The Almanac

Preface

Investment portfolios and society itself have transformed dramatically over the past 125 years. Waves of innovation have reshaped our lives, the global economy and investment opportunities. Because markets and investable assets are constantly evolving, there have often been many periods when investors have needed to make deliberate changes to portfolio structures to preserve relevance and maintain an appropriate risk-return profile.

Together, Sarasin's Compendium and The Almanac are designed to support investors in making timely, well-supported decisions by combining long-term perspective with a clear framework for interpreting change. At their core, they seek to address a simple question: how can investors best use today's opportunity set to meet their objectives, both now and over the coming years?

In the Compendium, we set out the asset classes we would expect to see in a multi-asset portfolio and examine how they have behaved historically across a wide range of market environments. Our focus extends beyond returns to include risks, trade-offs and structural characteristics that shape how asset prices behave over long horizons. The Compendium also addresses the practical skills and questions investors must consider when developing a bespoke investment policy, including governance, diversification and the interaction between objectives and constraints. In this new publication, we build on those foundations.

Over the past five years, Sarasin & Partners has developed its concept of Investment Regimes.

Regimes don't last forever: they change when the underlying political and economic foundations shift. A central aim of The Almanac is to ground investment decisions in durable medium-term trends by placing today's choices within a broader context.

Many of the challenges investors face are better understood through longer-term historical analysis than many investors consider.

This discipline also informs our dynamic approach to managing strategy. We are proactive in recommending change to strategy when circumstances suggest evolution is necessary, and we seek the freedom to operate within agreed tactical parameters in the intervening years.

This first edition of The Almanac is structured in three parts:

Adapting portfolios to changing market dynamics is seldom comfortable and rarely straightforward. In an ever-noisier world, we believe a regime-based framework can help investors stay focused on the long-term while providing a clear rationale for when more fundamental change is warranted. However, these thoughts are only ever a starting point for a discussion. Ultimately, we are a client-driven, solutions-led business, building investment strategies and portfolios that are designed to meet an individual client's specific objectives, constraints and requirements. The precise strategy, tactical degrees of freedom we are allowed to operate within, the degree of active management and use of specialist managers are all elements that are part of this discussion.

We hope you find the combination of the Compendium and The Almanac thought-provoking and a robust framework for policy setting, designed to support the pursuit of attractive returns over the period ahead.

Identifying and interpreting these regimes sits at the core of our investment philosophy.

The regimes we have identified and outlined below span several decades, reaching back to the end of the Second World War in 1945. When examining these periods, it is important to recognise that, within any given regime, variables such as growth, inflation, interest rates, and bond yields oscillate around distinct trends. However, these trends do not persist indefinitely; regimes shift when imbalances accumulate over time – for example, during the global financial crisis of 2008–09, or the breakdown of the Bretton Woods system in the early 1970s (which had maintained fixed exchange rates, with the US dollar convertible into gold at $35 per ounce).

Regimes can also shift in response to external shocks, such as the end of the Cold War in the early 1990s, or more recently, the global Covid-19 pandemic. These transitions are often marked by sharp market movements, followed by a gradual adaptation to the new trend.

Our Post-War Regimes in Historical Context

With this in mind, we can look at these specific regimes in more detail. We divide the post-war period into six distinct regimes (Figure 1A.1).

Figure 1A.1

From Global Cooperation to Global Fragmentation

The post-war global economy was characterised by Multilateralism, with the establishment of cooperative international institutions that helped stabilise prices and reduce inflation volatility. A post-war baby boom and widespread reconstruction further fuelled strong global economic growth.

Post-Bretton Woods covers the tumultuous period following the collapse of the gold standard in 1971, driven by persistent US current account deficits. The OPEC oil embargo of 1973, followed by the Iranian Revolution in 1979, triggered a dramatic surge in inflation. With monetary and fiscal policies remaining too loose, inflation expectations became unanchored and the global economy entered a period of stagflation.

The 1980s and 1990s brought the Great Moderation, marked by the reassertion of monetary discipline, supply-side reforms and the end of the Cold War. This ushered in a multi-decade period of stable, low inflation and reduced economic volatility. Interest rates declined, and business cycle fluctuations diminished sharply.

China's accession to the World Trade Organization (WTO) and the expansion of internet connectivity across the economy represented a positive supply shock. Globalisation accelerated, goods prices experienced sustained deflationary pressure, and inflation continued to decline.

This regime of relative stability came to an end with the global financial crisis of 2008, which ushered in a prolonged period of deficient demand – Secular Stagnation – as the balance sheets of banks, households and governments came under severe strain. In response, central banks pursued an aggressive strategy of financial repression: policy rates were cut to the zero lower bound, and large-scale asset purchases compressed term premia (the extra return investors demand for holding longer-term bonds instead of rolling over short-term ones) across fixed-income markets. Weak private demand, combined with persistent goods-price disinflation driven by China's integration into global supply chains, exerted further downward pressure on inflation, causing it to remain persistently below central bank targets.

Crucially, we believe that in recent years we have entered a new regime of Global Fragmentation. The post-pandemic global economy is shifting decisively away from an open, co-operative framework towards a more fragmented system dominated by power politics. In this less globalised world, governments must confront mounting fiscal pressures, climate-related challenges, ageing populations and heightened geopolitical insecurity. These forces are likely to result in more frequent supply shocks and less flexible supply chains. As a consequence, inflation and its volatility are expected to rise, accompanied by higher interest rates and term premia.

Regimes in Practice: The Role of Inflation

As long-term investors, regimes define the broad contours of the investment landscape. They drive the behaviour of key variables that we monitor closely: inflation, interest rates, term premia, growth and economic volatility.

In this context, regimes are best illustrated by the behaviour of inflation in the post-war US economy. While US inflation has averaged about 3.5% over the past 75 years, there have been wide divergences sustained over long periods.

After 1945, as multilateral institutions were established, inflation averaged around 2%, and its volatility declined sharply. In the early 1970s, the breakdown of the Bretton Woods arrangement, coupled with accommodative monetary policy, unmoored inflation, which averaged nearly 7% per year. In the early 1980s, policymakers adopted aggressive measures to re-anchor inflation expectations. Supported by supply-side reforms, inflation fell to around 4% during the 1980s and 1990s.

With the acceleration of globalisation in the early 2000s, inflation declined further, averaging about 2.7%. Following the global financial crisis of 2008, inflation continued to drift lower despite unprecedented monetary accommodation, settling at an average of 1.7%. Today, inflation has proved more persistent, remaining around 3% since 2021, and we expect it to stabilise within a 2.5%–3% range.

Chart 1A.2

US Inflation During Market Regimes

Chart 1A.2 illustrates the US Consumer Price Index (CPI) for headline inflation since the 1940s. It is worth noting that there can be persistence across regimes. For instance, inflation continued to fall on average through several of our identified regimes – from the 1980s to 2020 – encompassing the Great Moderation, Globalisation, and Secular Stagnation.

The drivers of this decline, however, have differed over time. During the Great Moderation, central banks adopted explicit inflation targets and pursued policies of opportunistic disinflation. In the era of Globalisation, China's integration into the global trading system acted as a sustained positive supply shock. During Secular Stagnation, the global economy experienced persistent shortfalls in demand as households and banks sought to rebuild their balance sheets.

Inflation is not the only variable to display regime-dependent behaviour. Interest rates, economic growth, term premia and volatility have also followed distinct patterns in response to shifting macroeconomic regimes. Table 1A.3 summarises how these dynamics have evolved within the US economy.

Regimes in the Context of Our Themes

For us, examining long-term regimes goes hand in hand with our focus on thematic investing – capturing the enduring trends that influence markets and economies over extended periods.

Slow-moving drivers such as demographics and technological change are key sources of thematic growth, expressed through our themes of Evolving Consumption, Ageing, Climate Change, Automation and Digitalisation. However, when a regime shifts due to material change in the macroeconomic or geopolitical environment, it can act as a catalyst for new thematic opportunities. At Sarasin, we have often introduced new themes at these regime turning points.

For example, in the early 2000s, as the Globalisation regime gathered momentum, we introduced our now-retired Global Convergence theme. This led to increased allocations to emerging markets – an approach that, in hindsight, proved highly successful. In the early 2010s, in the aftermath of the global financial crisis, we recognised the emergence of Financial Repression and reflected this in our asset allocation through a measured pro-risk bias.

More recently, following the global Covid-19 pandemic, we identified the breakdown of Secular Stagnation and the emergence of a new regime, which we define as Global Fragmentation. We subsequently explored the implications of this regime shift for equity markets and introduced a new equity theme under the heading Security.

How Regimes Inform Our Investment Choices

We believe that applying a regime lens enables us to calibrate investment decisions more effectively. As we have shown, the distinct behaviour of inflation, interest rates, term premia, growth and volatility within each regime shapes asset returns, correlations between asset classes and, ultimately, broader market structures.

While we were not personally investing fifty years ago, history offers clear lessons. After the breakdown of Bretton Woods in the 1970s, rising inflation pushed up both bond yields and equity risk premia, eroding their diversification benefits within multi-asset portfolios. In contrast, during Globalisation, disinflation lowered interest rates over time while also helping to anchor inflation expectations. That combination supported returns across both equities and bonds, even as they tended to move in opposite directions during growth shocks, creating a more reliably negative correlation in drawdowns. During Secular Stagnation, persistently low growth, subdued inflation and near-zero interest rates favoured long-duration and illiquid assets such as growth equities, infrastructure and private markets.

Today, as we transition into Global Fragmentation, we expect inflation to remain elevated and nominal growth to be robust. This view is reflected in default tilts to our asset allocation: a long-term positive outlook for global equities, a preference for short-duration bonds, and selective exposure to alternatives such as gold.

Demographics: From Tailwind to Constraint

For much of the post-war period, advanced economies benefited from favourable demographics (Chart 1B.1). Working-age populations expanded, participation rates rose, particularly among women, and dependency ratios (the relationship between the non-working age population and the working age population) declined (Chart 1B.2). Together, these forces provided a powerful tailwind to growth.

Chart 1B.1

Working-Age Population Growth (%)

That backdrop has now reversed. Populations across most developed economies are ageing rapidly, and growth in the working-age population has slowed sharply or turned negative. While higher participation among older workers has helped cushion the impact in recent years, the scope for further gains is limited by health constraints and already-high participation rates.

Immigration could offset these pressures, but political realities point in the opposite direction. Public resistance to large-scale immigration has intensified, suggesting that net migration will remain structurally lower than in previous decades.

Ageing also affects the composition of economic activity. As societies grow older, spending shifts towards health and social care – sectors that are typically labour-intensive and less productive. At the same time, demographic change alters saving behaviour, as a growing share of households move from saving to dissaving in retirement. Over time, this is likely to reduce aggregate savings and place upward pressure on real interest rates.

Chart 1B.2

Dependency Ratios

Technology: Productivity in a Constrained World

Against this challenging demographic backdrop, technological progress has become increasingly important. Digitalisation has supported productivity growth for decades, and recent breakthroughs in generative artificial intelligence represent the next phase of this process.

We believe AI has the potential to meaningfully lift productivity growth over the next decade, particularly in knowledge-intensive services such as finance, professional services and technology. The scale of the potential impact is comparable to the productivity acceleration seen during the 1990s technology boom.

However, these gains will not arrive overnight. Adoption is likely to be gradual, reflecting the need for organisational change, workforce adaptation and complementary investment. In the near term, the AI transition is more likely to boost investment spending – particularly in data centres, chips and energy infrastructure – than to deliver immediate efficiency gains.

Over time, as AI becomes embedded across business processes, productivity improvements should help offset some of the inflationary pressures generated elsewhere in the system. The benefits, however, will be uneven. Economies with flexible labour markets, deep capital markets and a large share of knowledge-based services are best positioned to gain, raising the risk of wider productivity gaps across countries.

Policy: High Debt, Harder Trade-Offs

Public debt levels across advanced economies are now historically high (Chart 1B.3). Governments face rising interest costs alongside growing spending pressures from ageing populations, rising defence expenditure and the climate transition (Chart 1B.4). At the same time, political support for fiscal restraint remains limited.

Chart 1B.3

Net Debt as % of GDP Estimates and Forecasts

This combination narrows policy choices. Persistent deficits risk crowding out private investment and weighing on long-term growth, while higher debt increases sensitivity to interest rates. As a result, fiscal sustainability has become a more prominent macroeconomic constraint.

Monetary policy also faces a more difficult environment. Unlike the post-financial-crisis period, which was defined by weak demand, today's challenges are increasingly supply-driven. Central banks must balance inflation control against financial stability and fiscal pressures, increasing uncertainty around policy paths and outcomes.

Regulatory approaches are also shifting, with the US in particular moving toward lighter regulation to support competitiveness and investment. While this may encourage innovation, it is accompanied by greater policy volatility and less predictable rule-making, adding to uncertainty for businesses and investors.

Chart 1B.4

Fiscal Deficit Composition, % of GDP

Geopolitics: From Integration to Rivalry

Perhaps the most defining feature of the new regime is the shift in the global geopolitical landscape. The cooperative, rules-based system that underpinned decades of globalisation is giving way to a more competitive and fragmented order.

Strategic rivalry, most notably between the US and China, is reshaping trade, investment and technology flows. Governments are making greater use of tariffs, subsidies and industrial policy to protect domestic industries and secure strategic advantages (Chart 1B.6). Supply chains are being redesigned for resilience rather than efficiency, making them more costly and less flexible.

Financial fragmentation is also emerging. The expanded use of sanctions has prompted some countries to reassess their reliance on the dollar-centric financial system. While the US dollar remains dominant, gradual diversification into alternative assets and payment systems is likely to continue. Many foreign central banks have started to shift their reserve holdings away from US Treasuries into gold (Chart 1B.5).

At the same time, rising geopolitical tensions are driving higher defence spending and renewed focus on strategic resources, reinforcing uncertainty and volatility across the global economy.

Chart 1B.5

Holdings of Reserve Assets

Chart 1B.6

US Customs Duty Collected Monthly (US Dollar, Billions)

Climate: A Slow-Burn Constraint

Climate change has not defined previous market regimes, but it is becoming an increasingly important factor. Over the next five to ten years, the direct global macroeconomic impact is likely to remain modest, in part because much of the burden, for now, is being absorbed by government balance sheets while the risks build. By contrast, regional disruptions from extreme weather events are becoming more frequent. The transition to a lower-carbon economy adds further complexity. Large-scale investment, regulation and carbon pricing place upward pressure on costs and add to the fiscal strain. More broadly, climate change contributes to political and social tension, reinforcing the sense of a more interventionist and uncertain policy environment.

Conclusion

Global Fragmentation reflects a fundamental reordering of the forces shaping the world economy. Demographic constraints, technological acceleration, high public debt, geopolitical rivalry and climate pressures are interacting in ways that differ markedly from the pre-pandemic era.

While innovation, particularly in AI, offers genuine long-term upside, it unfolds in a more constrained, volatile and politically complex world. Understanding these drivers is essential for navigating the decade ahead.

Macro Outcomes for the US

In this section, we bring together the key structural regime drivers discussed earlier to form a coherent set of macroeconomic forecasts for the United States over the next five to ten years. Specifically, we provide projections for average real GDP growth, inflation, the neutral real interest rate (r*), and nominal and long-term bond yields, and compare these outcomes with those observed during the 2010–2019 period. While some variables may continue to trend over a ten-year horizon, as they did during the post-Global Financial Crisis (GFC) decade, we argue that the composition of growth, inflation dynamics, and interest rates will differ materially from the previous regime.

This analysis focuses explicitly on US macroeconomic outcomes. However, we believe the underlying forces – demographics, deglobalisation, fiscal expansion, climate transition, and the diffusion of artificial intelligence – are global in nature. As such, while magnitudes may differ across regions, the directional trends and investment implications are likely to apply more broadly. Estimates for other major economies and regions are provided in the next article.

Labour Force Growth

Over the very long run, labour force growth in the United States has averaged approximately 1.2% per year. However, this headline figure masks significant variation across different historical periods. From the 1960s through to the late 1990s, labour force growth was supported by powerful tailwinds: rising female labour force participation, strong population growth, and high levels of immigration. During this period, total labour force growth frequently ranged between 1.5% and 2.5% per annum.

Since the turn of the millennium, these tailwinds have faded and, in some cases, reversed. Labour force participation has been on a persistent downward trend, driven largely by demographic factors. The retirement of the baby boomer cohort has mechanically reduced participation rates, while longer-term structural forces, including lower fertility rates and slower population growth, have further constrained labour supply. Although cyclical recoveries have periodically boosted participation at the margin, the underlying trend has been one of deceleration.

Looking ahead to the next macroeconomic regime, we forecast labour force growth of just 0.25%. This represents a meaningful step down from our previous forecast of 0.6% and reflects a confluence of structural constraints. In particular, sharply lower expected immigration flows materially reduce labour force growth relative to pre-pandemic assumptions. At the same time, continued population ageing exerts downward pressure on participation, especially among prime-age and older workers.

For context, labour force growth during the secular stagnation period following the GFC averaged around 0.5% per year. Our current forecast implies an even weaker contribution from labour inputs to overall economic growth, reinforcing the importance of productivity as the dominant driver of future GDP growth.

Productivity Growth

In contrast to our more cautious outlook on labour supply, we hold a relatively positive view on medium-term productivity growth. We forecast annual productivity growth of approximately 2.0% over the next five to ten years, a pace that exceeds the Congressional Budget Office (CBO) estimate and represents a clear improvement relative to the post-Global Financial Crisis experience.

During the 2009–2019 period, US productivity growth averaged roughly 1.5% per year. This subdued outcome reflected several headwinds, including weak capital expenditure, lingering balance sheet repair, and pessimistic growth expectations that discouraged risk-taking and investment.

Our more optimistic outlook rests on two key pillars. First, we expect a sustained improvement in capital expenditure, driven by a combination of industrial policy, reshoring of supply chains, and large-scale spending on digital and physical infrastructure. Second, and more importantly, we believe the diffusion of artificial intelligence into business processes has the potential to meaningfully lift trend productivity growth over the medium term.

To frame our 2.0% productivity forecast, we begin from a historical midpoint of around 1.5%. From this baseline, we incorporate several offsetting forces. On the negative side, we expect a drag of approximately 0.2 percentage points from the crowding out of private sector investment caused by persistently large fiscal deficits. Elevated government borrowing absorbs savings that might otherwise have financed more productive private investment. In addition, increased trade barriers and a partial reversal of globalisation are likely to shave a further 0.2 percentage points from productivity growth by reducing competitive pressures, fragmenting supply chains, and limiting knowledge spillovers. Offsetting these drags, we assume that artificial intelligence contributes a net positive effect of around 1.0 percentage point to productivity growth over the next five to ten years. Importantly, we expect this contribution to be back-loaded. While the underlying technology is advancing rapidly, deploying AI at scale requires complementary investments in skills, organisational change, data infrastructure, and regulatory adaptation. As a result, productivity gains are likely to accrue gradually rather than immediately.

GDP Growth

Combining our forecasts for labour force growth and productivity growth, we estimate that real GDP growth in the United States will average approximately 2.25% over the coming years. This is notably above the CBO's forecast of around 1.8% and slightly above our previous estimate of 2.0%.

While headline GDP growth remains comparable to historical averages, the composition of growth is shifting in important ways. Unlike the pre-2000 period, when labour force expansion played a dominant role, future growth will be driven disproportionately by productivity gains. In this sense, the next decade may resemble an inversion of the secular stagnation period: weaker labour inputs but stronger technological and capital-driven growth.

Inflation

We forecast average consumer price inflation of approximately 2.5% in the United States over the next five to ten years. This represents a clear regime shift relative to the post-GFC era, during which inflation averaged closer to 1.75% and persistently undershot central bank targets.

In earlier forecasts, we had expected inflation to trend upwards gradually from 2.5%, rising by around 10 basis points per year before plateauing near 2.75%. However, our stronger outlook for productivity growth, particularly in the latter part of the forecast horizon, leads us to moderate this trajectory. We now believe productivity gains will offset some of the underlying inflationary pressures, especially in the service sector, resulting in a more stable inflation outcome centred around 2.5%.

That said, inflation risks remain skewed to the upside relative to the pre-pandemic regime. Several structural forces continue to exert upward pressure on prices:

Compositionally, we expect the drivers of inflation to evolve. Goods and food inflation are likely to become more persistent as trade frictions and climate-related disruptions are passed through to consumers. By contrast, service sector inflation could moderate over time as AI-driven productivity improvements broaden across white-collar and consumer-facing services.

Nominal GDP Growth

Our forecast for nominal GDP growth remains unchanged at 4.75% over the medium term. However, the composition of this growth has shifted meaningfully relative to previous projections. We now expect a larger contribution from real GDP growth and a slightly softer inflation profile, both driven by stronger productivity assumptions.

Neutral Interest Rates (r*)

The neutral real interest rate, r*, is defined as the real rate of interest consistent with the economy growing at its potential rate while keeping inflation at its target. Typically, in the absence of imbalances, the neutral rate closely matches the real growth rate in the economy. Historically, the neutral rate averaged slightly above real GDP growth until around the year 2000. Following the GFC, r* fell sharply, reflecting a material imbalance between global savings and investment. This divergence created a meaningful wedge between r* and real GDP growth, a defining feature of the secular stagnation regime. As argued by economists such as Larry Summers and Lukasz Rachel, the post-GFC decline in r* was driven by an excess of savings, underpinned by rising life expectancy, increasing inequality, high demand for safe assets, and weak investment demand due to low growth expectations. Looking ahead, we expect this wedge to narrow but not disappear entirely. Over the next five to ten years, we forecast the savings-investment gap to average around -0.85% from about -1.25% previously. Several of the forces that previously generated excess savings are now reversing. Unfavourable demographics, deglobalisation, and sustained fiscal deficits are likely to reduce savings in advanced economies. At the same time, investment demand is set to rise due to climate transition spending, supply chain reshoring, AI-related capital expenditure, and electrification. As a result, we estimate r* to be approximately 0.85 percentage points below real GDP growth. Given our forecast for real growth of 2.25%, this implies a neutral real interest rate of around 1.4%.

Nominal Neutral Interest Rates (R*)

Adding our inflation forecast of 2.5% to the real neutral rate of 1.4%, we estimate the nominal neutral policy rate (R*) to average approximately 3.9% over the next five to ten years. This represents a modest increase relative to our previous forecast of 3.7%, largely driven by a higher estimate for r*. This level of neutral rates marks a clear departure from the ultra-low interest rate environment of the post-GFC era and has significant implications for asset valuations, leverage, and policy flexibility.

Term Premium and Long-Term Bond Yields

The bond term premium refers to the additional yield investors demand to hold longer-dated bonds rather than rolling over short-term instruments. It is a key determinant of the spread between long-term bond yields and short-term policy rates. We forecast the differential between the neutral policy rate and the 10-year Treasury yield to rise to approximately 0.85% over the next five to ten years. This represents a material increase relative to the compressed term premiums observed during the post-GFC period. Several factors support a higher term premium regime. First, inflation risk premiums are likely to remain elevated following a period of above-target inflation and greater uncertainty around inflation dynamics. Second, investors face increased uncertainty regarding long-term structural shifts, including demographics, technological change, and climate policy. Third, large and persistent fiscal deficits, combined with quantitative tightening and reduced foreign demand for US Treasuries, imply a significant increase in bond supply that must be absorbed by private domestic investors. Assuming the economy is operating at steady state, a neutral policy rate of approximately 3.9%, combined with a term premium of 0.85%, implies an average 10-year Treasury yield of around 4.75%.

Summary of Long-Term Forecasts

Relative to the 2010–2019 period, the next decade is likely to be characterised by slower labour force growth, stronger productivity, higher nominal GDP growth, higher inflation, and structurally higher interest rates.

Bond yields approaching the level of nominal GDP growth imply tighter constraints on fiscal policy and a reduced margin for error in macroeconomic management. At the same time, higher real rates and term premiums increase the hurdle rate for investment and place renewed emphasis on asset selection and balance sheet strength.

Global Fragmentation in Numbers: How the Regime Translates Across Regions

Above we set out the key structural forces defining the current regime of Global Fragmentation and translated those forces into macroeconomic assumptions for the United States, which we use as the reference case. This section applies the same translation exercise globally. The framework is identical across countries. What differs is the intensity of the regime forces, the starting point, and the institutional and structural features of each economy. As a result, outcomes vary by degree rather than direction. Table 1B.7 summarises the relative qualitative impact of the five main regime drivers across major economies. Table 1B.8 provides long-term forecasts for each major region.

Labour Force Growth: A Global Constraint with Differing Severity

Demographic ageing and lower migration are global features of the current regime. As in the US, labour force growth is slowing across all major advanced economies, though the extent differs materially. Outside the US, labour force constraints are generally more binding. In Europe, working-age population growth is weaker, reflecting earlier demographic transitions and lower net migration. In Japan, the labour force is already shrinking, while in China it has turned decisively negative as population decline and ageing accelerate. Emerging markets continue to benefit from positive labour force growth, but even here the pace is slowing as demographic transitions progress.

The implication is that labour supply contributes less to growth everywhere, reinforcing the importance of productivity as the primary engine of expansion in the current regime.

Productivity Growth: Shared Uplift, Uneven Gains

Technological progress, and particularly the diffusion of artificial intelligence, is a global positive force, but its impact is uneven. The US remains at the productivity frontier, benefiting from a large share of knowledge-intensive services, deep capital markets and rapid technology adoption. Other advanced economies also see a lift to productivity growth as AI diffuses, but the gains are smaller. Slower adoption, more rigid labour markets and less favourable sector composition limit the upside in Europe and Japan.

China’s experience is different again. While investment in technology and manufacturing remains high, productivity growth is weighed down by policy intervention, overcapacity and declining returns to capital. As a result, measured productivity growth slows materially relative to the past, even as headline investment remains elevated.

Emerging markets benefit indirectly from global technology diffusion, but gains vary widely depending on institutional quality, openness and access to capital.

Real GDP Growth: Convergence in Structure, Divergence in Pace

Combining weaker labour supply with higher productivity produces a broadly similar growth structure across regions: less contribution from labour, more from efficiency gains. However, headline growth rates diverge. The US sits toward the upper end of advanced economy growth outcomes, supported by relatively favourable demographics and stronger productivity. The UK and euro area grow more slowly, reflecting weaker labour force growth and more limited productivity gains. Japan’s growth remains modest despite rising inflation and interest rates, constrained by population decline. China experiences a more pronounced slowdown as the long-running investment-led growth model matures and demographic headwinds intensify. Emerging markets continue to grow faster than advanced economies, though at a slower pace than in the pre-pandemic era.

Inflation: Higher Everywhere, But Not Uniformly

A central implication of Global Fragmentation is structurally higher inflation across economies compared with the post-global-financial-crisis period. The drivers – demographics, trade fragmentation, fiscal pressure and more frequent supply shocks – are common across regions.

That said, inflation outcomes differ. In the US and UK, inflation settles at higher levels than in the 2010s, supported by stronger demand and looser fiscal positions. In Europe, inflation also rises relative to the past but remains lower than in the US, reflecting weaker growth and tighter fiscal frameworks. Japan represents a structural break from its own history. Inflation rises meaningfully from very low levels as the economy exits a long-standing liquidity trap, though it remains below inflation outcomes elsewhere. In China, inflation remains comparatively subdued, reflecting weak domestic demand, excess capacity and policy constraints.

Overall, the regime implies less global disinflation and more dispersion in inflation outcomes than investors were accustomed to over the past decade.

Neutral Interest Rates: Higher Globally, But Unevenly

The same forces that raise the US neutral interest rate – reduced excess savings, higher investment needs and persistent fiscal deficits – also operate globally. As a result, neutral rates rise across most advanced economies.

However, the level of neutral rates differs. The US continues to benefit from reserve currency status and deep capital markets, attracting global savings and moderating the rise in equilibrium rates. In the UK and euro area, neutral rates are lower, reflecting weaker growth and the absence of reserve currency advantages.

Japan has experienced decades of exceptionally low neutral rates driven by deleveraging, excess savings and imported deflation, but these forces are beginning to fade. As a result, Japan’s neutral rate rises more than elsewhere, albeit from a very low starting point. China moves in the opposite direction, with the neutral rate drifting lower as potential growth slows and investment efficiency declines.

Long-Term Bond Yields: Structurally Higher, with Renewed Dispersion

Higher neutral rates and a rise in term premia translate into structurally higher long-term bond yields across advanced economies. Term premia increase globally as investors demand compensation for inflation risk, fiscal supply and greater macro uncertainty, while central banks step back from large-scale asset purchases.

That said, yield levels diverge meaningfully. US yields remain the highest among major advanced economies, reflecting higher neutral rates and fiscal issuance. UK yields sit slightly below the US, while German Bund yields remain materially lower, consistent with lower inflation and policy rates in the euro area. Japanese government bond yields rise meaningfully from historic lows but remain well below US levels. In China, bond yields stay comparatively low, reflecting weak domestic demand and policy constraints, even as global rates rise.

Bringing It Together

The current regime is global in nature, but its numerical expression differs across countries. The direction of travel is broadly shared: slower labour force growth, higher reliance on productivity, higher inflation than in the past, and higher interest rates. The magnitude of these effects, however, depends on demographics, institutions and exposure to fragmentation.

The US provides the clearest illustration of the new regime, but it is not unique. Across regions, the era of ultra-low inflation and interest rates has ended, replaced by a world in which dispersion across countries matters again.

Its purpose is to capture how continued fragmentation, driven by intensifying geopolitical rivalry, supply chain reconfiguration and strategic resource competition, is turning security into a central force shaping investment risk and return opportunities.

Figure 1C.1

Sarasin & Partner's Thematic Framework

What We Mean by Security

Security aims to capture the rising importance of resilience, control and continuity in economic and corporate outcomes as fragmentation increases the scope for disruption, leverage and constraint.

In the post-war period, many of the conditions that enabled deep integration were treated as stable features of the system. Under fragmentation, security of supply chains, resources, technology, finance and alliances is increasingly managed deliberately, paid for explicitly, and priced more directly into business models and markets.

How Security Fits Within Sarasin's Wider Thematic Framework

Themes often overlap, and Security is no exception. It sits alongside our existing themes and helps explain a range of trends that cut across them.

In short, Security captures the set of fragmentation-related forces that was not adequately reflected in the existing themes.

Equity Implications

Our thematic philosophy is built on the view that modern equity markets tend to underestimate, and therefore misprice, the impact of structural trends or themes on company fundamentals. Security is creating a range of attractive investment opportunities aligned with this philosophy, which we organise into three main areas or sub-themes: structural demand in cyber and defence, resource security and resilience across energy, materials and infrastructure, and the relative durability of protected markets.

1. Cyber and Defence

Structural demand for defence and cybersecurity is rising, driven by geopolitical tensions, evolving digital threats, and a rapidly changing technology frontier that now includes drones, autonomous systems, space assets and AI-enabled intelligence. Defence budgets are rising across many regions as countries are upgrading ageing capabilities, repositioning to new theatres and alliance structures, and shifting from a largely peace-time posture to one that places more weight on readiness, resilience and sustained deterrence.

Defence and security spending is moving from a cyclical variable to a more structural feature of the investment landscape. That tends to favour industries where demand is anchored in multi-year procurement plans, ongoing maintenance and upgrade cycles, and long-lived platforms rather than one-off orders. It also increases the value of scale, reliability and trusted supply, as governments seek continuity of capability and greater security of domestic or allied supply chains. The result is a broader opportunity set than traditional “defence primes” alone, extending into enabling technologies and services where spending is increasingly structural, including secure communications, sensors, surveillance and intelligence, training and simulation, and cyber defence.

Cybersecurity sits within the same impulse and broadens it further. As competition increasingly plays out through software and networks, and as AI expands the attack surface and accelerates both offence and defence, governments and corporates place a higher priority on identity, data protection and operational resilience. In equity terms, this spending tends to be durable because it is tied to the continuity of operations, embedded in core systems, and reinforced by regulation, liability and repeated incidents. It can also be less economically sensitive than many areas of IT spend, because the consequences of underinvestment are asymmetric and increasingly visible.

2. Resource Security

Efforts to secure supply chains are making reliability of access and continuity more prominent considerations in corporate and policy decisions, even as cost and efficiency remain central. Strategic autonomy in energy, food and critical materials becomes more valuable as access is treated as conditional and exposure to disruption is priced more directly.

The effects are evident in both policy and capital allocation. Policymakers are increasingly comfortable using tariffs, subsidies, licensing and sanctions to build redundancy and domestic or regional capacity in strategically important areas. The opportunity set includes the companies that enable supply chain redesign, the build-out of industrial capacity, and the infrastructure required to make systems more resilient.

Commodities, particularly industrial and precious metals, benefit from structurally higher demand. The physical layer of electrification, grid reinforcement and data centre build-out is increasing demand for a range of critical inputs, and the strategic priorities behind that investment are being reinforced by both energy security and the AI-driven build-out of digital infrastructure. Fragmentation also strengthens the preference for reliable supply. In addition, eroding confidence in the US fiscal path and the dollar-based financial system increases the attractiveness of precious metals, supporting the case for gold miners.

3. Protected Markets

Protected markets capture the parts of the economy where fragmentation raises the value of continuity, domestic anchoring and essential service delivery, and where regulatory and institutional structures shape outcomes more directly. In these areas, durability is often supported by essentiality and policy, but returns are also more exposed to political priorities and distributional pressure.

Financial infrastructure, particularly banks, is one example. Banking is inherently domestic, and in a more fragmented environment the role of local intermediation and domestic financial plumbing becomes more important. Higher nominal GDP, higher inflation and steeper yield curves also improve the baseline for lending growth and profitability relative to the prior regime. At the same time, financial fragmentation gives regulators more latitude to favour domestic priorities over global norms, which can cut both ways – banks remain a tempting target for populist measures, as well as attempts to ease fiscal pressure through the repression of domestic savings.

Within healthcare, the security-related implications are most pronounced in biopharma. Ageing supports demand in aggregate, but governments are the dominant purchaser, and fiscal pressures strengthen incentives to cap spending growth and tighten reimbursement where political scrutiny is greatest. That is a direct headwind for parts of pharmaceuticals and biotechnology, particularly where pricing power is most exposed to public policy and where the economics depend on a small number of high-value products.

Consumer-facing industries also face new headwinds from stickier inflation, higher costs of resilience, and higher financing costs, which can tighten budgets and tends to widen dispersion between business models, even if nominal incomes continue rising.

Conclusion

Under Global Fragmentation, Security shapes economic and corporate outcomes more directly as resilience, control and continuity are rewarded more consistently, while dependency becomes a more explicit cost. In equities, this creates a diverse set of opportunities both in the provision of security itself and in the enabling infrastructure behind it, spanning cyber and defence, and the resources and systems that underpin energy, materials and supply chains. As fragmentation continues, Security will increasingly determine which industries and businesses can sustain profits and compound growth over time, and this theme provides a framework for identifying where that will matter most.

As the Cold War drew to a close in the early 1990s, the United States set out to cement its global leadership. With the USSR collapsing and China only beginning to look outward, the US stood as the world's unrivalled military, financial and economic superpower. Nowhere is American power more visible than in the dominance of the dollar. Though the US economy represents roughly 25% of global GDP, the dollar accounts for 57% of official foreign exchange reserves and 54% of global export invoicing, and is used in 60% of cross-border loans. Around 70% of global bond issuance is denominated in dollars, as is 88% of currency trading. In virtually every corner of global finance, the US dollar reigns supreme.

Dollar dominance confers a host of strategic advantages on the US. It reduces friction for firms operating overseas, grants policymakers rare insight into global financial flows, and provides a potent tool for imposing sanctions with extraterritorial reach.

But the greatest benefit lies in the dollar's role as the world's dominant reserve currency. Unlike other nations, the US need not stockpile foreign reserves to guard against depreciation of its own currency. Instead, the rest of the world holds dollars – creating a built-in global market for American debt that affords the US extraordinary monetary and fiscal latitude.

Chart 1D.1

US Current Account Deficit as % of GDP

Weaponising the USD

The US is abandoning its long-standing role as a benign hegemon. Washington's liberal use of sanctions and tariffs has put much of the world on edge about the safety of their large holdings of dollar assets, as the seizure of Russian assets demonstrated. Alongside a more transactional view of the world, sits a more circumspect view of the dollar's role in the global economy.

The Trump administration has expressed the view that a strong dollar has been a key driver of both domestic and global economic imbalances. The administration believes that America's trading partners have been pursuing policies that suppress wages, undervalue their currencies and provide industrial subsidies that have perpetuated chronic trade deficits. The implications for the dollar are nuanced, and arguably conflicting – while the Trump administration widely accepts that the dollar's reserve currency status is an 'exorbitant privilege', the administration simultaneously views the dollar's strength as an 'exorbitant burden' which has hollowed out the country's manufacturing base, led to 'excessive financialisation' of the economy, increased inequality and facilitated excessive government borrowing.

US claims that the dollar's overvaluation is the result of mercantilist policies of its trading partners are not without merit. Since joining the WTO, China has deliberately maintained an undervalued exchange rate to cement its position as the world's manufacturing powerhouse. Given its central role in the broader Asian supply chain, the weak renminbi has exerted downward pressure on the currencies of neighbouring economies as well. The net effect is that the trade-weighted dollar now stands more than two standard deviations above estimates of fair value – a level of misalignment that has played a meaningful role in America's ballooning trade deficits (Chart 1D.1).

The administration has made plain its aim is to rebalance the economy away from chronic trade deficits, revive domestic manufacturing, and largely plug a two-trillion-dollar fiscal deficit through the catch-all instruments of tariffs and currency depreciation. All the while, it seeks to preserve the benefits of the dollar's privileged status as the world's reserve currency.

Inflation Default on USD

A salient feature of America's chronic trade deficits has been the emergence of US Treasury bonds as the world's pre-eminent safe asset. As America's trading partners accumulated trade surpluses, they recycled them into US government debt. Deep and liquid markets for Treasuries, coupled with the Federal Reserve's demonstrated willingness to supply dollar liquidity in times of global stress, made them a natural home for foreign exchange reserves. After all, the US was a benign global hegemon, trusted to safeguard global finance. Looking forward, foreign appetite for US Treasuries is likely to wane. As global trade increasingly re-orients away from the US, fewer dollars are being accumulated abroad. Background chatter in Washington about taxing interest income on Treasuries, or forcibly extending the maturity of existing holdings is steadily eroding confidence in the asset class. We are witnessing a meaningful shift across the Emerging World. For example, in the 12 months to November 2025, the Reserve Bank of India's holdings of Treasuries fell 20% from 234bn to 187bn. Foreign investors face an additional headwind from America's deteriorating fiscal outlook. The recent passage of the 'One Big Beautiful Bill Act' worsens an already poor fiscal trajectory. Deficits are now expected to exceed 6% over the remainder of President Trump's term, while debt levels are expected to reach 130% of GDP over the next decade. With neither political party showing much appetite for raising taxes or cutting spending, the likely policy path involves a mix of higher inflation and prolonged interest rate suppression. For long-term foreign investors, this raises the risk of inflation eroding the capital value of their Treasury holdings. An overvalued dollar together with a diminishing appetite to hold US Treasuries will lead to a gradual erosion of the dollar's value against its main trading partners.

Transition Not a Rupture

Fragmentation does not imply the collapse of the dollar system. Our base case is gradual erosion, rather than immediate displacement. The dollar remains deeply embedded in global trade, finance and payment infrastructure, and no single alternative is capable of replacing it wholesale. What is changing is the willingness of the rest of the world to concentrate incremental savings in dollar assets at the pace they have done so over the past decade.

Substitution is taking place across many channels. Gold is again being treated as a strategic reserve asset, while countries increasingly hold physical inventories, and especially commodities, rather than the dollar inventories that supported just-in-time trade of bygone years.

Many major currencies face similar challenges to the USD. However, the Pound and the Euro are likely to benefit initially, as both are less overvalued than the dollar. In addition, countries are starting to de-risk their economies from the dollar payments system. The European Commission is seeking to establish bilateral currency swaps with its trading partners in an effort to internationalise the use of the Euro. However, weak productivity growth, ageing demographics and ongoing fiscal constraints limit the scope for sustained outperformance.

The Yen is heavily exposed to the Fragmentation regime. Japan is transitioning from a net saver and producer to a net consumer – best represented by its exit from deflation – which will push up the Yen from very weak levels. However, Japan's high public debt and sensitivity to rising rates limit the pace of interest rate increases, leaving the yen vulnerable to bouts of weakness. The result is likely to be greater volatility and a higher average level, rather than a return to persistent depreciation.

The largest mispricing in currency markets is relative to emerging markets. Countries with credible monetary frameworks, improving fiscal positions and manageable external debt are best positioned to benefit. As current account surpluses are increasingly invested or consumed domestically rather than recycled into dollar assets, exchange rates are likely to appreciate. Rising real exchange rates in emerging markets represent a return to the historical norm, where incomes and productivity gradually converge towards their developed country counterparts. This convergence had been temporarily paused during the period of exceptional dollar dominance, but Fragmentation, whether by carrot or stick, will once again lead to fundamentals reasserting themselves.

Backdrop: The Core Building Blocks

Part 1 of The Almanac considered the backdrop of the different investment regimes, with a focus on the Global Fragmentation regime we are currently living through.

Most investable assets, despite the variety of labels attached to them, can be understood as combinations of three underlying exposures: nominal claims (e.g. bonds), claims on tangible assets (e.g. property) and claims on the ownership of enterprise (e.g. equities). While the full spectrum is not tidy and contains many hybrids, the economic substance typically reduces to these components.

Nominal claims offer contractual clarity, but contracts are denominated in currency. Over long horizons, real outcomes are therefore dominated by the behaviour of the monetary regime, realised inflation, and the interaction between inflation and nominal yields. Even well-run systems still produce long periods where realised inflation exceeds what lenders expected, and the real value of repayment erodes.

Tangible (physical) assets provide an intuitively direct hedge against monetary inflation because they are relatively scarce, physical and not intrinsically tied to a unit of account. However, they are subjected to persistent frictions including illiquidity, high transaction costs, governance and operational complexity. These factors can limit their usefulness as a universal solution for diversified, scalable real wealth preservation.

The ownership of enterprise is different. This is the channel through which capital is allocated to ideas, translated into production through organisation, technology, coordination and scale, and is one of the mechanisms through which economies grow. Successful enterprises raise productivity, allowing societies to generate more and better output from the same inputs. This is the main source of rising living standards over the long run, and it is what makes enterprise a ‘real’ asset in the most meaningful sense.

Many routes exist for owning enterprise, but publicly listed equity remains the most scalable and accessible vehicle through which most investors can hold diversified claims across many businesses and geographies, without taking on the concentration risk and governance burdens typically associated with direct ownership. However, the structure of the equity market has evolved considerably over time, and we must ensure that public equities continue to provide sustainable, long-term exposure to real purchasing power.

A Brief History of Asset Allocation

We begin with an illustrative example: in the Sarasin & Partners Endowments Model, we allocate 70–80% to equities from 1900 through to the end of 2025. However, between 1900 and the mid-1970s, it is unlikely that long-term investment portfolios would actually have been invested in this way. A combination of prevailing investment beliefs, regulation, and exchange controls would likely have resulted in portfolios holding a much greater proportion of property and government bonds than in equities, which were deemed as speculative assets by most institutional investors prior to the 1950s.

As can be seen in Chart 2A.1, the Endowment Model begins in 1900 with 70% invested in UK equities and 30% in government bonds. As new asset classes become available, these are introduced into the model. We operate a “delayed entry” basis, allowing each new asset class to be widely accessible for 5–10 years before introducing it, on the basis that the average investor would not have allocated money to an untried and untested asset class immediately. Property is introduced in 1952, international equities in 1985, corporate bonds in 1996 and hedge funds in 2004.

Analysing this model allows us to draw out how the severe bear markets of the 1930s, 1970s and early 2000s impacted returns, while coexisting with the roaring bull markets of the 1920s, 1950s, 1980s and the period after the Global Financial Crisis of 2007–09.

However, the model does not consider the level of difficulty involved in making these shifts. Such decisions would not have been easy or obvious at the time. While some investors will have moved more quickly than our model implies, others would have moved more slowly or not at all. Even in 2026, there remain many UK investors who still carry a significant UK bias to their equity allocations and have little or no exposure to alternative investments or unlisted assets.

Chart 2A.1

Evolution of Sarasin's Endowment Strategy

Significant Moments in Investment

Equities become an institutional solution to inflation risk

Up until the 1950s, equities were considered speculative by most institutional investors—closer to wine or art than a core portfolio holding. Pension funds allocated little to them. Yields on British government bonds were lower than the yield on equities between 1900 and the 1950s, reflecting the perceived risk of equity investment.

By the end of the Second World War, stock markets resembling those we recognise today had been operating for several decades. In 1947, George Ross-Goobey was appointed fund manager of Imperial Tobacco's pension fund. He recognised that equity markets had matured in a number of important ways, becoming more diversified, liquid, better regulated – and, crucially – supported by increasing amounts of data available for analysis. Ross-Goobey persuaded the trustees that a diversified portfolio of equities, held for an appropriate period of time, could deliver better results than bonds given their link to the real economy and their ability to grow profits ahead of inflation.

As a consequence, the Imperial Tobacco pension fund switched virtually all of its investments into equities, and other investors subsequently followed suit to varying degrees over the years that followed. With the exception of the period following the Global Financial Crisis, when government intervention drove bond yields to artificially low levels, equities have yielded less than bonds.

Governance Constraints Shape What Portfolios Can Own

While most pension funds and many private individuals allocated increasingly heavily to equities from the 1950s onwards, many British charities were held back by regulation. The Trustee Act 1961 ('the Act') required them to split assets between 'safe' Narrower Range investments and riskier Wider Range investments, with only 50% permitted in the latter. Over time, this attempt to ensure charities were 'conservatively invested' did great damage. Through the 1960s, 70s and 80s, inflation eroded the real value of 'safe' assets while equities, despite significant volatility, delivered positive real returns. Through the 1980s and 1990s, trustees, investment managers and government ministers pressed for change. In the 1990s, the Act was diluted with Wider Range investments allowed to make up 75% of assets. In 1997 the Law Commission called the Act "over-restricted and cautious", and the Trustee Act 2000 finally introduced a General Power of Investment, allowing trustees to invest as if they were beneficial owners, subject to duties of care and advice.

Domestic Portfolios Go Global

For most of the post-war period, British investors treated the domestic equity market as a natural proxy for domestic economic exposure, leading to a significant home bias. This assumption was challenged as the world economy became more interconnected and as domestically listed companies increasingly operated on a global scale. Large UK firms increasingly earned revenues, paid costs, and deployed capital across multiple jurisdictions. The domestic index came to resemble a claim on global profit streams, expressed in sterling, rather than a claim on domestic output with a strong link to domestic inflation. Currency movements reinforced the case for looking beyond domestic markets. As can be seen in Chart 2A.2, in 1945, a British pound bought 4 US dollars: in September 2022 a pound bought just 1.03 dollars. While sterling has strengthened since then and stands a little above 1.30 (31.12.2025), this represents a near 70% decline in the value of a pound over the period – a shift of considerable importance for long-term purchasing power.

Chart 2A.2

UK Pound to US Dollar Exchange Rate

Once Foreign Exchange Controls were abolished in 1979, capital moved quickly. Insurance companies and pension funds channelled four times as much into overseas equities in the first half of 1980 as in the first half of 1979. Annual flows rose from £1 billion in 1979 to £18 billion by 1985. Yet, home bias persisted well into the 2000s. The most common rationalisation was that UK-listed companies already generated around 65% of earnings overseas, so there was no need to own foreign shares directly. While this reduced currency sensitivity, it missed the deeper point - the ability of UK equities to safeguard domestic purchasing power had weakened in an increasingly global world. Specifically, the UK stock market had become increasingly concentrated in sectors that bore little resemblance to the balance of what asset owners were spending their money on. Worse, many of the sectors to which the UK market was over-exposed were either 'ex-growth' or expected to grow more slowly than those in which the market was under-represented. For a UK private client, a greater proportion of returns was also being generated in income, taxed at around double the rate of capital gains. In response, Sarasin & Partners both advocated for and implemented a move towards greater global diversification while it was still relatively uncommon. For many investors, this was simply just "too different" and significant UK allocations continued to be promoted for many years. One might reasonably question whether parts of the pro-UK investment establishment were conflicted, given their domestic research focus and infrastructure. Over time, however, fully international investment has become the norm for the majority of investors, as the benefits from wider diversification and returns have increasingly justified the shift.

Expanding into Alternative Asset Classes

Hedge funds emerged in the early 1990s, adopted first by US endowments and family offices. British investors followed more slowly, with interest accelerating after hedge funds performed well through the dot-com and 9/11 stock market declines between 2000 and 2003.

This second wave of UK adopters learned a hard lesson about implementation. Most hedge funds were denominated in dollars. Between 2002 and 2007, sterling appreciated against the dollar by 45%, wiping out much of the return for the typically unhedged British investor. Today most hedge funds offer currency-hedged share classes - but this episode illustrates how the adoption of new opportunities without careful attention to all relevant factors can disappoint.

At the same time that hedge funds emerged, a range of new and more esoteric opportunities also developed. As governments around the world sought to rebuild key infrastructure, projects were increasingly opened to private sector participation. Alongside this, a subset of infrastructure investing developed as investors looked to allocate capital to ‘green’ and renewable energy projects such as wind farms and solar facilities. Commodities, including gold and industrial metals, also became easier to access via liquid exchange-traded funds. Other less traditional asset classes, such as high yield debt and distressed debt, became more widely accessible through listed and open-ended funds as their track records became sufficiently established to attract a broader range of investors.

When taken together, these ‘alternative’ investment opportunities offered investors the potential to allocate to a basket of assets capable of producing attractive returns with lower correlations to their core bond, equity and property allocations.

Having invested in many of these assets in a small and tactical way since the late 1990s, Sarasin made its first formal strategic allocation to alternatives in 2005 with the launch of Sarasin's Endowments Fund for charities. An initial 5% allocation (funded from bonds and equities) grew to 10% (funded from bonds and property) as investors became increasingly comfortable with our approach to investing in these new asset classes.

Sarasin & Partners' allocation has certainly proved its worth, producing a positive total return in every calendar year since 2005, except 2023. Overall, the alternatives have generated a total return well in excess of bonds and not too far short of global equities, with significantly less volatility. (See page 41, Chart 2C.3).

However, while hardly anyone blinks an eye when we suggest an allocation today, many investors were far less enthusiastic when we first invested back in 2005. The inclusion of alternatives in our flagship funds and client portfolios was often cited as a reason not to invest with us. Twenty years later, what was once considered risky has become common practice, with some portfolios having 20% allocations.

Lessons Learned: When to Be Dynamic

There is a common thread across these examples – investors who recognise the changing nature of asset classes, and dynamically adjust their portfolios in response, tend to be rewarded over the long-term.

‘Dynamic’ in this context does not mean constant activity or short-term tactical trading. It means periodically reconsidering what an asset class can deliver and whether it remains fit for purpose: making use of tactical flexibility most of the time, and then resetting benchmarks or approaches when circumstances suggest more permanent evolution is required.

There is a long list of potential triggers including:

A deep analysis and an understanding of these forces, together with an appreciation of market structure and an open mind about new opportunities, can help anchor and, where appropriate embolden, tactical thinking.

Less frequently, matters will reach the threshold for more fundamental change – whether adjusting benchmarks, altering strategic allocations, or rethinking how an asset class is accessed altogether.

Two Mechanisms Reshaping Public Markets

We have shown that for long-term investors equities are the most scalable route to broad exposure to enterprise and, through that, to growth in real purchasing power over time. We also traced how that exposure has been accessed - from domestic equities as the default through internationalisation, and from listed equity exposure to unlisted opportunities for some investors.

As new avenues to access enterprise have emerged and market structure has changed, the question now is whether public equities still serve their original purpose of protecting and growing real purchasing power. Two mechanisms in particular have reshaped public equity markets over recent decades.

Mechanism 1: Benchmarking and Passive Ownership as the Default

Benchmarking is often discussed as a measurement tool, but in practice it is a behavioural constraint. Once a global market-capitalisation benchmark becomes the ‘reference’ portfolio, deviations from it become explicit active decisions that require justification, monitoring and governance. Portfolios constructed with reference to fixed country weights and target rebalancing are replaced by an approach in which country, sector and style exposures drift with market value unless they are actively managed.

This has two possible interpretations. The critical view is that it creates self-reinforcing dynamics; as the proportion of capital invested relative to benchmark weights rises, more capital is mechanically allocated to the leaders, potentially pushing valuations beyond rational levels. The more benign view is that the rise of benchmarking has increased the speed at which genuine corporate success is reflected in market prices.

Consider a company whose fundamentals have improved: it has grown its profit base, established structural growth drivers, or become demonstrably more profitable than before. Under fixed-weight approaches, a non-holder could observe the company's improved fundamentals and still do nothing - there was no mechanism forcing the question. Under a benchmark-relative approach, the market automatically rewards the company with greater index weight, and active managers must either follow or explicitly decide to run a bigger underweight. The window in which genuine improvement can be ignored is shortened, improving the speed and consistency with which market prices incorporate new information.

Both interpretations may contain some truth, but they importantly point in the same direction; concentration rises, and index outcomes become more sensitive to shifts in the drivers of corporate success. If the current leaders continue to compound, they are swiftly rewarded. If the underlying drivers shift, the index becomes more exposed to that change than it would have been without this behavioural constraint. It is possible that benchmarking and passive investing have increased short-term market efficiency while simultaneously increasing concentration and the risks that follow from it.

Mechanism 2: Lifecycle and Ownership Shift

Public equity markets were historically described as engines of capital formation: the place where those with ideas but not enough capital were matched to those with excess capital in need of opportunities. They remain important for capital raising, but in many parts of the world their centre of gravity has shifted towards providing liquidity, facilitating price discovery and enabling ownership transfer for businesses that have already reached meaningful scale.

A larger share of early and mid-stage corporate growth is now financed privately; the pre-IPO phase has lengthened; and companies can remain privately funded while building capabilities that, in earlier eras, would have been built as publicly listed firms. At the same time, the once-attractive ‘public small-cap’ archetype has been eroded by acquisition, as private and strategic buyers purchase high-quality smaller companies before they ever become large enough to matter to increasingly large professional investment managers. The key observation is that there are fewer publicly listed companies relative to private enterprises than there were 20–30 years ago.

Chart 2B.1 shows the number of listed companies in key markets and how it has changed. It is of concern to listed equity investors that public indices cover a less comprehensive ‘enterprise map’ than they once did.

Chart 2B.1

Listed Companies in the UK and USA Over Time

That said, the boundary between public and private markets is not fixed. The incentive to list responds to the cost of capital, regulatory burdens, disclosure expectations and the state of exit markets. The congestion currently visible in private markets – and the lack of appetite from listed investors to buy companies from private owners – may reflect valuation and expected return considerations as much as any structural decline in the attractions of public markets. This is a reason to allocate fresh capital to private markets on an opportunistic basis when conditions are attractive, rather than an urgent strategic reallocation.

Cross-Sectional Concentration: The Facts

Benchmarking, the rise of passive, shifting ownership, and changes in the fundamental drivers of corporate value have all contributed to increasing concentration in public equities over the last two decades.

Chart 2B.2

Share of Rolling 12 Month S&P 500 Returns Attributable to Top 10% of Contributors

Chart 2B.3

Proportion of Stocks Outperforming S&P 500

This concentration is evident in the composition of index returns. Chart 2B.2 shows the proportion of annual S&P 500 returns attributable to the biggest contributors has been trending higher in recent years. Chart 2B.3 tells a similar story; only c.30% of listed companies have outperformed within the S&P 500 in each calendar year since 2022 – a clear hallmark of a narrow market.

Digging deeper, a small number of extremely large technology stocks have driven much of the concentration in returns in 2023 and 2024, much as it was in 1998 and 1999.

In 2025 concentration reduced somewhat as commodities and banks performed strongly more recently, but it remains elevated by historical standards. In short, the likelihood of finding a reasonable number of outperforming stocks has fallen significantly, as the composition of returns has become increasingly narrow.

Chart 2B.4

US Sector Concentration in 2025

Chart 2B.5

US Sector Concentration in 1900

Chart 2B.4 shows that concentration across sectors is similarly elevated today. The dominance of a small number of sectors driving index returns isn't new (Chart 2B.5) but the current degree is notable.

Chart 2B.6

Geographic Concentration of the Global Equity Market Over Time

Finally, concentration across countries and regions is most visible in the rise of the US share of global equity indices over the past 15 years. However, a review of a longer time period (Chart 2B.6) shows that there have been other instances where the US market was a much larger part of global stock markets, and this at a time when economies were much less globally connected.

Across a range of measures, concentration looks high. Some of this reflects enduring shifts in the nature of enterprise, such as the rise of capital-light business models that can scale globally, and the remarkable ability of the US to remain at the forefront of successive waves of technological innovation.

But competitive structures evolve. Policy, regulation and international relations are becoming more fragmented and less predictable. At the same time, AI may disrupt existing advantages as well as entrench them. And the inflection in physical investment, from data centres, energy infrastructure, supply chains, to resource and military security, may favour different business models over the coming years.

The question therefore is not whether concentration is high, but what follows. History suggests there are a range of very different potential outcomes. We lay out three possible paths.

Concentration in Context: 3 Paths

Path 1: Crash — when financial value far exceeds economic potential

Some concentration episodes end badly because optimism and exuberance run ahead of what the underlying businesses can deliver. The ‘Nifty Fifty’ episode in the United States is one example. A group of “one-decision” steady growth stocks were bid up to valuations that assumed their growth could persist almost indefinitely, and the subsequent decade was painful for holders of these claims even though many of the underlying businesses remained solid.

Another example is the decline of the Japanese market – ultimately as inevitable as the fall of the Nifty Fifty. Chart 2B.7 looks at the median Price Earnings Ratios of Japanese and US stocks in 5-year increments from 1990 to the present day. A clear valuation bubble had emerged by the early 1990s that took over 15 years to unwind, with the Japanese market falling from 41% of the World Index to just 6%.

Chart 2B.7

PE Ratio of US vs Japan

Path 2: Broadening — as dominant areas lay foundations for new growth drivers

In other cases, concentration reflects an economy utilising a position of comparative advantage to then move up the value chain. Dominant firms and sectors become large because businesses scale up and leverage their organisational advantage and profitability into industry verticals or adjacent markets. Over time, their products and services unlock opportunities for new growth drivers to emerge.

Switzerland's economic progression over two centuries illustrates this well. Agricultural and textile industries in the 18th and 19th centuries built capabilities in dyes and chemical processes, which by the early 20th century had evolved into industrial chemistry. Through to post-war period, this in turn, developed into the pharmaceuticals and life sciences industries that dominate today. The Swiss market has long appeared concentrated, but this reflects the evolution of comparative advantage rather than any specific speculative boom.

Mobile and cloud computing offer a more recent example. In the early 2010s, concerns were widespread that concentration in a small number of platform companies resembled earlier bubbles. In hindsight, revenues and profits have met or exceeded expectations; the platforms have become infrastructure on which new layers of economic activity were built. The market broadened because the opportunity set expanded.

Path 3: Combination — real potential and financial excess together

Some concentration episodes combine genuine economic transformation with financial excess. The railroads of the late 1800s transformed the American economy but also attracted speculative capital that periodically ran ahead of what even successful rail companies could deliver. The result was repeated cycles of boom and bust – but the long-run transformation was real, and patient investors still did well over very long horizons. Interestingly, from an overall market perspective, when the long-term decline did set in, it was not especially felt by market-wide investors.

Chart 2B.5 shown on Page 32 shows the size of the Railway sector within the US stock market in 1900 was a staggering 63%. By 1940, it was a fraction of this and today it barely registers. However, despite this decline, between 1900 and 1940, the US equity market generated a real return of approximately +5.6% per annum, not far off the 6.7% achieved from 1900 to today. Notably, the 1900 to 1940 period also included the crash of 1929 and subsequent Great Depression.

The technology, media and telecoms (TMT) episode of the late 1990s was similar. There were genuine productivity advancements as the internet opened up new business models and unlocked economic potential. But financial claims for many companies ran far ahead of deliverable value.

Stock market historians often talk of the ‘lost decade’ from 2000 to 2010, during which the US market generated a rare negative real return of –2.2% per annum.

However, this assumes investment from the peak of the market in early 2000 and includes the unrelated and tragic terrorist attack of 9/11. As can be seen in Table 2B.8, an investor who enjoyed the run up and the decline (1995 to 2005) actually generated a real return of 9.1% per annum.

One of the dangers of episodes like this is exiting too early. The crash, when it came, was severe, but over three years after Alan Greenspan coined the phrase ‘irrational exuberance’ in December 1996. Many of the original reasons for optimism in a ‘brave new world’ ultimately proved correct. The ‘net’ impact of the boom and bust, when taken together, was significantly positive for markets overall.

Implications for Long-Term Investors

So where do we stand today? In reality all three paths remain plausible, alongside the possibility that concentration persists without dramatic resolution for an extended period. It is certainly possible that in the coming years, the predominantly US-listed technology leaders that dominate global benchmarks could severely underperform, dragging down index performance.

That said, the P/E ratios already shown in Chart 2B.7 don't suggest a massive relative over-valuation nor does Chart 2B.9, which examines the multiples of today's large technology stocks relative to leading technology companies at the peak of the dot.com bubble in 2000.

Much of what has driven the high levels of concentration today appears to still hold. US real growth has been structurally stronger than the rest of the world. The largest companies operate capital-light, high-return business models with genuine competitive advantages. AI represents a long-term technological transition with real productivity potential – though, as with past transitions, investment is likely to precede the productivity payoff.

At the same time, financial claims may have run ahead of what even successful businesses can deliver. Passive flows have contributed to mechanical concentration, though it is not clear that this has yet pushed valuations to unsustainable levels.

Self-evidently, reducing exposure to market leaders before concentration reverses can improve long-term returns if timed well. In practice, markets often continue rising long past the point many investors consider justified; and when leadership is driven by a mix of real potential and financial excess, an eventual correction can still leave prices above where cautious sellers exited.

Markets have a remarkable habit of making good their losses by broadening out and producing offsetting growth elsewhere, and investors have historically been poor at mapping new use cases and recognising the full value of technological breakthroughs early.

A narrow focus on near-term mean reversion risks missing the major shifts in technology, society and the economy that ultimately drive long-run growth in purchasing power, which is the original reason for allocating to equities.

Practical Matters: The Poor Performance of Active Managers

The period of concentrated leadership described above has coincided with – and is likely linked to – an unusually tough period for active managers. When a small number of very large stocks drive the bulk of index returns, any diversified portfolio is likely to lag. This was very much the case in the aftermath of the 2020 pandemic, where dramatic market declines were followed by concentrated technology-led recovery, an extraordinarily difficult backdrop for active managers. Table 2B.10 considers the fortunes of active global equity managers over the past 20 years.

It can be seen that between 2005 and 2020, investors had a broadly 50:50 chance of finding a fund that beat the index each year, and if one were to find a top quartile manager, the rewards were significant. However, the past 5 years have turned this pattern on its head. The average fund has failed to beat the index in any single year, and the rewards for identifying a top quartile manager have been much reduced. The recent past has polluted the long-term record to the degree that the prior period is easily forgotten.

If one simply looks at compound relative performance over 1, 3, 5 and even 10 years passive implementation appears to be a compelling proposition, and when reviewed from that perspective, the rise of index tracking should not be a surprise.

However, an examination of the discrete annual results over a longer time frame may suggest that the recent past is the anomaly rather than the norm.

Concentration may persist, but greater dispersion of returns has historically been more conducive to active outperformance. If concentration unwinds through the ‘broadening’ path, active managers should perform relatively better while overall index returns remain satisfactory.

A sharply negative reassessment of the current leaders, on the other hand, could damage real returns from equities for everyone other than the bravest active managers.

Conclusions

Public equities remain the largest, most liquid and transparent claims on enterprise and therefore the primary instrument for compounding purchasing power over long horizons. However, they increasingly represent a less comprehensive ‘enterprise map’ than they once did. Private markets now hold more of the early lifecycle and a growing share of attractive mature businesses that have no need of listed markets, and should be considered a useful tool for opportunistically adding diversified exposure to real purchasing power growth.

Concentration is a risk, and the probability of disappointing index returns has risen, but the evidence does not yet justify fundamental change such as reverting to some form of fixed regional or equal-weighted approach. Similarly, while there may well be opportunities for active managers to avoid the full extent of any value destruction in excessively weighted stocks, sectors and companies in due course, moving too early is likely to be as damaging to returns as moving too late.

At Sarasin, we believe our global ‘thematic’ equity process, with its focus on the structural themes driving long-term value creation in the current regime, is well-placed to navigate a market whose structure is shifting more rapidly than ever.

Context: Why Alternatives Matter

Equities concentrate portfolio risk in corporate earnings and valuation cycles, while bonds concentrate risk in interest rates, inflation and the credibility of fiscal and monetary policy. For long-term investors, the challenge is not only to earn a return, but to do so with resilience and consistency, so that spending, capital protection and long-term objectives can be met through a range of market conditions.

Alternative assets are intended to widen the opportunity set and broaden the drivers of return. The goal is to both add sources of return that are meaningfully different from equity and bond beta, and to improve the portfolio's behaviour, particularly in difficult markets when diversification within and between traditional markets is less reliable.

When Alternative Assets Become Investable

For many alternative ideas, the key question for us is not whether the underlying opportunity exists, but whether it can be analysed, owned and governed in a way that is appropriate for fiduciary-managed client portfolios.

Investability therefore starts with clarity of purpose. We want to be able to explain, in plain terms, what the asset is expected to do in a portfolio and how it is likely to achieve this.

Some alternatives are held primarily to diversify equity risk. Others are held to provide a volatility cushion, to reduce the severity of drawdowns, or to introduce exposure to inflation-linked cash flows or scarce real assets. If the proposed return stream largely repackages equity or duration risk, then its inclusion must be justified on better terms than can be achieved by owning those traditional assets directly.

Next comes evidence and transparency. Alternatives often arrive with a compelling narrative, but little fundamentally analysable substance. At Sarasin & Partners, we look for a sufficiently long and intelligible record to understand the core return drivers, behaviour in different conditions, which offer the likely range of plausible outcomes.

Finally, fiduciary-quality investability requires efficient and scalable implementation. Costs matter, but so do the less visible frictions: dealing spreads, dilution and financing costs embedded within structures. While listed vehicles like investment trusts bring liquidity, their tendency to trade at significant premiums or discounts offers a mix of further risk and opportunity, with this factor dominating outcomes at the wrong point in the cycle. Open-ended funds can result in performance dilution if they grow too fast or unexpected costs if they shrink rapidly. Private market vehicles like LLPs offer tax efficiency and an ability to own complex businesses but their illiquid nature locks down capital for extended periods of time.

However, when these elements come together, alternative investments become a powerful component in a modern multi-asset portfolio.

How the Alternatives Mix Has Evolved Across Regimes

Alternatives are most valuable when treated as a range of quite different asset classes in their own right, as opposed to a single static asset class. Their role is to address specific needs that are not easily met by traditional public markets, and those needs vary meaningfully across different environments. The alternatives universe has expanded steadily over time, creating a wider set of instruments and strategies, but also increasing the importance of how and when they are used.

A regimes lens helps clarify this evolution by linking each environment to the objective investors were pursuing and the alternative exposures that best served it.

Chart 2C.1 sets out the way that the Sarasin & Partners allocation to alternatives has varied over the past 20 years.

Chart 2C.1

Evolved Alternatives Endowment Model

Globalisation

In the mid-2000s, as globalisation deepened and risk premia compressed, investors struggled to find “cash-plus” assets that offered an attractive return above government bonds. In this environment, hedge fund strategies grew in prominence as a means of seeking uncorrelated returns or incremental carry when traditional spreads were tight. The rapid industrialisation of China helped underpin demand for commodities, and allocators increasingly viewed commodity exposure as both a return opportunity and a diversifier.

Secular Stagnation

The role of alternatives shifted meaningfully after the Global Financial Crisis. Policy rates moved to the lower bound, bond yields fell sharply, and the search for yield pushed investors towards alternative income strategies that could provide bond-like characteristics, often through illiquid structures. This period also saw increased interest in explicit downside protection in some portfolios, alongside broader efforts to improve resilience as equity valuations rose and the opportunity cost of holding protection appeared manageable.

Global Fragmentation

You can see that as we have entered the fragmentation regime, we have materially increased our exposure to commodities. This has been concentrated in gold as we see its role in portfolios as having moved from being a small and occasional tactical position to a more permanent strategic holding.

Our intention is not to make a short-term call on the gold price, which we fully expect to be volatile. Rather, the objective is to improve portfolio resilience in scenarios that are becoming more plausible – and potentially more frequent in the current regime. These include inflation surprises, policy credibility shocks and episodes of heightened geopolitical risk.

We have also been materially reducing the interest rate sensitivity of our alternative holdings as we believe long-term interest rates are more likely to rise in an environment of higher inflation. Taking on complexity and illiquidity in alternative investments whose fundamentals are largely ‘bond-like’, face stiffer competition from simpler fixed income solutions. Alternatives with a large fixed income element increasingly need to earn their place through credible diversification, distinct return drivers, or access to exposures that are difficult to replicate in public markets.

As we are still in the early stages of the Global Fragmentation regime, our hedge fund portfolio is focused on strategies that can profit as new trends establish themselves and old trends fade. We therefore favour strategies that benefit from increased dispersion in the market and can adapt to new trends and have the tools to make return by selling the old ones.

We fully expect the shape of a dynamically managed alternatives allocation to continue to evolve over the years ahead. As always, the precise mix will depend on the prevailing regime, the opportunity set available and the relative pricing of diversification and protection at the time.

The Elephant in the Room: Is Bitcoin the Next Investable Alternative or a Speculative Bubble with No Fundamental Support?

Bitcoin is increasingly discussed in the same breath as established alternatives. The most coherent way to analyse it is not as an equity-like technology investment, nor as a mainstream currency, but as a scarce, apolitical, non-cashflow asset that could compete with gold and other stores of value.

One of the natural next questions would therefore be whether it is mature enough to warrant a role alongside existing alternatives.

Bitcoin does not generate cash flows, and cannot be valued in the same way as a bond, equity or property. In fact, it does not fit into any of the three core mediums we touched on in earlier chapters: it is not a nominal claim on a cash flow, a tangible physical asset or linked to any meaningful enterprise. Precious metals, soft and hard commodities are all linked to industrial uses and are required by society in meaningful and valuable ways. Even collectible assets like classic cars, art and wine have uses and meaning over and above their potential to act as stores of value.

The problem with bitcoin and other digital ‘currencies’ is that they are solely purchased to enhance or protect wealth.

If there is an investment case, it therefore depends on scarcity, durability and desirability, and on whether a growing set of holders will treat it as a store of value through time. We think of bitcoin as a digital, fungible collectible, closer in economic character to gold than to a productive asset.

Sarasin's regime work has led us to actively seek out assets that are scarce, politically neutral and less dependent on the USD-based financial system. Against that backdrop, we expect bitcoin to continue to mature and gain acceptance as an alternative store of value. We could see a plausible role for bitcoin as a complement to gold within a broader set of inflation-protected and apolitical assets.

The analogy with gold also helps to clarify both the opportunity and the limits. We should recognise that at around US $5,000 (as at 31.12.2025), the gold price is not significantly underpinned by its fundamental or intrinsic value; its price is set by the balance of buyers and sellers and our analysis has for several years suggested that this would be significantly imbalanced by more buyers than sellers. See Chart 2C.2 below.

Like gold, bitcoin is scarce by design, portable and difficult to counterfeit, and it can be held outside the traditional banking system. Gold, however, has millennia of history, deep physical markets and a mature ecosystem of custody and regulation. Bitcoin is younger, operationally more complex and far more volatile, and it has not yet demonstrated consistent safe haven behaviour in periods of acute stress. This could make bitcoin a potential complement to gold, not a substitute.

ESG and reputational considerations remain central for many investors. Bitcoin's energy use and its association with financial crime have attracted legitimate scrutiny.

Chart 2C.2

Holdings of Reserve Assets

Our assessment is that these concerns are material but can be contextualised, including by comparison with the environmental and social footprint of gold. The governance model is unconventional, but the decentralised consensus mechanism is a core feature rather than a flaw. For those living in parts of the world where local currencies suffer from high inflation and international depreciation – not to mention political and physical dangers – bitcoin offers the potential to genuinely protect wealth in a meaningful and societally positive way.

Lastly, if we like bitcoin's potential to offset regime risks and to act as a helpful diversification away from gold, as noted earlier, we need to consider its practical investability from both a regulatory and efficient ownership standpoint. This has improved meaningfully over the past 12 months, largely because exposure can now be accessed through regulated exchange-traded products with familiar dealing and reporting. That brings bitcoin closer to the operational standards required for many discretionary-managed portfolios, through greater accessibility and institutional adoption.

In conclusion, our current assessment is that bitcoin is approaching the point where it could be used, selectively, as a limited tactical allocation tool within diversified portfolios. We view it less as a productive asset and more as an emerging, scarce, politically neutral store of value, with potential to complement, rather than replace, gold. For now, it is not a holding, but it may become a tactically deployable option as it continues to mature.

To date, Sarasin & Partners' alternatives allocation has a demonstrable track record as a diversifying return source. It has produced a positive total return in every calendar year since 2005, except 2023. Overall, alternatives have generated a total return well in excess of bonds and not too far short of global equities, with significantly less volatility, as illustrated in Chart 2C.3 below, comparing alternatives' performance versus various indices.

Chart 2C.3

How an Actively Managed Alternatives Allocation Can Perform

Regimes and the Role of Bonds

Our regime framework describes the dominant backdrop shaping the opportunity set across assets. Each shift in the overall regime often changes the balance of risks, but it does not automatically imply a wholesale change in the optimal strategy for every asset class. Some approaches remain robust across multiple regimes; others become more conditional.

Bonds illustrate this well. A shift in the broader regime often changes inflation dynamics, fiscal risk and the policy reaction function, shaping bond returns and equity–bond correlations. The implications for bonds do not always change with each regime shift, as term premia, duration supply and demand, and central-bank balance sheets can either reinforce or temper those forces.

Why Investors Own Government Bonds

In practical portfolio terms, government bonds have tended to play three roles. First, they provide liquidity and optionality, allowing investors to rebalance and meet spending needs without relying on forced sales of risk assets. Second, they can protect capital in deflationary or recessionary shocks when policy rates fall and yields decline. Third, they offer a baseline return that helps anchor portfolio expected returns when risk premia are compressed elsewhere.

Those roles remain relevant, but they are conditional. Bonds diversify equities when the dominant shock is to growth and when inflation remains low and stable. When the dominant shock is inflation, or when fiscal and monetary dynamics push yields higher, bonds can fall alongside equities.

Diversification Is Regime Dependent

Equity–bond correlation is not a structural constant. It is an outcome of the macro environment and of how policymakers respond to shocks. When inflation is stable and central banks have room to cut rates, duration tends to provide protection in equity drawdowns. When inflation is volatile and policy is constrained, the same duration exposure can amplify portfolio drawdowns. Recent decades illustrate the point.

Multilateralism and Post-Bretton Woods: Inflation Dominates

In the 1960s and 1970s, the breakdown of the Bretton Woods system and successive energy shocks contributed to high and volatile inflation. Real returns from nominal bonds were weak, and bonds provided limited diversification benefits. Cash proved a more reliable companion to equities during long stretches of high and uncertain inflation. In short, bonds were a poor companion to equities in a balanced portfolio.

Great Moderation: Credibility Returns, Correlations Were Mixed

From the early 1980s into the 1990s, policymakers re-established monetary discipline and inflation gradually fell. Bond returns benefited from that shift, while correlations with equities remained variable.

Globalisation and Secular Stagnation: The Exceptional Period for Bonds

From roughly 2000 to 2020, government bonds became a more dependable diversifier. A combination of global disinflation, high central-bank credibility and a persistent shortage of demand drove inflation and interest rates lower. In that setting, equity drawdowns were more likely to coincide with falling yields, and duration produced both diversification and strong total returns. Inflation surprises were limited, term premia compressed, and bonds often rallied during equity drawdowns. By the end of the period, and for a growing share of decision-makers whose careers were shaped by it, these relationships were increasingly treated as rules rather than outcomes contingent on the environment.

Figure 2D.1

Why Gilts Don't Always Play the Same Role in a Multi-Asset Portfolio

Fragmentation and the Outlook for Nominal Assets

The market stress of 2022–23 illustrated the other side of the relationship. A surge in inflation, combined with a rapid tightening cycle, pushed yields higher at the same time that equity valuations were being pressured by higher discount rates. In that environment, bonds and equities can fall together, and the traditional 60/40 portfolio feels less balanced. Subsequent episodes of volatility have reinforced the point that the diversification benefit depends heavily on the macro backdrop. When inflation concerns re-emerge, or when fiscal credibility becomes more salient to investors, yields can rise even as risk assets are under pressure. In those circumstances, bond protection can be short-lived and correlations can become less favourable for balanced portfolios.

Our central case for the current regime is Global Fragmentation. We expect inflation to remain more variable than it was during the 2000–20 period, with more frequent supply shocks and less elastic supply chains. At the same time, fiscal pressures are rising as governments respond to ageing populations, climate- and AI-related investment needs and higher security spending. These forces increase the likelihood of higher term premia and higher equilibrium interest rates than prevailed during Secular Stagnation, pushing yields higher even as interest rates come down from post-pandemic highs.

This also impacts credit markets. Credit spreads have tightened materially in recent years even as government bond yields have risen, and by historic standards the compensation above government bonds appears less appealing. However, historic averages may be a less reliable guide to fair value if government yields are being increasingly influenced by structural factors, and changes in spreads partly reflect shifts in the government benchmark rather than richer credit pricing.

Portfolio Implications

In this environment, the case for holding government bonds remains strongest at shorter maturities, where sensitivity to inflation and term-premia shocks is lower. Long bonds are most valuable when growth risk dominates and inflation expectations are likely to soften, and less effective when markets are repricing inflation persistence or fiscal and monetary credibility. In short, this regime calls for selective use of longer-dated bonds, or modest allocations, rather than a core, sizeable holding.

Diversification is therefore better approached by using a wider range of assets than just considering the relationship between equities and bonds. Cash retains value as an option on future opportunities. Inflation-linked bonds can improve robustness where inflation uncertainty is a central risk, though we must be careful of the volatility of longer dated issues. Other diversifiers, including gold, can play a complementary role when confidence in monetary arrangements weakens and when real assets regain scarcity value.

Conclusion

In conclusion, the dynamic investor understands that we cannot take the old bond rules for granted. In fact, an analysis of history shows that the ‘old rules’ relate only to a relatively short period of time. We were treated to a golden 20-year period for bonds between 2000 and 2020, delivering positive real returns, excess returns versus cash, and a negative correlation to equities. With hindsight we can say markets have been spoilt, and investors got used to it.

A more fragmented world raises the probability that bonds behave in a more conditional way. In response, we need to be more thoughtful, more selective, and maybe a bit more sceptical about some of the assumptions of the last 20 years.

Strategy

When we think strategically, we are considering time horizons of 7–10 years and beyond. We believe strategy should be developed in partnership between the asset owner and the investment manager. Where applicable, Investment Policy Statements are created through careful assessment of objectives and constraints including risk and return requirements, liquidity needs, other assets owned by the client, and ethical considerations. These must then be aligned with the characteristics of the available asset classes as they are structured today, recognising that an asset owner's circumstances may change, or that market conditions may warrant a meaningful or permanent shift in benchmarks requiring broad support and asset owner approval. Experience tells us that, in practice, these factors result in material strategic shifts roughly every 5 years.

Tactics

While some investors will choose to invest entirely ‘passively’, using index funds as much as possible to implement policy (with regular asset allocation rebalancing back to the agreed strategy), there is a spectrum of ways in which an active manager might expect to add value over and above this baseline portfolio.

Active judgements can be applied in one of two ways: via stock selection within each asset class or by tilting the asset allocation away from the strategic benchmark. Expanding on the latter, we tend to think that tactics can operate at two speeds.

First, over the medium term (which we define as 3–7 years) to reflect deep regime-type trends that can influence whole asset classes, or parts of them, for prolonged periods.

Second, when markets are materially impacted by short-term sentiment or ‘events’, which can generate significant volatility and valuation anomalies, creating shorter-term opportunities over 12-month periods.

The Foundations of a Model Endowments Portfolio

In Part 1, we considered why market regimes matter, reviewed the current Global Fragmentation backdrop and considered the opportunities and lasting trends we expect to influence markets over the period ahead. In Part 2, we considered some of the most significant changes investors have historically needed to make to maintain the relevance of their portfolios, and whether the current structure of markets and opportunities available today suggest that strategic or tactical regime tilts should be taken.

In this final chapter, we draw these thoughts together to reach some recommendations as to how we believe portfolios should be managed over the period ahead, and how this impacts the returns available to the patient, long-term investor. How can the wide range of assets at our disposal be blended together to generate the most attractive absolute and risk-adjusted returns?

The Endowments Model, as written about in the Compendium of Investment, projects a total return of 6.8% per annum over the next 7–10 years, with a real return of 4.0%.

However, the model in the Compendium, for the sake of simplicity, makes four assumptions: there is no value added or subtracted by ‘active’ management; we do not take account of costs; current valuations will hold and the asset mix remains unchanged throughout.

Since we first published our Endowments Model twenty-five years ago, this approach has projected long-term real returns ranging between 3% and 5% per annum.

From a Theoretical Model to Real World Outcomes

Historically, we have worked on the assumption that the average active manager will not outperform after costs, but will not underperform either: they will be able to negate costs and perform in line with a given benchmark. Until the last 5 years, this broadly reflected the median asset owners' experience, supported by the evidence shown in Table 2B.10 on page 36.

Frustratingly, the last five years have been an unusually challenging environment for active managers. We expect this recent trend to moderate over time, but feel it prudent to factor in an element of underperformance after costs going forward.

However, implementing the Endowments Model on a predominantly passive basis would also result in a below-benchmark return after unavoidable implementation costs are factored in.

We suspect a reasonable assumption would be that both the median active manager and the typical passive portfolio will underperform by about 0.35%. On that basis, Evolution 1 shown in Table 3.1, which implements the Endowments Model in the simplest way, could be expected to deliver a real return of 3.7% per annum.

To What Extent Are Results Likely to Deviate Away from Evolution 1?

There are two key factors that will influence returns in any one year and over the medium term. First, markets tend to re and de-rate to a greater degree than a simple and static long-term model can capture, as covered in the explanation of investment regimes. Second, different fund managers and methods of implementation will add or subtract value. In terms of the variation of manager returns, ARC Research Data has been tracking the investment performance of charity and private wealth portfolios for many years. Table 3.2 shows an analysis of ARC Charity Research data, looking at quarterly results over the past 10 years.

While there are significant variations in performance over any single year, it can be seen that this gets diluted over 5 and 10 years. This should not be unexpected: it is rare that a manager or single portfolio will appear in the top decile consistently. The level of risk, style bias or difference to the competition required to achieve a top decile result is such that one or two very good years are often followed by one or two bad years. Over time, there is a natural degree of ‘reversion to the mean’.

That is not to say that achieving a long-term, top quartile result isn't worth having: 0.6% to 1.2% per annum above the average result can equate to a meaningful increase in value over 10 years. But outlying results over 1, 3 or 5 years should probably not be extrapolated.

Despite this, it is evident from our own experience and indeed everyone we speak to in the market, that new business flows are invariably greatest when performance has just been especially strong and lightest when one has just suffered a setback. It appears to be all too easy to ‘buy high and sell low’, which in most circumstances, results in long-term dissatisfaction.

The ARC data is a helpful metric in terms of managing expectations: it would suggest that any diversified multi asset approach that projects much more than 1¼ % per annum over the average result, over the longer term, is probably not credible.

Lastly, it might be better to buy into a strong and consistent long-term record after the manager has suffered a setback, than appoint the manager with the current strongest 3 or 5-year return.

Using Our Understanding of Investments Regimes to Add Value to Evolution 1: How Might a Top Quartile Result Be Achieved Over the Next 7-10 Years?

We can develop the costed Endowments Model in two ways, evolving it to take account of the key messages covered in Parts 1 and 2 of The Almanac. In Table 3.3, we adapt the Evolution 1 – the base case with implementation costs – without introducing any new asset classes, by making the following changes and assumptions to reflect the current regime:

In Evolution 3, shown in Table 3.4, we build on Evolution 2 to incorporate illiquid assets:

Listed equities have recently outperformed most private funds, but there remains congestion in private market exits. Private debt funds are also part way through a setback we highlighted as being likely two years ago. For those seeking to embrace private assets, a steady and opportunistic switch into a mix of semi-illiquid and illiquid strategies may both timely and appropriate.

This final derivation results in a projected absolute return of 8.0% per annum and a net real return of 5.0% per annum.

History would suggest this would be a top decile result within the ARC Steady Growth Universe: appropriate given the inclusion of private assets and reward for the risks associated with a less liquid portfolio.

These scenarios illustrate the potential returns – and associated assumptions – that could be required to generate attractive, above-average performance over the period ahead, recognising that all outcomes remain uncertain until delivered.

Our models are illustrative and designed to generate a discussion: there are a wide range of variations between the approaches outlined.

Ultimately, Sarasin & Partners is a client-focused, solutions-led business, designing investment strategies and portfolios tailored to each client's individual requirements.

We would welcome the opportunity to discuss how we can design and implement a portfolio that suits your particular requirements.