SMF - Q1 2025 Update

Top 3 investment themes – Q1 2025          

Policy uncertainty

The first quarter of 2025 has been marked by significant policy uncertainty, driven largely by the US, where new domestic and foreign policies were announced. President Trump’s main area of focus has been on tariffs. These include a 25% tariff on imports from Canada and Mexico, a global 25% tariff on steel and aluminium, a 25% tariff on autos and auto parts, and an increase in tariffs on Chinese goods from 10% to 20%. Other areas of substantial uncertainty include fiscal and geopolitical policies. Questions remain about the potential impact of cost-cutting measures by the Department of Government Efficiency, led by Elon Musk, and the future of income tax. Additionally, the significant shift in policy towards Ukraine and NATO means Europe can no longer rely on the US to play an outsized role in maintaining security.

This policy uncertainty has impacted the US economic outlook. Investors are increasingly concerned about inflation, with the US 1-year inflation swap rising to its highest level in two years at 3.25%, and the latest 3-month annualised Core PCE data reaching 3.6%, its highest level since March 2024. Major banks have revised US growth expectations for 2025 downward, and consumer confidence and expectations have fallen to their lowest levels since January 2021 and March 2013, respectively. This has contributed to a significant risk-off move in markets, with gold, a perceived safe-haven asset, achieving its best quarter since 1986 with a gain of 16.3%.

Doubts over US exceptionalism?

The first quarter of 2025 has seen a notable shift in the performance of US equities relative to other regions, raising potential questions on US exceptionalism. The release of DeepSeek’s AI model in January first raised significant concerns about the sustainability of US tech valuations, with the Nasdaq and Nvidia dropping 3.1% and 17.0% in one day, respectively. Although this initial move was quickly unwound, increased investor concerns about growth and inflation stemming from tariffs led to the S&P 500 falling 4.3%, its biggest quarterly decline since 2022, and the ‘Magnificent Seven’ tech giants falling 16%, shedding nearly $2 trillion in market value. The US dollar also struggled, with the dollar index down 3.9% throughout the quarter.

In contrast, European equities saw significant gains, with the STOXX 600 up 5.9% and the FTSE 100 rising by 12.3%, marking the biggest performance gap between the STOXX 600 and the S&P 500 in a decade. This outperformance was partly driven by significant fiscal stimulus announcements, including Germany amending its constitutional ‘debt brake’ to allow higher defence spending and allocating €500 billion for infrastructure spending. This helped European defence stocks to surge, with the STOXX Aerospace and Defence Index up 28.9%.

Central bank divergence

In the US, the Federal Reserve (Fed) kept interest rates unchanged in Q1 2025, continuing to signal two cuts for the year in its March dot plot. The Fed also slowed the pace of quantitative tightening, reducing the runoff in Treasury holdings from $25 billion to $5 billion starting April 1. However, the inflation and growth impact of tariffs has increased uncertainty regarding the path of US rates. While the risk-off move and mounting speculation of a recession helped support US Treasuries this quarter, with a total return of 2.9%, potential stagflation introduces competing narratives on interest rate policy.

In Europe, the European Central Bank (ECB) delivered further 25bp rate cuts in both January and March, taking its deposit rate down to 2.50%. The prospect of higher spending led to a selloff among European sovereign bonds, with bunds down 1.8% in total return terms and the 10-year yield rising 37bps to 2.7%. Meanwhile, the Bank of Japan delivered another hike in January, taking its policy rate up to 0.5% and signalling further hikes ahead. Japan's 10-year JGB yields surged to their highest since 2008, up almost 50bps, set for their biggest quarterly jump since 2003.

Q1 2025 Market performance (GBP terms)                                                     

Past performance is not a reliable indicator for future performance.

Source: Morningstar as at 31 March 2025. All equity and commodity returns are in GBP and fixed income is GBP hedged.

How did SMF perform?

Growth assets

Q1 has been eventful for risk assets with uncertainty over US tariffs, and potential retaliation, leading to negative performance across most equity regions despite a strong start in January. Market sentiment soured over the quarter as Trump implemented tariffs on key trading partners (Canada, Mexico & China) and threatened to expand them to other countries (this was confirmed on April 2). European and UK equities were the exception, delivering positive returns over the quarter which was reflected the Growth sleeve. Both markets have continued to benefit from a shift in fiscal policy towards more defence spending, and the UK remained relatively unimpacted by tariff concerns over Q1. Given this backdrop, our overweight position in US equities, which was also held versus underweight positions in European and Emerging market equities, detracted over Q1 (all now closed positions). However, our overweight US financials position, versus US equities, was additive due to a market rotation towards more defensive stocks.  

Defensive assets

Global fixed income generally delivered a positive, although muted, performance over the quarter, given the risk-off tone. However, it has been a mixed picture across specific bond markets. In particular, German Bunds have seen their yields trend significantly higher (driving prices lower), given a focus on increased defence spending and UK Gilts yields also ticked up slightly, following the Spring Budget announcement. Additionally, in Japan where the BoJ continues to hike rates amidst signs of building inflationary pressures, Japanese bonds were down 2.4%. In contrast, US Treasuries have benefitted from their status as a safe haven asset which saw US Treasury bonds outperform over the last quarter, delivering a return of 2.9%. In terms of active positions, this meant that our overweight position in Gilts, versus an underweight to US Treasuries detracted, as did our overweight to Bunds v French government bonds (now all closed positions). However, this was partially offset by our underweight position in Japanese government bonds earlier in the quarter, and our outright overweight Gilts position.

Alternative assets

Alternative assets performed well in over Q1 as both AIMS and our property holding delivered positive performance, helping to cushion some of the equity weakness. In particular, AIMS has benefitted from its exposure to the gold rally over the quarter, as well as its overweight position in European equities.

Key active management themes in Q1 2025

• 1. Closed our overweight equity exposure  
  • Closed our overweight US equity positions
    • Given continued uncertainty around US tariff policy, and in anticipation of volatility leading up to ‘Liberation Day’, we closed our overweight positions in US equities.
    • We have also closed our overweight US financials v underweight US equities position to take profit.
  • Opened underweights in US and European equities
    • We are now underweight US equities given the challenges that tariff-related threats pose to US growth, which are expected to impact consumer and corporate sentiment.
    • We have also opened an underweight US healthcare relative value trade as the sector is likely to be particularly impacted by US tariffs on Europe, due to the volume of pharmaceutical exports between the US and Ireland.
    • In terms of European equities, we have opened an underweight position given signs of investor complacency on tariff risks to European companies, as investors focus on expansionary fiscal plans. 

• 2. Increased our overall overweight duration exposure 
  • Increased our Gilt overweight and re-opened an overweight to US Treasuries
    • We continue to maintain an overweight to Gilts as continued macro weakness presents the potential for more rate cuts by the BoE than are currently priced by the market.
    • Similarly, an overweight to US Treasuries has been opened as downside growth risks may lead to a need for further monetary easing by the Fed.
  • Opened an underweight position in French OATs
    • We have closed our overweight Bund v underweight French OATs relative value position, given changes to Germany’s debt brake.
    • However, we retain an outright underweight to French OATs, given the threat of additional fiscal risks in France and continued political uncertainty. 

• 3. Adjusted our FX positioning 
  • Given the more cautious outlook on the US, we have closed our long USD v GBP position.
  • Instead, we have opened a long EUR v USD position, reflecting the relative differences in economic and fiscal outlooks for the two economies. 

Past performance is not a reliable indicator for future performance.

Source: Morningstar as at 31 March 2025. Performance of the funds are net of fee.

The launch date of SMF (pension) was 11/12/2017, SMF (bond) 18/02/2019, SMF II (pension) 30/06/2021 and SMF II (bond) 30/06/2021.

SMF Strategic Asset Allocation

Source: Aviva Investors. This diagram is for illustrative purposes only, asset allocations are subject to change. The reference fund is SMF, based on its strategic asset allocation as at 30 June 2024.

Top 10 Equity holdings

Source: Aladdin, as at 20 March 2025. The reference fund is SMF. The companies mentioned are for illustrative purposes only, not intended to be an investment recommendation.

SMF & SMF 2 Fund Price Adjustments (FPA)

There were no fund price adjustments in Q1 2025.

Market outlook and positioning: what do we believe happens next?

From an active asset allocation perspective, the outlook for equities has changed as a result of President Trump’s broad-based tariff policy. Whilst corporate earnings have remained strong, growth risks are now generally tilted to the downside, and we have derisked our portfolios to reflect this. In contrast, global fixed income is better positioned in a risk-off market environment, where the negative skew of economic and monetary policy risk could place a ceiling on bond yields. We now also hold an FX position in which we are overweight EUR v underweight USD as an additional expression of a weaker US macro outlook, relative to Europe due to the region’s expansionary fiscal plans.

In terms of equity regions, we are now underweight US equities and European equities. Regarding US equities, we believe that US tariff policy poses challenges to the growth outlook, and hence consumer and corporate sentiment going forward. We are also underweight the US healthcare sector through a relative value position. Whilst this sector has been a key beneficiary of the defensive market rotation this year, it is particularly exposed to tariffs on Europe due to trade with Ireland. In terms of European equities, we are underweight as we hold the view that markets are overly focused on fiscal stimulus in the region, and have overlooked the risk that tariff threats, and global growth slowdown, pose to European companies.

Regarding our fixed-income allocation, we have increased our overweight position in Gilts and opened an overweight in US Treasuries. Fixed income is positioned well in a risk-off environment and in both the US and UK, downside growth risks could lead to continued central bank easing, above that currently expected by investors. For France, we have opened an underweight position as we see specific fiscal risks where higher increases in spending, compared to the rest of Europe, are likely to put downwards pressure on bond prices. 

Any companies, or markets, mentioned are for illustrative purposes only, not intended to be an investment recommendation.

Key risks

• Investment not guaranteed: The value of an investment is not guaranteed and can go down as well as up. You could get back less than you’ve paid in.
• Specialist funds : Some funds invest only in a specific or limited range of sectors. This will be set out in the fund’s aim. These funds may be riskier than funds that invest across a broader range of sectors.
• Suspend trading : Fund managers are often able to stop any trading in their funds in certain circumstances for as long as necessary. When this happens, cashing in or switching your investment in the fund will be delayed. You may not be able to access your money during this period.
• Derivatives: Derivatives are financial contracts whose value is based on the prices of other assets. Most funds can invest partly in derivatives so that the fund can be managed more efficiently or to reduce risk, but there’s a risk that the company that issues the derivative may default on its commitments, which could lead to losses. Some funds also use derivatives to increase potential returns – this is known as ‘speculation’ – and an additional risk warning applies to those funds.
• Foreign exchange risk: When a fund invests substantially in overseas assets, its value will go up and down in line with movements in exchange rates as well as the changes in value of the fund’s investments.
• Emerging Markets: Where a fund invests substantially in emerging markets, its value is more likely to move up and down by large amounts and more frequently than a fund that invests in developed markets. Emerging markets may not be as strictly regulated, and investments may be harder to buy and sell than in developed markets. Emerging markets may also be politically unstable which can make these funds riskier.
• Smaller Companies: Where a fund invests in substantially the shares of smaller companies, it’s more likely to move up and down by large amounts and more frequently than a fund that invests in the shares of larger companies. The shares can also be more difficult to buy and sell, so smaller-companies funds can be riskier.
• Fixed Interest: Where a fund invests substantially in fixed-interest assets, such as corporate or government bonds, changes in interest rates or inflation can contribute to the value of the fund going up or down. For example, if interest rates rise, the fund’s value is likely to fall.
• Derivatives: Some funds also invest in derivatives as part of their investment strategy, not just for managing the fund more efficiently. Under certain circumstances, derivatives can cause large movements up or down in the value of the fund, making it riskier compared with funds that only invest in, for example, company shares. There’s also a risk that the company that issues the derivative may default on its commitments, which could lead to losses.
• Cash/Money Market funds : These are different to cash deposit accounts, such as those held with high-street banks, and their value can fall. Also, when interest rates are low, the fund’s charges could be higher than the return from the investment, so you could get back less than you’ve paid in.
• Property Funds: When a fund invests substantially in property funds, property shares or directly in property, you should bear in mind that: · Property isn’t always easy to sell, so at times the fund may not be able to cash-in or switch part or all of its holdings. You may not be able to access your money during this time. Property valuations are made by independent valuers, but effectively they remain a matter of judgement and opinion. Property transaction costs are high due to legal costs, valuation costs and stamp duty, all of which affect the value of a fund.
• High Yield Bonds: These are issued by companies and governments that have a lower credit rating. When a fund invests substantially in high yield bonds, there’s a higher risk that the bond issuer might not be able to pay interest or return the capital that was invested. The value of these bonds is also more greatly affected by economic conditions and interest rate movements. There may be times when it’s not easy to buy or sell these bonds, so cashing-in or switching your investment in the fund may be delayed. You may not be able to access your money during this period.
• Reinsured Funds: Where a fund invests in a fund that’s operated by another insurance company, you could lose some or all of the value of your investment in the fund if the other insurance company became insolvent.
• Long-Term Asset Funds: The fund invests partly in one or more long-term asset funds (LTAFs), giving access to sectors such as infrastructure, venture capital, private equity and debt investments. LTAFs add diversity to the fund, but it takes longer to move money out of them than from many types of asset. This could mean that in exceptional circumstances cashing-in or switching your investment in the fund may need to be delayed. To reduce this risk, we set strict limits on how much of the fund can be invested in LTAFs and monitor this closely.

Important information

THIS IS A MARKETING COMMUNICATION

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable but, has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. This material is not a recommendation to sell or purchase any investment. In the UK this is issued by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: 80 Fenchurch Street, London, EC3M 4AE. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178.