Hurdles navigated, but what lies ahead?

Despite frequent concerns about politics and potential recessions, equity markets remained resilient in 2024. US equities posted another exceptional year, whilst market concentration rose to record highs. Most other equity markets delivered decent returns in sterling terms, and the rebound in China was ferocious at times. Those wishing for 2024 to be ‘the year of the bond’ had reason to feel disappointed for the second year running. Although corporate bonds fared well as credit spreads contracted, volatility in government bond markets remained.

Looking to 2025

The agenda for 2025 feels less formalised. With major elections now out of the way, attention turns to how freshly-installed governments and policymakers will deliver – and the incoming Trump administration will no doubt be high up on the watchlist. The Trump agenda regarding taxes and tariffs will likely draw the market’s attention, and perhaps the state of fiscal deficits will too, as more details emerge. Elsewhere, China remains a key issue for many economies around the world. Policymakers have shown a willingness to put significant stimulus into the economy, and attention will turn to delivering results.

Strategic Asset Allocation

As a reminder, we set six core asset allocations that cascade to the different funds and portfolios. The application of our 1-6 portfolios, or risk profiles, is linear within the growth ranges. Risk profile 3 acts as a starting point for the Income Fund and Income MPS 1, while risk profile 5 acts as a starting point for the Income & Growth Fund, Income MPS 2 and the Responsible Screened Growth Fund.

We regularly review and look to evolve our process to ensure it remains relevant. For 2025, we’ve made two structural changes to the asset allocation framework: the removal of Alternatives and the introduction of Emerging Markets ex-China.

In 2024 our research indicated that we weren’t getting characteristics that justified using Property and Infrastructure as Alternatives within our optimisation. We have therefore removed these assets from the optimisation process, and now consider them to be equity sectors that are available for tactical use instead.

Overlapping country positions within our allocations to Asia ex-Japan and Emerging Markets had been a bugbear for some time. However, significant product development and a new willingness to improve costs mean we can now separate these regions into three distinct allocations: China, Emerging Markets ex-China, and Pacific ex-Japan – the latter being a developed market index. This improves the quality of our optimisation, and gives greater flexibility and transparency regarding China.

Both changes are covered more extensively in these articles:

We’re also making some SAA changes for 2025. Our forecast returns for cash are still attractive, albeit slightly diminished by interest rate cuts throughout 2024. This compares with persistent volatility in government bonds and reduced credit risk premiums. As a result, we’re allocating more to cash in risk profiles 1 to 4.

Throughout the last couple of years, the portfolios have benefitted from allocation to global high yield bonds. For 2025 this is supplemented by an increased allocation to Emerging Market Debt (EMD) for risk profiles 1 to 4. Fiscal and monetary policy in emerging countries is often dancing to a different beat than those of developed countries, meaning they currently offer diversification benefits with an attractive yield. The allocation to high yield in risk profile 6 has been removed, as yields are broadly in line with equity market expected returns, leaving this portfolio 98% invested in equities.

Within equities, the optimisation has tilted positioning towards the value on offer in Europe, and we’re increasing the allocation to the US. Within the Funds and Passive MPS we have taken this opportunity to diversify away from the traditional market cap exposure in the US towards an equal weight index to manage concentration risk. The allocation to UK equities is reduced for risk profiles 3 to 5, keeping our home bias in check after a decent 2024, and as we seek opportunities elsewhere.

Overall, the portfolios have an increased allocation to equities, as they act to balance out the reduced volatility coming from an increased allocation to cash, the removal of property and the tactical changes we have made within fixed income allocations.

That leads us to the Tactical Asset Allocation (TAA) decisions we have made for 2025. These all focus on a building risk we see within bond markets, namely inflation. We believe service sector inflation is proving sticky, and whilst goods prices have been stagnant and are even falling in some cases, there’s little scope for error. A revival of goods prices this year, or some form of shock, could cause a resurgence of widespread inflation that necessitates a further rise in bond yields. This would pose another nasty surprise for longer duration positioning, so we’ve reduced duration from c.5-6 years to 3-4 years. This moves the portfolios from what felt for us like a neutral level of duration, to a short duration position – albeit not an extreme one. In addition, we’ve added some US TIPS to risk profiles 1-3 to add another layer of protection.

In conclusion, the 2025 SAA sees higher turnover within the portfolios to facilitate our structural changes to the process, the refreshed optimisation of positioning, and some tactical intervention. As we progress through the year, we’ll remain committed to our disciplined approach to asset allocation changes, and will only act if we see a significant opportunity or risk to our current positioning.

For even more information on our Strategic Asset Allocation approach for 2025, head to our dedicated area, where you’ll find our latest AJ Bell Funds and Managed Portfolio Service portfolios, further reading and a Q&A with our Head of Investment Solutions, James Flintoft.

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