SMF quarterly update

Welcome to your Q2 2-24 update from the Aviva Investors' Multi Asset Team.

How did SMF perform?

Growth assets

Asia Pacific ex Japan equities and Emerging Market equites were the best performers this quarter, and our Emerging Market index fund was the best performer within Growth assets for Q2. Asia-Pacific ex Japan equities benefited from the strong performance of commodities such as precious and industrial metals. Japanese equities, on the other hand, struggled partly due to yen depreciating, which eroded returns from a sterling investor’s perspective. In fact, the yen was the worst performing currency among the group of ten (G10) economies in Q2, for the second consecutive quarter. Within developed markets, UK and US equities performed well. In fact, the US equity market once again reached new all-time highs due to the strong performance of the Magnificent Seven. From an active performance perspective, our overweight position in US equities was a positive contributor in Q2, whilst our overweight to Japanese and European equities detracted from performance.

Defensive assets

Whilst equity markets performed well, fixed-income markets struggled. Despite interest cuts from the ECB and Bank of Canada, the combination of persistent inflation and resilient growth in the US economy resulted in investors continuing to temper their expectation for the scale and timing of interest-rate cuts. This resulted in the poor performance of most developed-market government bonds. Global High Yield ended in positive territory and investment-grade credit markets were flat. Given this backdrop, our overweight to Gilts detracted from performance, whilst our underweight position in Japanese government bonds contributed.

Alternative assets

The Alternative assets within the fund produced a positive return in Q2. This was driven primarily by the Aviva Investors Target Return fund which has benefitted from the commodities rally this year. This helped to offset losses within the Defensive sleeve. 

Key active management themes in Q2 2024

1. Remain overweight equities, with a preference for European equities

• We remain overweight US, Japanese and European equities, with a preference for greater exposure to the latter. The low valuations of European equities continue to present an attractive opportunity.

2. Closed our long German government bonds position

• We closed our overweight in German government bonds as markets have continued to temper their expectations for rate cuts this year.

Top 10 Equity holdings

Source: Aladdin, as at 30 June 2024.The reference fund is SMF.

SMF & SMF 2 Fund Price Adjustments (FPA)

There were no fund price adjustments in Q2 2024.

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

From an active asset allocation perspective, we prefer equities given they have the potential to perform well in a disinflationary environment where major economies do not slow materially. Regarding fixed income, markets have continued to temper their expectations for interest-rate cuts, which means fixed-income assets may have more scope to perform better going forward.

In terms of equity regions, we remain overweight the US, Japan and Europe. Although US equity valuations may be high, they are still being supported by strong earnings generation, particularly from tech stocks, and a relatively resilient economic growth in the US. Regarding Japanese equities, we continue to see opportunities as the country finally emerges from decades of deflation, coupled with significant corporate governance reforms; these positive trends have contributed to Japanese equity markets reaching new highs. European equities look attractive from a valuation perspective, with promising signs these companies can deliver better growth. 

In terms of our fixed-income allocation, we continue to be overweight UK gilts and underweight Japanese government bonds. Essentially, we believe Japan is at the start of its hiking cycle, with inflationary pressures likely to lead to further interest-rate hikes by the Bank of Japan following its historic exit from negative interest rates in the second quarter. Central banks in other economies are likely to start to cut interest rates this year, but relatively weaker growth in the UK, compared with the US, could lead to more, or faster, rate cuts by the BoE.

Top 3 investment trends – Q2 2024

Investors continued to temper their expectations for interest-rate cuts in the second quarter, even as the European Central Bank (ECB) cut rates for the first time since 2019. Despite that, equity markets continued to perform well, with the US equity market reaching a new all-time high thanks to the strong performance of the “Magnificent Seven” group of tech firms. Finally, investors turned their attention to political risks, particularly French President Emmanuel Macron’s decision to call a snap election, which led to a fall in the value of French assets.

1. The Magnificent Seven propels US market to new heights

The US equity market was propelled to all-time highs thanks to the strong performance of the Magnificent Seven, a group that includes some of the largest companies in the world, such as Apple, Meta and Nvidia. Nvidia, a US semiconductor chipmaker, was the star performer. It briefly became the biggest public company in the world, overtaking Microsoft and Apple, after shattering analyst expectations in its May earnings report. The company has returned a scarcely credible 27,000 per cent over a ten-year period, in large part thanks to the smart moves it made years ago to corner the artificial intelligence (AI) chips market.

There was less excitement in other areas. Equity market returns were disproportionately driven by the Magnificent Seven; for example, the equally weighted S&P 500, which better represents the performance of the wider US equity market, delivered a negative return in the second quarter, which underlined the extent to which the leading tech firms have been responsible for driving positive market returns. The hope for investors going forward is that positive returns will begin to broaden out to other sectors, rather than continue to be driven narrowly by the Magnificent Seven.

2. Interest rate cuts have started, but slowly

Inflation and the potential for interest rate-cuts continued to be the primary focus for investors. There were growing concerns inflation was starting to get stuck on the way back down, particularly in the US, where the annual personal consumption expenditures (PCE) inflation (the Federal Reserve’s preferred inflation measure) increased by +2.7 per cent in March versus 2.5 per cent in February. Stickier inflation, coupled with a resilient US economy, led to the Fed deciding not to cut interest rates in Q2, with the central bank’s officials now signalling just one interest-rate cut this year. That’s a big change, given investors thought at the beginning of the year that the Fed was going to start cutting interest rates as early as March.

Similarly, in the UK, the Bank of England (BoE)  decided to keep interest rates on hold at 5.25 per cent (the highest level in 16 years) in its June meeting, despite recent indications inflation had returned to the bank’s two per cent target. Nevertheless, this decision was in line with what investors expected. From here the expectation is for the BoE to cut twice this year, with a possibility of the first cut occurring in August. Some central banks did, however, begin to cut interest rates. For example, the ECB and the Bank of Canada both delivered cautious rate cuts of 25 basis points in June. This was the first ECB cut since 2019 and helped to reduce the deposit interest rate to 3.75 per cent. Despite these cuts, investors’ overall expectation is now for fewer rate cuts this year. 

3. Elections took centre stage

It was always likely that politics would become a dominant theme in 2024. About 50% of the world's population go to the polls this year. Although political risk is ever present for global investors, the wider range of possible outcomes makes this year feel different. Political developments were back in focus from June, as the European Parliament elections took place at the start of the month. The results showed a rise in support for right-wing parties, such as National Rally led by Marine Le Pen, known for its Euroscepticism. Following that result, investors were shocked by President Macron’s decision to call a snap election, with the first round taking place on June 30. That led to a rise in uncertainty and a notable fall in the value of French equity and bond assets. Although a left-wing alliance won the most seats in the second round of the vote on July 7, no party wielded an absolute majority.

The UK’s general election on July 4 caused little to no market reaction, as investors fully expected a changing of the guard with Labour securing a majority, and the result was as anticipated. Looking forward, the big political event for investors will be the US presidential election in November. Although this is still months away, Joe Biden and Donald Trump went head-to-head in their first televised debate of their 2024 election campaigns on June 27. Following the debate Trump maintained his lead in some polls, as worries about Biden’s performance added to the uncertainty around his re-election prospects.

 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

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited ("Aviva Investors"). Unless stated otherwise any opinions expressed 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. 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.

Issued by Aviva Investors UK Fund Services Limited. Registered in England No 1973412. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119310. Registered address: 80 Fenchurch Street, London, EC3M 4AE. An Aviva company.