Market commentary
- Fahad Hassan
- 11 hours ago
- 6 min read
Executive summary
US-Israel-Iran conflict has effectively closed the Strait of Hormuz, oil and gas prices are higher.
Portfolios had already been defensively positioned — gilts exited, duration cut, UK mid-caps and European small caps removed — all of which have since fallen sharply.
Macro
The last month has seen a reset of inflation expectations, as the US and Israel entered a conflict with Iran. The Strait of Hormuz, a narrow body of water responsible for 20% of the world’s seaborne oil supply, is effectively closed. Oil prices are significantly higher and could rise even further. Natural gas, a key input into fertiliser production,
has seen a significant price increase, which in turn is causing a rise in food prices.
March has highlighted how quickly the prevailing market narrative can be upended. This year started with hopes of falling inflation, looser monetary policy and an acceleration in corporate earnings growth. Despite some concerns around AI spending, the economic backdrop remained favourable, giving investors the freedom to explore riskier asset classes. Emerging market bonds, European equities and commodities benefited as investors sought diversification away from the Magnificent 7
Our 2026 Strategic Asset Allocation (SAA) included these assets for diversification, while balancing with valuations, economic data and broader risks.
Bond investors expected monetary policy to be eased in 2026 even as US economic growth remained resilient. This “goldilocks” scenario was reflected in elevated equity and corporate bond valuations (tight credit spreads). Inflation risks appeared to be in the rear-view mirror, and portfolios were lifted by both bonds and equities rising in unison.
We saw the risk of a rebound in inflation in the second half of 2026, driven by loosening fiscal and monetary policy, tight labour markets and the delayed impact of tariffs. We shortened the duration in our government bond allocations as we moved portfolios to the 2026 Strategic Asset Allocation. We exited all exposure to UK government bonds (gilts) and reduced infrastructure, which is a yield-sensitive asset class. While bond yields at the start of 2026 were higher than in 2022, they were clearly mis-priced for a sudden increase in oil prices. 2-year gilts started the year yielding 3.7% and now yield 4.3%. 10-year gilts were yielding 4.5% and now yield 4.8%. The dramatic move in shorter-dated yields reflects a reassessment of the ability of the Bank of England to cut policy rates.
While a closing of the Strait of Hormuz was not in our crystal ball for 2026, a plan to deal with higher inflation was clearly helpful for client portfolios. Within equities, the impact of SAA shifts has been more mixed. We increased exposure to Asian and European equities by reducing US exposures, as we sought to insulate portfolios against the impact of a sell-off in technology stocks. While these actions seemed appropriate early in the year, the start of
hostilities in the Middle East caused a sharp sell-off in Japanese, Asian and European equities. These regions are dependent on the Middle East for most of their oil and gas supply and are therefore susceptible to energy shortages. While the initial sell-off was driven by derisking and a momentum reversal, the longer-term case for Asian equities may suffer as well, due to resurgent inflation concerns. The other large shift in equity exposures
was away from UK mid-caps and European smaller companies. Both these equity sectors have suffered large declines in March, and portfolios have benefited from their timely removal.
We value liquidity in client portfolios throughout their investment journey with us. This discipline helps portfolios avoid drawdowns resulting from a flight of capital during market turmoil. As we think about the longer-term consequences of the war in Iran, we are guided by history and our active, risk-aware investment process. A reduction in duration and small cap equity exposure has already helped reduce portfolio volatility. We have identified follow on actions to help mitigate portfolio drawdowns and protect client assets if the market backdrop continues to deteriorate.
Funds in focus
Past performance is not a guide to future performance.
Given the sell-off in March, it may seem somewhat redundant to examine the quarterly figure. However, it provides some perspective on what has been delivered over the three-month period, separate from the noise of the conflict in Iran and rising energy prices. The standouts here are Infrastructure, UK Equity Income and Asia Pacific Equities. Infrastructure - typically a benign asset class - has generated some incredible returns off the back of the prospect of falling rates and the clamour for stocks that are tangible, i.e. not able to be disrupted by AI. In March, initially, it held up well with the inherent inflation protection and high quality of the assets, helping it to stave off the worst
of the falls. But once bond yields had risen above a certain level – and infrastructure is viewed as a bond proxy – then the funds in the space slipped, as taking equity risk became less appealing. Nevertheless, a 10% quarter is enormous for the sector – even if it was aided by AI fears and utilities that had lagged for some time.
The other surprise is that despite being hit harder than virtually anywhere else in March, one of our picks in Asian equities was still up double digits. The Taiwan and Korea heavy L&G Pacific Trust was up 10.2%, even with a 12.4% decline in March.
Meanwhile, UK equity income had been in high demand in the first two months of the year, as falling rates made the UK’s high-yielding stock market look very attractive. The Vanguard FTSE UK Equity Income fund finished the quarter up 6.4% and restricted losses in March to 4.9%.
In fixed income, high yield and short-duration were leading the charge in March and the quarter. Highlights here were the Man GLG High Yield Opportunities fund returning 0.7%, while the Vanguard Global Short Term Bond Index fund was flat. Both funds were added to core models in February to protect portfolios from what we viewed as risks in the bond market. Equally, our decisions to exit UK mid-caps and European small caps in February were fortuitously timed after they fell 9.6% and 6.1% respectively in March.
US equities disappointed in the quarter, and our allocations are all at the bottom of the return charts for Q1. We did dial down exposure a little in February, but the crisis has shown us that the US economy and its currency are still the place to be in times of turmoil.
Funds performance
Past performance is not a guide to future performance.
Conclusion
The sharp deterioration in March, driven by the Iran conflict and rising energy prices, demonstrated the value of active, risk-aware portfolio management. A more defensive positioning applied in our February rebalance — exiting gilts, reducing duration, removing UK mid-caps and European small caps — proved well-timed and meaningfully cushioned the blow. While the shift into Asian and European equities delivered mixed results, strong quarterly returns from Infrastructure, UK Equity Income and select Asia Pacific holdings have offset some of the falls.
The inflation risks we were concerned about materialised in a far more dramatic form than anticipated. However, portfolios had been positioned with their return in mind and were better placed to weather the storm. As the situation in the Middle East evolves, the focus remains on protecting capital, maintaining liquidity, and positioning for a world where energy prices and inflation may stay elevated for longer than markets had hoped.
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