'If you don't proactively rebalance, then you might be taking on more risk than you are actually comfortable with taking,' warns investment expert
The second quarter of 2025 has not gone the way many institutional investors originally thought. Some have even adjusted their earlier forecasts altogether as the global trade landscape shifts under the weight of renewed tensions and volatile negotiations.
Now, leading portfolio managers are carefully watching market sentiment and actively rebalancing portfolios in Q2 without succumbing to fear-driven overreactions.
Chris McHaney, EVP and head of investment management and strategy at Global X Investments Canada sees the current environment as a turning point for institutional allocators, especially those who have long been overweight US assets.
While the US has delivered strong returns in recent years, he believes the trade war has prompted a broader reconsideration of portfolio composition.
“The long-term implications are that this can be a little bit of a trade away from the US over time,” he said, adding that this isn't necessarily a negative development. Rather, institutional investors globally have been content holding overweight positions in US equities and currency because "that's where the growth and the returns have been."
But that complacency may be shifting as he notes the US has “almost created this sort of catalyst for institutions to revisit that allocation,” McHaney said.
“That US overweight from an investment standpoint becomes very easy to say, ‘Let's trim some of this back. We'll reallocate to other areas,” he added. “It doesn't mean we're going to underweight the US... maybe I'm just going to take a little bit off the top. That's why we saw US equities, US bonds and US dollar all sell off at the same time, which is a pretty rare thing to see.”
Meanwhile, Dustin Reid, believes investors “are seeing a structural recalibration towards more US dollar hedging.” While full hedging isn’t likely, he expects a 5 to 20 percentage point increase in hedging levels, especially among equity managers. This shift, he warns, could weigh heavily on the dollar over time.
“It could have a really negative impact on the US dollar over quarters,” said Reid, vice-president and chief strategist, fixed income at Mackenzie Investments, calling it one of the key long-term implications emerging in Q2.
Additionally, Reid underscored that market behavior has triggered doubts about whether US Treasuries and the dollar can still be counted on as reliable safe havens in times of stress.
“I think the general view with global investors is that it's probably not,” he said. “If you were significantly overweight US assets, maybe you go to moderately overweight and if you were slightly overweight, maybe you go to neutral. These correlations across asset classes may not hold up with the same amount of rigid correlation metrics that we’ve come to expect,” he said.
BeiChen Lin, senior investment strategist and head of Canadian strategy at Russell Investments agrees, noting that while the US economy might be on track for a soft landing, the risks are still elevated. His core advice is to focus on making portfolios more resilient through diversification.
“It would probably be a good idea to try to think about how to make the portfolio more robust, to really try to emphasize the value of having a diversified portfolio across sectors, across geographies,” Lin said. “Unless we see signs of a clear and compelling dislocation in the market, sticking close to that strategic asset allocation might be the best way to ride out the bumps.”
McHaney believes now is an opportune moment for portfolio managers to reassess their allocations, particularly considering what may be a shift in the long-term economic regime. The key, he argues, is to return to fundamentals, starting with policy benchmarks and re-evaluating how far portfolios have deviated from them.
A major factor in that return to fundamentals is the re-normalization of the fixed income market.
“The fixed income market is not artificially depressed in terms of interest rates,” he said, pointing out that the yield curve has shifted back into positive territory, unlike the inversion seen over the past two years.
However, Reid warns that fixed income investors may be facing a tougher environment in the near term, especially as yields begin to climb.
“I think we're in for a little bit of trouble here on fixed income,” he said, noting that the outlook depends on where investors are positioned along the yield curve.
His team had previously held a modest overweight in US duration, particularly around the 10-year mark but has recently scaled that back, “because we can see yields kind of drifting higher here,” he said, noting the implication could result in bond prices falling as yields rise.
Lin, however, highlights most institutional investors are refraining from making major portfolio shifts. Instead, he notes a more cautious and tactical approach is prevailing.
“It's mostly about nibbling away at the edges and then taking advantage of certain market moves and volatility to perhaps close some of the underweight or overweight,” he explained, emphasizing that while investors are adjusting, they’re doing so incrementally rather than taking aggressive positions.
“When you look at the sectors, there's not necessarily a very compelling argument where one particular sector has been so dislocated,” Lin added.
For example, within the Canadian equity market, the communications sector has seen steep declines. But that doesn’t automatically present a buying opportunity.
“Part of the reason why the communication sector is scoring as a little bit cheaper is because people are thinking about what the implications are of Canada’s new immigration policy,” he said, pointing to concerns about slowing population growth and reduced subscriber additions for telecom firms.
But where the reallocations are going, as McHaney notes, are into developed markets like EAFE and EM, which have outperformed recently. Consequently, Lin underscores that EM equities, particularly China, have become more attractive.
“Because there were so many cyclical headwinds impacting China, Chinese equities were out of favour for such a long time. Now, you have people getting back in because they think the valuations in Chinese equities are looking quite compelling,” he said.
Ultimately, he believes that portfolio rebalancing should be driven by actual changes in portfolio composition - what he calls "portfolio drift" - rather than by arbitrary time intervals, like quarters, especially in volatile markets where allocations can shift significantly without investors realizing it.
“If you don't proactively rebalance, then you might be taking on more risk than you are actually comfortable with taking,” he warned.
