Fast forward to the final day of February, and the outbreak of the US/Israel-Iran conflict marked a turning point in both market leadership and sentiment. Global stock and bond markets subsequently declined, with equities erasing their earlier gains, ending the first quarter down 1.2%. Meanwhile, gilts returned -2.1%, falling sharply in March on the back of renewed inflationary concerns.
At a regional level, the period saw considerable divergence in performance across equity markets. US equities lagged their global counterparts, posting a return of -2.4% in Q1 when measured in sterling terms, with UK investors partially shielded from the full extent of the losses due to the strength of the US dollar. European markets experienced pronounced volatility, with an 8.7% drop in March driving returns into negative territory (-2.1%) for the quarter. Similarly, emerging market and Japanese equities saw a steep sell-off in the final weeks of Q1, exceeding 10% declines during March. Nevertheless, the substantial gains achieved earlier in the period enabled these markets to finish the quarter in positive territory overall.
Closer to home, the MSCI United Kingdom Index concluded the first quarter with a positive return of 2.9%. This resilience was largely attributable to the robust performance of energy stocks, which make up more than 10% of the index and provided crucial support amid broader market turbulence. Indeed, the effects of geopolitical conflict were most evident in energy markets, with the effective closure of the Strait of Hormuz – a vital shipping channel responsible for approximately 20% of global oil and gas supplies prior to the conflict – leading to a sharp increase in energy prices. Brent crude, the international oil benchmark, surged by about 63% from its pre-conflict level, reaching a peak of US$120 on Monday, 9 March. The announcement of a ceasefire in recent days has seen this price fall back to below $100, but clearly this remains a different energy environment to that present at start of the year.
Strategy Returns
The strategies posted negative returns in Q1. Consistent with the market dynamics outlined above, the gains achieved over January and February were overshadowed by the sell-off that occurred across asset classes in the final few weeks of the period. This resulted in low single-digit declines (approx. -1% to approx. -4%) for most risk profiles, with March’s reversal in sentiment leaving few places to hide, as markets questioned the potential impact of these events on growth and inflation. While bonds and equities lost ground, the period also proved challenging for alternative investments such as commercial property and, to a lesser extent, select hedge fund strategies.
Although the US stock market underperformed global peers over Q1, it did demonstrate more defensive characteristics during March’s geopolitical turmoil. A strong rally on the last trading day of the period also proved welcome, although this movement will not show until April due to it occurring after the funds’ midday valuation point. These late moves aside, the relative performance of the US market over the quarter – especially technology companies – was shaped by two distinct concerns associated with the growing influence of AI. Firstly, investors questioned the long-term sustainability and return potential of the significant capital expenditure plans announced by the largest technology firms, with billions committed to expanding data centre infrastructure to support advanced large language models (“LLMs”) from companies such as OpenAI, Anthropic, and Google. Secondly, software companies experienced sharp share price declines, as fears mounted that AI tools could disrupt traditional business models and diminish pricing power. This confluence of fears impacted the strategies’ holdings in names such as Nvidia, Microsoft and Intuit (the owner of QuickBooks). However, in each case we believe these concerns to be exaggerated, with current valuations particularly compelling given the robust anticipated earnings growth for these and other strategy holdings.
Security selection was positive in March, helping to offset some of the broader market declines, but negative for the quarter. A positive contribution from the strategies’ emerging market equity holdings was a notable highlight, while in the UK an overweight position to BAE Systems also proved supportive given the prevailing uncertainty. In contrast, an underweight to Utilities proved a headwind, while acute AI disruption fears also impacted holdings including global data and analytics business Experian, London Stock Exchange Group and information-based analytics and decision tools provider RELX. In Europe, the outbreak of hostilities proved challenging for the Industrials and Materials sectors, impacting holdings such as global specialty chemicals company Sika, Siemens, and cement and aggregates producer Heidelberg Materials.
Activity
In March, the most notable action was our decision to increase the strategies’ existing Energy sector exposure across the North American Equity (via Chevron) and European Equity (via TotalEnergies) allocations, a move taken on the expectation that energy prices, even in the event of a permanent resolution to the current conflict, are likely to settle at a higher level for the foreseeable future. With an already healthy allocation to both Shell and BP, we left the UK Equity allocation to this sector unchanged. Across other sectors, we selectively added to positions on weakness, taking advantage of depressed share prices amid the prevailing volatility.
Elsewhere, we adjusted our preferences within the UK Real Estate sector, exiting British Land in favour of SEGRO, the owner, manager and developer of warehouse and industrial property, and a previous holding within the strategies. With weakening labour market indicators, and London employment now lagging the national average, not to mention the as-yet undetermined impact of AI on companies’ long-term hiring policies, we see a diminished case for retaining material exposure to London offices, which continues to comprise around half of British Land’s portfolio. This has prompted a change to our original investment thesis. In contrast, SEGRO has no exposure to the office market, and with a recent shift to developing fully fitted data centres, we have moved to reinitiate a position in the company. While data centres currently only represent around 8% of the portfolio, SEGRO has the land, capital and, crucially, secured power capacity to grow this exposure up to five‑fold based upon current agreements, with more than half of that growth achievable within the next three years. To summarise, the company provides rare UK‑listed property exposure to one of the fastest‑growing real estate sub‑sectors, while continuing to manage a well-positioned, core urban logistics portfolio that benefits from resilient demand near major population centres.
Outlook
The war in the Middle East has delivered a negative shock to financial markets, and the longer energy supply disruption persists, the greater the adverse effect will be on economic growth and inflation. While the April ceasefire (at the time of writing) is a positive step forward, its foundations already appear shaky. Nevertheless, while acknowledging the short-term headwinds we anticipate to both the global economy and investor sentiment, we still see reasons to be optimistic, with exciting investment ideas presenting themselves across different segments of the global equity market, as well as other asset classes.
In constructing our strategies, we seek to manage risk in volatile and uncertain periods through diversification. As an example, UK equities have provided a positive return in Q1 as European and US stocks have fallen. In a similar fashion, a broad range of sectoral exposures across the strategies’ equity allocations has also provided support against aggressive rotations in market leadership. And although gilt returns were negative through the period, the relatively high starting yield provides a cushion (and attractive source of income), with yields having to rise significantly higher for investors to lose money by year end. Thus far the bond market reaction has been overwhelmingly focused on inflation, but higher energy prices, should they persist, would be expected to weigh on growth, which in turn would provide support to the asset class within client portfolios.
Furthermore, while periods such as these are uncomfortable for investors, it is important to remember that they are not unusual. 15 of the last 25 calendar years have seen the MSCI All Country World Index experience an intra-year decline in excess of 10%. However, on only three occasions has the index ended the year down 10% or more. Volatility is, quite simply, the price of admission to receive the historically higher returns from equity markets.
History shows that cutting through the noise, focusing on market fundamentals, and sticking to an investment process and strategy clearly aligned with investors’ risk profiles and time horizons, has proven to be the correct course of action. This approach remains the basis of how we manage clients’ portfolios, with the flexibility afforded by our portfolio structure enabling us to manage risk, while simultaneously taking advantage of opportunities as they arise.
