Beneath the Surface of a 3% Quarter

In the 3rd quarter, the S&P 500 Index gained a solid 3%, but beneath the surface, there have been shifting tides. Software outperformed semiconductors by a whopping 40%, value beat growth, and the S&P 600 small-cap index is up over 20% on the year.

August was a strong month for equity markets, as global stocks gained close to 3%. Almost all asset classes and styles exhibited similar performance, yet growth did slightly outperform value, large caps outperformed small cap in the U.S., and international small caps and emerging markets were the overall equity outperformers. Despite obvious inflationary pressures and nervous bond investors, the bond market held its ground for the month and produced a return close to 0%.

Equities: a solid quarter to date for performance, ending August 31, 2026. Source: YCharts. Data as of August 31, 2026.

Momentum vs. Fundamentals

With explosive growth in semiconductor and AI-related stocks this year, investors’ general fear of losing money has now been replaced with “I just want to keep up,” or worse, “I just want in on the new hot thing.”

That appears to have been the prevailing mindset until this quarter, when investor exuberance was tamed and rationality returned to the fray. Investors decided that enough was enough for this AI rally, at least for now, and semiconductor stocks sold off by more than 20%.

What Is Shifting Beneath the Surface?

• Tech stock leadership has become fractured: investors are becoming more discerning about which tech companies they own. It is no longer enough to just index the sector. This year has produced major performance differences between the Magnificent Seven hyperscalers, semiconductor companies, memory manufacturers, and software firms, all of which are tech stocks. Quarter to date, in a reversal of fortunes, the iShares Software ETF Index outperformed the iShares Semiconductor ETF Index by a whopping 40%.
• Value greater than growth: value stocks outperformed growth stocks during this quarter as money flowed from the AI trade into fundamentally undervalued areas of the market. More importantly, value stocks provided investors with meaningful diversification and a way to capitalize on changing market leadership.
• Small-cap resurgence: small-cap stocks are experiencing a quiet resurgence. While loud voices had been calling for the demise of small-cap stocks, the S&P 600 Index is up over 20% this year.
• Emerging markets: emerging market stocks continue to be the leading equity asset class for the year.

How Is Frontier Positioned?

Important portfolio attributes include:

• Underweight large-cap stocks: most Frontier strategies remain relatively underweight U.S. large-cap stocks.
• International stocks: Frontier holds near benchmark positions to international stocks but also maintains unique exposures in international small-cap stocks and emerging markets.
• Small-cap stocks: most Frontier strategies maintain measured overweights to small-cap stocks.
• Fixed income: bond positioning remains below benchmark duration and implemented mostly with active managers.
• Fund selection: to provide an additional layer of risk management and strategy diversification, Frontier strategies hold considerable exposure to risk-managed funds.

Current positioning vs. long-term targets, Balanced and Moderate Growth strategies. Source: Frontier Asset Management. Data as of June 1, 2026.

Performance Highlights: A Broadening Market Is Doing the Work

August was a solid month for Frontier Strategies, as our multi-layered risk management approach was additive. Most Strategies kept up or outperformed benchmarks during this fractured but narrow market. For the year-to-date and one-year periods, most Frontier Strategies remain materially above their benchmarks.

• Frontier strategies are benefiting from a broadening market, in which asset classes like small-cap stocks and emerging market stocks are experiencing outsized returns.
• Growth strategies, tech heavy funds, and indexing drove gains in the second quarter, but have lagged quarter to date.
• Defensive managers like First Eagle Global and value funds in general were the point of diversification quarter to date.
• Alternative strategies like covered calls and Victory Market Neutral provide differentiated diversification.
• The right mix of funds and strategies: our portfolios continue to hold robust combinations of funds with differentiated performance patterns. We have lost less when markets declined and captured enough upside when markets gained to finish mostly ahead of our benchmarks over the one-year period.

Why Strategy Diversification, Not Just Asset Allocation?

The major performance theme for this year is confirmation of our “strategy” mixes. Because we optimize fund strategies as well as asset allocations, we are effectively combining each fund’s differentiated investment strategy and performance pattern. These patterns are often different from those of the indexes. This “strategy” diversification can be greatly beneficial in difficult markets and can generate excess return over time.

Everybody wants to win when the winning is good, but investors will face a myriad of outcomes over their investment horizons.

Proper diversification should account for the multiple market environments that are possible in the future, not just the single path that has occurred in the past.

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