Preparing portfolios for a more uncertain market year

By James Yardley on 21 January 2026 in Equities

2026 is barely underway and it is already proving to be a roller coaster. The US administration has accelerated its foreign policy agenda, threatened a trade war with its allies and compromised the independence of the Federal Reserve.

This comes at a time when the bull market was already looking long in the tooth. It is a year when protecting a portfolio is likely to be particularly important.

There is no single solution, but rather a combination of factors is likely to help protect portfolios in the year ahead. It may seem unimaginative, but traditional defensive options may be a good starting point. A few years ago, areas such as consumer staples, healthcare or utilities were too expensive to offer real protection for a portfolio. However, they have all struggled in recent years. Consumer staples have been hit by the advent of GLP-1 drugs for obesity, while healthcare stocks have fallen in response to worries over drug pricing. This has brought them down to a level where they could fulfil a defensive role for investors.

Quality fund managers tend to gravitate to these areas and could benefit as the market uncovers the value. Mark Ellis, manager on the Nutshell Growth fund, says: “Market leadership in 2025 was somewhat bifurcated. Returns were dominated either by speculative, AI-related high-beta “story” stocks or by more traditional value and cyclical exposures, particularly within Financials and Defence. While there is no direct S&P 500 Profitability Index, the S&P 500 Quality Index provides a close proxy for our factor exposure and aligns well with our investment philosophy of owning high-quality businesses at sensible valuations.

“In 2025, the S&P 500 returned 17.9%, compared with 13.4% for the S&P 500 Quality Index – an underperformance of 4.4%. This is a rare outcome. Over the past 30 years, the only larger episode of underperformance occurred during the late-1990s technology bubble, when Quality lagged in 1999.” Another advantage of holding quality companies is that their outperformance tends to be strongest when markets are sluggish.

The case for active funds

2026 may also be a year when active funds may thrive over passive funds. There has been real concentration in markets, not just in the US, but in the UK, Asia and Europe. In the US, the ‘Magnificent Seven’ reached its largest weighting ever in the S&P 500 index in November. Asian markets have been led by the semiconductor sector, with strong gains for the Taiwan and South Korean markets. Even in the UK, a handful of stocks have been dominant – Rolls-Royce for example.

There are small signs that investors are starting to shift position. In the most recent Investment Association fund flows statistics, active funds recorded their highest inflow in six months at £297 million, outpacing passive funds by £64m*.

James Thomson, manager of Rathbone Global Opportunities, says: “For three years, markets have been plagued by heavy concentration in returns – large-cap growth, tech, communications have dominated. None of the ingredients have been there for broadening out. But, this year, that has changed

“There is improving housing activity, a Fed that has been easing for at least 12 months, money growth is expanding, 10-year rates have been lower for at least a year. Oil prices are at historic lows and there is cyclical fiscal stimulus coming through, cheques are being sent to every American later in the year. These could mean a broader participation in the market starts to come through.”

He believes technology is unlikely to repeat its outperformance of traditional cyclical and defensive companies. In the four years leading up to the dotcom crash, the Nasdaq experienced eight 10%+ corrections. “In the last few years, we’ve barely had any. It’s symptomatic of a market that has become too concentrated.” While he doesn’t see a rerun of a dotcom-style crash, he is broadening his portfolio with companies such as Hermes, CostCo, Home Depot and Next.

Lower-risk alternatives for your portfolio

Bonds would normally provide a ballast to a portfolio, but parts of the bond market are now looking highly valued. Corporate bond spreads are still at historic lows over government bonds**. While all-in yields are still high enough to provide some protection, and lower interest rates should support bonds in the year ahead, it may be worth considering alternative, higher-yielding options to provide some balance.

Infrastructure has traditionally been a beneficiary of lower interest rates, and has some inbuilt inflation protection. Nick Langley, manager of the FTF Clearbridge Global Infrastructure Income fund, points out that infrastructure has already been benefiting from structural tailwinds such as decarbonisation, investment in ageing network infrastructure to improve resiliency, and AI and data centre growth, which is driving power demand.

He believes these themes will all still be in play in 2026 and beyond and aren’t yet being captured by markets.

“Infrastructure valuations look attractive to us, especially given the length and transparency in their spending and returns. Most of our exposure is in the United States, where utilities are experiencing unprecedented, regulated earnings growth generated by increases in their asset bases because of this enormous capital spending…In addition, the fiscal environment has been positive, especially in the United States and Europe, and global monetary policy is currently generally neutral to easing.”

Inflation threats still linger

Inflation has been well behaved over the past 12 months. The low oil price has helped minimise price rises, but there are risks to this benign picture. A re-escalation of the tariff war could ignite inflationary pressures, while resource nationalism could raise prices for key commodities.

Investors need to ensure that they are well insulated against inflationary threats. Maintaining higher weightings in equities should help, but adding some weighting in commodities may also help. WS Amati Strategic Metals or BlackRock World Mining Trust are potential options. Both funds will flexibly allocate to commodities with structural demand and should offer some protection should inflation spike higher.

In 2025, investors got away with maintaining higher weightings in technology and ignoring the rest of the market. They may do so again in 2026, but that trade becomes riskier with every month that passes. Financial markets are already starting to shift and the diversification trade is likely to build momentum from here. Investors will need to be prepared.

*Source: Investment Association, 8 January 2026

**Source: ICE BofA US Corporate Index Option-Adjusted Spread, at 16 January 2026