Markets have been focused on the situation in the Middle East, with fears of escalating inflation likely contributing to the heavy selloff in bonds across Europe over March (-€18.15bn, or almost two-thirds of the total redemptions for the month). In the UK, bond sales are in negative territory, year to date—though not as much as equities are, of which more later.
Europe’s economies remain reliant on energy imports and sensitive to the inflationary effects likely from the changes in energy prices. Investors will be mindful of the impacts of the 2022 inflationary shock, fresh in the memory, and with many portfolios still bearing the scars.
Events over 2022 demonstrated that inflation is bad for bonds, especially longer duration securities. Developed market central banks tended to be initially sanguine about inflationary pressures as economies opened in the wake of Covid… then rushed to tighten, as inflation began to spiral upwards. Base rates rose rapidly, negatively impacting the returns of fixed income securities.
UK gilt funds suffered particularly badly, falling 23.59% on average over the year. However, the worst performing fund classification was one that you might have thought would weather the storm: UK Index-Linked Gilts: assets that, given the name, should be a good hedge when inflation is running riot. However, UK linkers funds fell by an average of 32.42% over 2022. The reason is that they have a much longer average duration than, for example, the much bigger US inflation-linked market: the UK linker sector had an effective duration of 17.9, while its Global Inflation Linked Bond counterpart had an average of 7.5 and was consequently not as adversely affected.
It’s therefore not surprising to see redemptions from Bond GBP Inflation Linked funds escalate over March in the UK, although flows for UK government bonds are still quite flat.
Nevertheless, in Europe markets repriced the ECB policy outlook substantially over March, responding to the stagflation risks from the energy shock, according to FTSE Russell research. This caused 1-3 yr Bund yields to spike about 60 basis points from late February, resulting in a significant flattening of the yield curve in Europe. This is known as “bear flattening”, where the yield curve flattens as short-term bond yields rise more than long-term yields, typically driven by central bank rate hikes—or, as is the case now, high inflation expectations. It signals a negative environment for bonds. This market reaction at the front end of the curve may be the legacy of central banks underestimating the scale of the 2022 inflation shock, resulting in rate rises and the subsequent “higher for longer” environment.
Nevertheless, both fixed income and total flows overall remain in positive territory in Europe over Q1. For whatever reason, European investors display greater risk toleration that their UK peers, who have been shunning risk assets to a greater degree and for a longer time.
The effects of macroeconomic, sector, and geopolitical events are not, of course, limited to the world of fixed income. In equity terms over the quarter, we also see strong thematic trends at play. For example, the Information Technology hardware-software divergence on AI disruption fears has hit software-heavy indices such as the US and emerging markets more than hardware-heavy ones in Asia Pacific. Despite this, APAC funds continue to see net redemptions. Investors continue to trim their Equity US overweights, instead favouring broad-based global and emerging market alternatives over the course of the year.
In performance terms over March, Energy was often the only industry that made significant gains. Financials stocks, on the other hand, were adversely affected by those same flattening yield curves.
Equity Sector Energy funds took €2.56bn over March in Europe, making it the fifth most popular sector. UK investors have been slower to the party, with these funds seeing positive but far more muted flows. Conversely, European Equity Sector Financials funds suffered redemptions of €4.19bn, with much smaller amounts also withdrawn from their UK-listed equivalents.
One reason for the UK’s more muted response could well be the UK market’s more tepid uptake of ETFs. These vehicles increasingly dominate equity flows—and so allocation calls—in Europe and the US, though not so much the case in the UK. ETFs seem generally to be investors’ favoured way of implementing sector or thematic calls, which begs the question—is the UK less nimble than other major markets?
Which begs a further question: does it matter? Others may be fleeter of foot, but if those feet land in the wrong place, then slow and steady will still win the race. So, I looked at flows versus performance of 15 equity sector and thematic fund classifications over 12 months to March 2026 to see if there was a statistically significant relationship (see chart). The correlation was 0.23—positive but not particularly strong. I’m not overclaiming this relationship, and I’m certain that choosing different periods would yield a wide variety of results.
Chart 1: Flows v performance of Lipper Equity Sector and Thematic Classifications (USD bn, %, March 2025 to March 2026)
Source: LSEG Lipper
However, that the results are positive suggests the reallocations add value overall.
The test did, however, yield one particularly interesting result. Amid the market focus on AI or energy stocks, and the recent precious metals volatility (see the far right of the chart), the recovery of the alternative energy theme seems to have been missed. Over the year, these funds have quietly made 52.63%—way ahead of the still impressive 30.26% delivered by Equity Sector Information Technology funds.
That’s a quite impressive under-the-radar delivery, though this corner of the market will likely struggle to deliver once again in a rising rate environment. Renewable energy projects have high up-front investment that pays off over the long term. Higher interest rates decrease future cash flows, so renewables stocks are sensitive to the threat of higher rates.
What’s more, the strongest performers over the year (200%-plus) are Korean funds, which has had a stand-out year. But it does show that not all the good news makes the headlines.
This article first appeared in the summer edition of Personal Finance Professional.
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The views expressed are the views of the author and not necessarily those of LSEG Lipper. This material is provided as market commentary and for educational purposes only and does not constitute investment research or advice. LSEG Lipper cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. Please consult with a qualified professional for financial advice.
