How AJ Bell funds performed in the third quarter and what to watch for next

The three months leading up to the end of September were a relatively quiet time for stock markets compared to other quarters earlier in the year, but bonds experienced a much more tumultuous period driven by a selloff in government debt.

This led to muted returns across our lower risk funds but also showed that our focus on diversification was effective in smoothing out an uncertain period. Here's how our different funds performed.

Depending on which fund you invest in, different parts of the market will have a greater impact on your money. Those investing in our Cautious and Moderately Cautious funds, for example, will be more heavily impacted by moves in bond markets because they have a higher weighting to this asset class. The further your fund is towards the higher end of the risk spectrum, such as the Adventurous or Global Growth funds, the more it will rely on stocks rather than bonds for its returns.

It can be helpful to get a picture of what your fund holds before diving in to understand which parts are most relevant to you.

Stocks: US and UK push forward as emerging markets falter

While equity markets were broadly positive, we didn’t see the rapid increases from themes like AI that we have dominated markets in previous quarters.

Oil prices continued to be a big factor in stock markets this quarter, as prices shot past $100 per barrel once again, and oil companies enjoyed a similar surge in share prices. However, the relationship between oil prices and the general stock market started to change throughout the quarter. Earlier this year, there was a strong inverse correlation between oil prices and markets, with markets dropping when oil prices rose. Now, as markets adjust to ongoing conflict, this relationship is softening. Both oil prices and stock markets rose throughout the quarter, as investors became more comfortable with the effects of an oil shortage on the economy and business.

Most of our funds hold an additional position in the US energy sector, which worked to balance the scales earlier this year when broader stock markets struggled. But this quarter, the position has served as more of an extra boost to the broader market’s positive performance.

Emerging markets excluding China, which dominated the growth story for the first half of the year, decreased slightly throughout the quarter after a period of ups and downs.

Earlier in the year, investors became excited about this area of the market because of its strong tie to the AI theme: it is home to chip producers like TSMC (Taiwan Semiconductor Manufacturing Company) in Taiwan for example. But now, the companies essential to the AI supply chain are factoring in a lot of company profit growth. Areas of speculation have also calmed, such as that in the Korean market, where individual investors borrowed heavily to invest in stocks earlier this year.

Japan has been a strong performer throughout the quarter and the year. We’ve been able to benefit from this by holding more than the average weighting towards the country. One of the main drivers here has been governance: Japan has been on a journey for the last decade to crack down on poor company performance with mixed success. But this year, their policies are having greater success and we are seeing more substantive change rather than a tick-box activity.

Government debt selloff rocks the bond market

Typically, bond investors enjoy a much smoother ride than stock investors. But this quarter, government bonds made headlines as they experienced dramatic selloffs, causing price drops that resulted in higher yields.

This isn’t the first time we’ve seen a rise in government bond yields this year, but it is now trickling into other parts of the bond market as well, such as corporate bonds and emerging market debt.

Changes to government bond yields happen as a result of changing interest rates. While inflation can be a common driver of this, it’s not the only factor that comes into play. For example, investors also have growing concerns about the amount of debt that governments are taking on.

Whatever the reason, yields have moved higher. The good news is, we’ve been positioned well for this period. Most of our government bond holdings are in short-dated bonds that tend to be less sensitive to interest rate changes than, for example, a 10-year gilt. We also hold a group of inflation-linked US and UK government bonds, that had managed a positive return during the period.

Some of our funds also hold positions in investment-grade corporate bonds and high yield bonds. Investment-grade corporate bonds felt the effects of the rising government bond yields, combined with a period of high bond issuance from companies following the summer holidays. This increased availability of bonds, as well as the attractive yields offered on government bonds, led to a price drop for corporate bonds. High-yield bonds were a bit more resilient because of they already pay out high rates to those who are willing to take on the risk.

What are we watching out for?

The final three months in this year will feature elections in the US as well as throughout Europe. This tends to create some short-term drama in the markets, but it’s important to keep in mind that other factors tend to be more significant in the long term.

What we will be keeping our eyes on is earnings. In the past few years, we’ve seen some of the companies with more lofty valuations, like Nvidia, be able to back their numbers up with earnings, closing the distance between their price and their earnings in recent years. This creates a valuation that feels more comfortable for investors and is a tentative positive sign. But we are looking to keep a close watch on if these earnings are truly robust and can withstand the tests the market is sure to deliver in time.