Exchange-traded fund usage has taken on a bigger role in advisors’ allocations, according to a new report from Boston-based Fidelity Investments.

According to the firm’s third-quarter “Portfolio Construction Insights” report, the biggest increase in portfolio allocation was in exchange-traded funds: 25% of all portfolios in the third quarter were invested in ETFs, which one strategist said is up from 18% two years ago.  

“We think the increase of ETFs from 18% two years ago to 25% right now is actually driven a lot by those interested in different kinds of ETFs,” said Paul Ma, the lead portfolio strategist at Fidelity. 

Among the types of ETFs that are garnering interest are active and smart beta ETFs, according to Ma. 

Advisors are investing more in U.S. stocks than international ones as economies struggle overseas and the domestic economy thrives, the report said. 

The firm’s portfolio construction report for the third quarter analyzed more than 2,000 professionally managed investment portfolios and found that many of them are investing about 80% of their overall portfolio in U.S markets and only 20% in foreign markets.  

There are a number of factors that make investing in the U.S. more attractive than international right now, Ma said. Both China and Europe, which make up a significant portion of the international market, are dealing with financial hardship. China is trying to come out of a recession, and Europe just reported 0% GDP growth last quarter, he said. 

“Advisors see a lot of issues when it comes to investing in the international markets, so my team is seeing a trend in that advisors are moving back from international to more strategic USA.”

The markets in the United States are showing more positive signs, with inflation coming down and GDP at 4.9% for the third quarter. 

Part of the reason is trade. “There are countries out there that depend more on trade,” Ma said. Those that are have started to lag. Only 3% of the U.S. GDP depends on trade, he said, while “70% depends on consumerism.”

The report also found growing interest in alternative investments: 15% of all the third quarter portfolios had some type of investment in the space. Part of the reason for that is greater access: Investors can now gain a foothold in these investments with lower minimums than they could in the past.  

When determining how much of an overall portfolio an advisor should put into alternatives, Ma said 8% was a good starting point. As for which type of alternatives to use, it depends on the investor, he added. 

“It’s not about pushing a product, which is what a lot of advisors do,” he said. Advisors must “figure out the goal of the pain they’re trying to solve for and then match the right category.” 

For instance, if the investors are looking for enhanced returns over stocks and bonds, then it makes sense to use private equity. If they are seeking better diversification over bonds, then a market neutral hedge fund could fit. Finally, if the investor wants reliable income they could invest in private credit, Ma said.

The report found that investors are less allocated to fixed income; 30% of the portfolios were invested in the asset class, down from 33% in the second quarter. Eighty percent of those allocations were to investment-grade bonds.  

Advisors are starting to figure out that GDP could start to slow down if higher interest rates start to harm the economy, Ma said. Investment-grade bonds have become more interesting for that reason, since their duration is helpful in a recession.

“Based on our data, advisors are actually getting smarter about it; they’re elongating the duration a little bit [and] they’re getting more investment-grade bonds,” Ma said. “They’re getting the message that going forward … high interest rates might hurt the economy.” 

Fidelity conducts the quarterly “Portfolio Construction Insights” report to track the way advisors are building and managing portfolios. It helps them find out what their colleagues are doing and the strategies they are employing, Ma said.