U.S. equities allowed these platforms to capitalize on the robust performance of the domestic market.

Large-cap stocks outperformed small-cap stocks during this period. The Russell 1000 Index, representing large-cap equities, returned 10.80% annually, significantly higher than the Russell 2000 Index’s 1.81% return for small-cap stocks. Fidelity Go capitalized on this trend with its substantial 75% allocation to large-cap equities, surpassing the average allocation of 69%. Wealthfront came in slightly above the average with a 71% allocation, while Zacks Advantage was slightly below at 67%. The strong performance of large-cap stocks contributed significantly to the overall returns of these portfolios.

While growth stocks slightly outperformed value stocks, the difference was not as pronounced as in previous periods. The Russell 3000 Growth Index posted an annualized return of 11.29%, higher than the Russell 3000 Value Index’s 8.65%. All three platforms—Fidelity Go, Wealthfront, and Zacks Advantage—had growth exposures close to the average of 27%, with allocations of 27%, 25%, and 25%, respectively. Given the relatively similar performance between growth and value stocks, growth exposure was not a significant differentiator in their portfolios.

In the fixed income arena, short-duration bonds outperformed long-duration bonds amid a rising interest rate environment. The short-term bond index returned 3.18% annually, while the long-term bond index suffered a loss of -8.35%. Zacks Advantage effectively mitigated interest rate risk with a lower portfolio duration of 4.08, well below the average robo-advisor duration of 5.86. Fidelity Go also maintained a slightly shorter duration at 5.54, while Wealthfront’s duration was higher at 6.53. Zacks Advantage’s and Fidelity Go’s emphasis on shorter-duration bonds helped these portfolios preserve capital and achieve better fixed income performance.

Municipal bonds outperformed corporate bonds, reversing a trend from previous years. The Bloomberg Municipal Bond Index achieved a modest annualized return of 0.09%, outperforming the Bloomberg US Corporate Bond Index’s loss of -1.18%. All three top-performing platforms incorporated municipal bonds into their portfolios, which proved advantageous. The tax-exempt nature and relative stability of municipal bonds contributed positively to their fixed income returns.

Additionally, high-yield bonds outperformed investment-grade corporate bonds, with the Bloomberg US Corporate High Yield Bond Index returning 3.10% annually. While none of the top performers had significant allocations to high-yield bonds, their focus on municipal bonds and shorter-duration instruments provided a balanced approach to fixed income investing.

Domestic Equity Exposure Helps Zacks Advantage, Fidelity Go, and Wealthfront Over the Prior Seven Years

The standout performers during this time were Zacks Advantage, Fidelity Go, and Wealthfront (2016). These portfolios tended to favor investments in large-cap and domestic equities, an approach that has proven particularly advantageous given market conditions over the past seven years.

Zacks Advantage had a substantial 83% allocation to domestic equities, significantly above the average allocation of 67% for the robo-advisors we track during this period. Wealthfront and Fidelity Go also exceeded the average with allocations of 75% and 71%, respectively. The importance of having a large allocation to domestic equities is shown by the S&P 500 Index achieving a strong annualized return of 14.46%, surpassing the MSCI EAFE Index’s return of 6.60% and the MSCI Emerging Markets Index’s return of 4.00%. This strong focus on U.S. equities allowed these portfolios to benefit from the robust performance of the domestic market.

Moreover, the emphasis on large-cap stocks varied across portfolios, with Fidelity Go allocating 75% to large-cap equities and Wealthfront allocating 71%, both above the average robo-advisor allocation of 69%. In contrast, Zacks Advantage had a below-average allocation at 67%. The benefit of large-cap equity exposure can be seen with the Russell 1000 Index, which tracks large-cap equities, delivering an impressive annualized return of 14.15% over this period, outpacing the Russell 2000 Index’s return of 7.33%.

The balance between growth and value allocations played a role in shaping equity performance in the market more generally. However, the winners’ allocations to growth stocks did not significantly differ from their peers. Fidelity Go had a growth exposure of 27%, matching the average, while Wealthfront and Zacks Advantage each had 25%. This shows that growth exposure was not the primary factor in their outperformance during this period, even though growth has significantly outperformed value. Over the last seven years, the Russell 3000 Growth Index achieved an annualized return of 17.50%, significantly outpacing the 9.30% annualized return of the Russell 3000 Value Index.

Portfolios with higher allocations to value stocks tended to struggle. For example, Schwab Intelligent Portfolios and Betterment, which had higher allocations to value stocks, were the worst-performing robos over the 7-year time period. Schwab’s portfolio had the largest allocation to value stocks, with a 39% allocation compared to the average of 30% for the robos we track. While a higher allocation to value stocks provided some cushion during periods of market volatility, the overall dominance of growth stocks over the seven-year period caused these portfolios to underperform relative to those that had a focus on growth closer to the average.

Additionally, Wealthfront benefited from its strategic investment in the energy sector through the Vanguard Energy ETF (VDE). While VDE delivered an annualized return of 7.81% over the seven-year period, Wealthfront has added to or reduced this position over the years in a way that produced outperformance within the portfolio. This success highlights the strong returns from energy investments and demonstrates Wealthfront’s effective market timing, having initiated the investment in April 2020 and partially exiting in July 2022. This well-timed decision played a key role in enhancing the portfolio’s overall performance.

In the fixed-income arena, the best-performing fixed income portfolios over the prior seven years all maintained higher-than-average allocations to high yield. The best-performing fixed income portfolio was Axos Invest, which maintained an allocation of 6.81% of its fixed income portfolio in high yield. The runners-up in this category were Fidelity Go and Empower, which had high yield allocations of 3.43% and 3.92%, respectively, notably higher than the average allocation of 2.33%. The importance of high-yield exposure is shown with the Bloomberg US Corporate High Yield Bond Index returning 4.70% annually compared to 2.42% for the Bloomberg US Corporate Index.