SMF - Q1 2026 Update

Top 3 investment themes – Q1 2026                

1. Middle East tensions drive oil price shock and volatility  

Geopolitics reasserted itself as a major market driver in Q1, with Middle East tensions pushing energy prices sharply higher and unsettling risk assets. Following US and Israeli strikes on Iran and subsequent disruption through the Strait of Hormuz, Brent crude briefly moved above $100 a barrel for the first time in four years, helping drive a broad sell‑off across bonds and equities. This marked a staggering 83.3% increase for the quarter. Ongoing supply cuts from Gulf producers, combined with alternating signals of escalation and de‑escalation, kept volatility elevated throughout the quarter.

2. Energy shocks reshaped inflation and rate expectations

The escalation of the Iran conflict reignited inflation concerns in Q1, derailing the easing trend following 2022.  Moving forwards, the outlook now heavily depends on how long tensions persist. Eurozone inflation rose to 2.5% in March, prompting a notably more hawkish shift from the ECB, which markets began to price as willing to raise rates as early as April, while the Bank of England held rates at 3.75% in a finely balanced February decision. This rapid shift from a broadly dovish tone at the start of the year to a decisively hawkish backdrop by quarter‑end weighed on asset valuations.

3. Risk assets felt the fallout

Q1 began with a relatively constructive growth backdrop, underscored by the IMF upgrading its 2026 global growth forecast to 3.3% in January on the back of US AI‑led resilience, making the subsequent reversal more striking. By March, the escalation in the Middle East had materially worsened the outlook, with higher energy prices prompting the OECD to roll back earlier upgrades and markets selling off broadly - global equities fell 1.3%, with US equities down 2.4% in GBP terms. There were few exceptions, though Japan, Asia Pacific and the UK proved more resilient due to greater exposure to energy and defence. Gold was a notable outlier, rising modestly over the quarter despite significant selloffs in January and March - a move more consistent with broad de‑risking than a reassessment of its role as a diversifier.

Q1 2026 market performance (GBP Terms¹)                                                                                                         

Past performance is not a reliable indicator for future performance.

_{Source: Morningstar as at 31 March 2026. ¹Equity and oil returns are in GBP, commodity is GBP hedged, and fixed income is GBP hedged.}

How did SMF perform?

Growth assets

Despite a strong start to the year, equity markets saw a sharp reversal after the strikes began at the end of February, as surging oil prices revived fears of a stagflationary shock reminiscent of 2022. Whilst US equities were also impacted earlier in the quarter by the software sell-off, it proved relatively more resilient once the conflict escalated, reflecting the US’s status as a net energy exporter and greater insulation from supply shocks. In contrast, Europe suffered more acutely as a net energy importer, falling 7.5% in March alone. Japanese equities stood out, delivering positive returns by the end of the quarter, following PM Takaichi's snap-election victory. Over Q1, our regional overweight positions in Japanese and Emerging Market equities, as well our sector-based position in European basic resources added to performance. However, our overweight positions in US equities and European banks slightly detracted. 

Defensive assets

Defensive assets also struggled in Q1 as the conflict pushed inflation expectations higher and forced a rapid rethink of the interest‑rate outlook, reversing the dovish stance ​that dominated at the start of the year. In the US, markets moved from pricing over 50bps of rate cuts for 2026 to almost none, while in Europe expectations swung even more dramatically, with markets pricing over 70bps of rate hikes after having priced cuts before the strikes. That shift drove a sharp rise in yields, with the 10‑year US Treasury yields rising to 4.3%, and 10‑year German Bund yields to 3.0%, their first close above that level since 2011. This increase in yields negatively weights on bond prices. The US Dollar also had a strong quarter, as investors looked for flights to safety – and alternatives to gold. Our underweight position to long-term 30-year German government bonds added to performance, whilst our underweight to the US Dollar slightly dragged. 

Alternative assets

Oil was the dominant story of Q1, with Brent crude surging +94%, its biggest quarterly jump since the 1990 Gulf War, and ending the quarter around $118/bbl. Gold had a tricky March amidst broad de‑risking across markets, but this reflected a broad de-risking rather than a loss of confidence in its defensive role. Through strong performance in January and February, gold still finished the quarter in positive territory. The UK Property fund also performed well given the falling interest rate environment, which improved investor sentiment. 

Active management themes in Q1 2026

1. A tale of two halves for equities

• Q1 was centred around rotation rather than outright risk‑on or risk‑off. Early on, we reduced our overweight to US equities as more compelling opportunities emerged, most notably in Europe and Japan.
• We increased exposure to European equities, particularly defence stocks, reflecting a significant fiscal shift led by Germany’s infrastructure and defence spending plans. In Japan, we added an overweight following Prime Minister Takaichi’s decisive election victory, with a $135bn near‑term stimulus package providing a supportive backdrop for equities.
• As geopolitical risks intensified later in the quarter, we became more selective. We trimmed relative value positions such as Emerging Markets versus US equities and European banks versus broader European markets, and closed our overweight to UK mid‑caps given their sensitivity to both geopolitical and domestic political risk.
• Markets now appear to be pricing a fairly balanced central case, but with fatter tails on both sides. Against that backdrop, we continue to retain some equity exposure to participate in potential upside. With overall market direction (beta) dominating returns rather than sector selection, we have a preference for global market‑cap exposure over more granular bets.

2. Fixed Income: inflation realities reassert themselves 

• By the end of Q1, we closed our overweight to Australian government bonds relative to US Treasuries, given the Royal Bank of Australia has stated that inflation will remain above target until 2028. This environment is damaging for bond returns, as higher inflation erodes their real value and maintains upwards pressure on yields.
• We added an underweight position to long-dated German government bonds following EU and German fiscal stimulus. We continued to add to this position throughout the quarter.

3. Remain underweight the US Dollar, with opportunities elsewhere

• We increased our overweight to the Australian dollar, supported by sticky inflation, higher‑for‑longer rate expectations, and rising commodity prices.
• We also increased our overweight to the euro relative to sterling, reflecting stronger European growth prospects linked to fiscal stimulus, while opening an underweight position in sterling given the UK’s subdued growth outlook and rising political uncertainty.

Q1 2026 Performance

Past performance is not a reliable indicator of future performance

_{Source: Morningstar as at 31 March 2026. Performance is shown net of fees.} 

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 31st August 2025.}

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

The escalation in the Middle East and the subsequent rise in oil and gas prices have added a fresh layer of uncertainty to the global outlook, however the extent of the impact is bound by how quickly a resolution is reached and the reopening of the Strait of Hormuz - a critical global oil choke point. In our central scenario, 2026 inflation risks have shifted higher while the growth outlook has softened, particularly in energy‑importing regions like the UK and Europe. In terms of interest rates, central banks may initially look through the oil shock, but the risk of persistent inflation could delay or even halt expected policy easing. We now expect rate hikes from the ECB, and in an adverse high oil-price scenario, see the possibility of rate rises from the BoE and Fed as well. 

In terms of equity regions, despite heightened geopolitical uncertainty, the outlook for equities remains broadly positive but with the potential for more extreme outcomes, whether that be positive or negative. To maintain upside market participation, our overweight positions are focussed on the US, Japan and Emerging Markets in which their growth prospects remain relatively resilient. We also retain relative value positions in European defence and banks given the longer-term structural themes.

In fixed income, given increased fiscal spending in Europe – and especially Germany - which facilitates greater levels of spending, we hold an underweight position to long-term German government bonds. We retain our underweight US Dollar position, which is relative to overweight positions in Australian Dollar Euro & EMD Local Currency. We also remain underweight the Pound given political risks surrounding the government with the upcoming local elections. 

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

Key risks

• Investment/Objective risk - The value of an investment and any income from it can go down as well as up. Investors may not get back the original amount invested.
• Currency risk - The fund is exposed to different currencies. Derivatives are used to minimise, but may not always eliminate, the impact of movements in currency exchange rates.
• Derivatives risk - Investments can be made in derivatives, which can be complex and highly volatile. Derivatives may not perform as expected, meaning significant losses may be incurred. Derivatives can have some degree of unpredictability (especially in unusual market conditions), and can create losses significantly greater than the cost of the derivative itself.
• Emerging market risk - Investments can be made in emerging markets. These markets may be volatile and carry higher risk than developed markets.
• Fixed Income risk - Investments in fixed interest securities are impacted by market and credit risk and are sensitive to changes in interest rates and market expectations of future inflation. Bonds that produce a higher level of income usually have a greater risk of default.
• Specialist Funds risk - 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.
• Suspension of trading risk - 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.
• This is a summary of the key risks. For further information on the full risks and risk profiles of the fund, please refer to the relevant Fund Factsheet.

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.

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