Financial markets delivered positive returns across most major asset classes for the third quarter (Figure 1). Improving fiscal policy clarity was a major theme throughout the quarter, with the passage of the U.S. budget package in July and the continued reduction of global trade tensions. Fears of significant tariff-induced inflation abated as only a modest pass-through to goods prices was reported during the quarter. On the monetary policy front, the Federal Reserve (Fed) cut rates by 25 basis points in September, as it shifted its focus from inflation to labor market weakness.
Figure 1: Index Performance, %
Strong quarterly performance for markets, despite initial volatility
3Q2025 |
Jul |
Aug |
Sep |
|
U.S. Equity |
||||
Russell 3000® |
8.2 |
2.2 |
2.3 |
3.5 |
S&P 500® |
8.1 |
2.2 |
2.0 |
3.7 |
Avantis U.S. Large Cap Value |
6.2 |
1.7 |
3.3 |
1.1 |
S&P 500 Equal Weight® |
4.8 |
1.0 |
2.7 |
1.1 |
S&P 500 Value® |
6.2 |
0.9 |
3.4 |
1.8 |
S&P 500 Growth® |
9.8 |
3.4 |
0.8 |
5.3 |
S&P MidCap 400 |
5.5 |
1.6 |
3.4 |
0.5 |
S&P MidCap 400 Value® |
5.5 |
1.0 |
4.6 |
-0.1 |
S&P MidCap 400 Growth® |
5.6 |
2.2 |
2.3 |
1.0 |
Russell 2000 |
12.4 |
1.7 |
7.1 |
3.1 |
Russell 2000 Value® |
12.6 |
1.8 |
8.5 |
2.0 |
Russell 2000 Growth® |
12.2 |
1.7 |
5.9 |
4.2 |
MSCI USA IMI/Real Estate |
3.5 |
0.1 |
3.4 |
0.0 |
International Equity |
||||
MSCI ACWI Ex USA IMI |
6.9 |
-0.2 |
3.6 |
3.4 |
MSCI World Ex USA |
5.3 |
-1.2 |
4.4 |
2.1 |
MSCI World ex USA Quality |
2.0 |
-3.4 |
3.3 |
2.2 |
MSCI World Ex USA Value |
7.9 |
0.3 |
5.7 |
1.7 |
MSCI World Ex USA Growth |
2.8 |
-2.7 |
3.1 |
2.6 |
MSCI World Ex USA Small Cap |
7.2 |
0.0 |
5.0 |
2.2 |
MSCI EM IMI |
9.9 |
1.8 |
1.5 |
6.4 |
Fixed Income |
||||
Bloomberg U.S. Aggregate |
2.0 |
-0.3 |
1.2 |
1.1 |
Bloomberg Municipal |
3.0 |
-0.2 |
0.9 |
2.3 |
Bloomberg U.S. Corporate High Yield |
2.5 |
0.5 |
1.2 |
0.8 |
Bloomberg EM USD Aggregate |
3.4 |
0.9 |
1.3 |
1.1 |
As of 9/30/2025. Source: Morningstar Inc.
The MSCI All Country World Index experienced its strongest third-quarter performance since 2020, led higher by growth and large-capitalization (cap) equities amid artificial intelligence (AI) enthusiasm in the United States and China. A better-than-expected second-quarter earnings season and solid economic data provided additional support for U.S. equities. The rebound in small-cap equities and positive returns for major bond indices were primarily due to short-term interest rates moving lower during the quarter on the expectation for additional rate cuts in 2025.
Which Asset Classes Led in Q3?
U.S. Small-cap Equity (12.4%)
Our thesis: The current backdrop of elevated inflation and interest rates is challenging for U.S. small-cap equities, but we believe they can benefit from U.S.-centric revenue exposure over the long term.
What worked in the quarter: Small-cap equities rallied to have their best quarter since 2023 and ultimately reached an all-time high in September – a first instance since 2021. Strong performance from the interest-rate-sensitive asset class was supported by improved clarity on tariff policy, lower short-term interest rates and the potential for additional Fed easing later this year.
Looking ahead: While small-cap valuations remain historically low relative to large cap, they are close to their long-term averages. We believe an earnings growth catalyst will be required to reduce multiples from current levels, but improved clarity on interest rates and trade policy have been positive developments.
Emerging Market Equity (9.9%)
Our thesis: Emerging markets (EM) contribute approximately 50% of global GDP, in contrast to their 10% allocation within the MSCI All Country World Index by market cap. We believe long-term potential secular and economic growth themes support our positive view of the asset class.
What worked in the quarter: EM equities posted a second consecutive double-digit quarter of returns, led higher by equities in China, Taiwan and South Korea. Continued AI developments helped boost mega-cap technology companies, particularly market leaders in China.
Looking ahead: Global trade policy has not been a headwind for EM equities thus far, and the weakening U.S. dollar has been a tailwind. Given the stronger earnings outlook relative to developed markets and easing financial conditions in China, we continue to have a positive outlook for EM.
U.S. Large-cap Equity (8.1%)
Our thesis: We believe U.S. large-cap equities are the long-term growth and innovation engine of public equities given their sustainable, high-quality fundamental characteristics and robust technology exposure.
What worked in the quarter: The index hit multiple record highs during the quarter, supported by strong returns in the Information Technology and Communication Services sectors. Additionally, second-quarter corporate earnings came in above expectations and AI developments continued to be a market driver, particularly for mega-cap technology companies.
Looking ahead: Earnings growth and profit margins may be impacted by tariff policies in the short term, but we believe the higher-quality nature of large-cap companies can help them navigate this environment and invest for the future relative to smaller-cap companies.
Which Asset Classes Lagged in Q3?
Core Fixed Income (2.0%)
Our thesis: Core fixed income tends to be the primary ballast in multi-asset portfolios given its broad diversification across U.S. Treasury, corporate and securitized markets.
What happened in the quarter: Interest rates for most maturities across the asset class declined during the quarter, and coupled with credit spread compression, helped drive the positive quarterly return.
Looking ahead: Over the long term, we believe core fixed income will provide stability in portfolios and help dampen portfolio volatility. In the near term, we expect current yield levels will offer reasonable compensation to investors given our outlook for only modest inflation.
U.S. High Yield (2.5%)
Our thesis: Over the course of a full business cycle, we expect high yield to outperform core fixed income. Historically, the asset class has a stronger correlation with equity markets than the direction of interest rates, acting as an important diversification consideration for investors.
What happened in the quarter: Issuance during the third quarter was the highest since 2020, helping drive credit spreads to the narrowest level since 2021. Declining interest rates and positive returns for risk assets contributed to the quarter’s returns.
Looking ahead: Compared to prior credit cycles, we believe high yield issuers currently have a better fundamental backdrop to manage higher borrowing costs. However, valuations will continue to richen as high yield credit spreads sit near cycle lows.
Emerging Market Debt (3.4%)
Our thesis: We believe EM debt offers better fundamentals and higher income generation than what is available in developed international markets. Most of the index is comprised of sovereign debt, which reduces credit risk relative to corporate credit.
What happened in the quarter: Returns were positive across every major geographic region, led by the Middle East, which sourced meaningful issuance during the quarter. Falling yields offset U.S. dollar strength and reached the lowest level since first quarter 2022.
Looking ahead: Returns were positive across every major geographic region, led by the Middle East, which sourced meaningful issuance during the quarter. Falling yields offset U.S. dollar strength and reached the lowest level since first quarter 2022.
