Positioning our portfolios for 2026

As we step into 2026, investors face a dynamic landscape shaped by shifting market forces, evolving asset allocation strategies, and the relentless advance of technology.

The past year has underscored the importance of diversification, tactical flexibility, and a keen eye on valuation – principles that will continue to guide successful portfolio management in the months ahead.

Market backdrop: risk-on, but with nuance

2025 was another strong year for riskier assets, with equities delivering robust returns across regions . Yet, for UK-based investors, currency movements played a pivotal role: while US equities performed well the weakening dollar tempered gains, whereas European equities benefited from favourable currency shifts. The AI revolution remained a central narrative, calming market volatility and fuelling optimism.

Bond markets, meanwhile, revealed a stark divide. Government bonds wrestled with inflation uncertainty and political crosswinds, even as interest rates fell. In contrast, corporate credit thrived in a benign global economy, with high-yield bonds standing out as investors embraced risk.

This environment highlights a recurring truth: while short-term market attention is unpredictable, long-term returns are often anchored in valuations.

Capital market assumptions: valuations and yields

Equity valuations have climbed, narrowing the gap in expected returns across regions. In the US, rising earnings have offset higher market levels, while other markets have seen valuation multiples expand. The upshot? The difference in expected returns between equity markets has shrunk for the second year running.

On the fixed income side, government bond yields remain steady despite rate cuts, but corporate bond yields have fallen, compressing credit spreads to near record-lows. Corporate bonds do however offer a compelling yield advantage, which is increasingly viewed as lower risk than government debt amid ongoing fiscal expansion.

Strategic Asset Allocation: diversification takes centre stage

The most notable shift in high-level asset allocation for 2026 is the introduction of GBP-hedged global government and corporate bond asset classes. These offer attractive yields relative to volatility and are less volatile than UK gilts. In higher-risk portfolios, cash allocations are reduced in favour of equities – a more efficient use of capital given the acceptance of higher expected volatility.

At a more granular level, several changes stand out. As interest rates declined in 2025, returns on cash and money market funds fell, making government bonds more appealing. The asset allocation now includes hedged allocations to global government and corporate bonds, with a particular focus on inflation-linked bonds and European diversification.

Within equities, the narrowing of valuation spreads has prompted a further rotation toward the US, funded largely by reductions in European equities. While the outlook for Europe remains positive, our unemotional optimisation process has tempered enthusiasm when considering historical volatility in the region.

Tactical Asset Allocation: responding to opportunity

Tactical changes focus on areas where risk perceptions diverge from model assumptions. The optimisation model, while robust, relies on historical data and major asset classes, leaving room for more nuanced analysis at the sector and country level.

Bonds: short duration and diversification

Portfolios remain short duration, reflecting uncertainty about compensation for lending longer amid inflation risks. Attractive real yields are now available in the UK and US, and diversification is expanding to include Germany and France, though exposure to the broader global government bond market remains limited.

You can read more about what we are doing with bond allocations in this article below.

Passive Funds and MPS: sector strategies

The move towards US equities provides a juncture to use sector allocations to enhance diversification. Defensive sectors like Healthcare and Utilities provide stability and AI-driven efficiency gains, while Energy offers cyclical upside and long-term relevance as AI increases power demand. The strategy balances resilience with growth potential – a barbell approach that leverages AI benefits.

You can read more about what we are doing with sector allocations in this article.

Active MPS: blending styles and sectors

Growth portfolios in the UK now include the Evenlode Income fund for quality exposure, complementing existing core and value styles. In the US, sector ETFs tilt portfolios toward Utilities, Healthcare, and Energy. Japan allocations blend the Jupiter Japan Income fund’s quality growth approach with the broader M&G Japan fund.

Outlook: embracing uncertainty with discipline

As 2026 begins to unfold, the investment environment remains rich with possibilities. Diversification – a core principle at AJ Bell – remains vital. While headlines may be captured by dominant narratives like AI, the focus is on building robust portfolios that can weather diverse scenarios. Opportunities will emerge as equity market dynamics shift, and much will depend on how the AI theme evolves. In fixed income, the yield curve’s shape will guide decisions on duration and risk.

Next steps to consider

If you have any questions about how these changes affect your portfolio, please contact your Investment Business Development Manager.

For deeper insight into our 2026 asset allocation approach, download our latest brochure.

The value of investments can go down as well as up and your client may not get back their original investment.

Past performance is not a guide to future performance and some investments need to be held for the long term.