As 2025 draws to a close, one theme stands out: the year has been defined by the tension between immediate policy uncertainty and broader structural shifts. In Australia, upside inflation surprises reignited debate over the RBA’s path, creating a sharp disconnect between markets pricing in potential 2026 hikes and economists who see cooling labour markets and moderating demand as foreshadowing eventual easing. Meanwhile, the widening “K-shaped” economy highlighted divergent household fortunes, complicating policy transmission and credit dynamics. Slowing growth and peaking inflation provide a solid anchor, but curve steepening, fiscal supply, and volatility risks are acting to cloud the inflation outlook, supporting active management, tactical flexibility, and selective risk-taking.

This year has reinforced something that has been long known. Defensive assets are not optional. Despite the surge in gold this year, government bonds have reaffirmed their role as a cornerstone of defensive allocation. Over the medium to long term, bonds have consistently delivered strong total returns compared to traditional safe-haven assets, providing liquidity and stability that investors can rely on. For investors seeking resilience and predictable income in an uncertain macro backdrop, government bonds stand out as a disciplined choice.

Markets that tested every nerve

2025 has been a year of extremes.  It was a year defined by policy whiplash, data uncertainty, and a re-pricing of term premia. Globally, the shift from fiscal largesse to fiscal tightening in the U.S., frequent tariff headlines, and an unprecedented data blackout during the federal shutdown kept risk assets on edge.

The domestic picture mirrored global cross currents but with local nuance. The RBA’s measured stance anchored the front end while a slowing growth pulse, uneven disinflation (with intermittent CPI surprises) and a cooling labor market kept cuts in play even as markets reacted to hawkish repricing late in the year. Credit bifurcated: high‑grade remained orderly, while private credit showed signs of late‑cycle strain, demanding caution.

Looking ahead, the global backdrop remains complex. Fiscal consolidation in the U.S., ongoing tariff negotiations, and structural shifts in energy policy will continue to influence term premia and global government bond yield curve dynamics.

While inflation has moderated, intermittent upside surprises and geopolitical risks suggest that volatility will persist well into next year, at the very least. Credit conditions are tightening, and sporadic signs of stress in private credit may become more visible and indeed systemic if growth slows further, the business cycle turns, and labour markets deteriorate. For fixed income markets, assuming no major geopolitical events or unforeseeable pivots in macroeconomic, trade, fiscal and regulatory policies across major advanced economies, 2026 is likely to be characterised by range-bound yields, selective opportunities in duration, and heightened focus on liquidity as policy uncertainty and structural imbalances remain key drivers.

Why defensive assets matter more than ever

Defensive assets are a practical tool for managing risk, income, and liquidity, and their value is most evident in periods of market stress.

• Capital preservation:  Government bonds can serve as a portfolio hedge, providing liquidity, duration, and convexity benefits that help preserve capital during market drawdowns.
• Reliable income: Government bond yields remain and transparent, which can help clients meet cash flow needs without forcing advisers into opportunistic or reactive decisions.
• Liquidity: Unlike private credit or alternative investments, government bonds can offer liquidity even when markets are under pressure. This allows advisers to rebalance portfolios, respond to client withdrawals, or redeploy capital where it’s needed. As such, there was no change in our buy-sell spreads during periods of market stress this year, reflecting consistent liquidity through the year.

The importance of these factors cannot be overstated. When clients see their portfolios drop in value, their instinct is often to sell. Defensive allocations provide portfolios the resilience to withstand shocks, protect capital when markets turn and keep investors focused on the bigger picture rather than short-term noise.

Defensive assets and geopolitical risk

This year, geopolitical events have consistently moved markets, reminding us that risk is not always economic - it can be political, social, or environmental. This means portfolios need buffers that are negatively correlated with risk assets or at least uncorrelated, so they hold value when other parts of the portfolio are stressed. At current interest rates, government bonds have continued to serve as an effective risk buffer, combining high-quality liquidity and duration exposure to preserve capital during periods of market stress driven by political and macroeconomic shocks.

Income and liquidity: How our clients have benefited in practice

In practice, income and liquidity were particularly valuable in 2025. Regular income from government bonds meant advisers could continue to fund client objectives without selling growth assets at an inopportune time or times. Daily liquidity ensured that portfolios could be rebalanced or repositioned when opportunities or client needs arose, something that illiquid assets, even if attractive on paper, simply cannot provide.

Portfolio construction lessons

The real lesson is that defensive assets are the foundation of a diversified portfolio, and as such, are not optional. They can anchor portfolios in multiple ways:

1. Drawdown mitigation: They reduce the impact of equity corrections and other risk asset declines.
2. Regular Income: They can provide regular cash flow, supporting client spending and reinvestment.
3. Liquidity management: They allow advisers to act decisively without being forced into selling illiquid positions.
4. Behavioural anchoring: They help clients stay invested and avoid emotionally driven decisions during volatility.

When combined thoughtfully with equities, alternatives, and private credit, defensive allocations allow advisers to construct portfolios that are both growth-oriented and resilient.

Looking Ahead to 2026

As we step into the new year, the lessons from 2025 highlight the importance of disciplined portfolio construction. Defensive assets support capital preservation, and generate regular income to meet long term objectives.

Globally, 2025 is closing with a calm across markets that is as uneasy in the circumstances as it is unusual. This is despite intermittent shocks ranging from tariff uncertainty to surging AI-driven investment and the longest U.S. government shutdown on record. The absence of timely U.S. data has muted pronounced directional moves and kept fixed income markets rangebound, reinforcing a theme of stability. Yet as we look ahead, the backdrop is more nuanced. Strong asset performance and the apparent resolution of U.S. trade and macroeconomic policy uncertainty provide a fundamental juxtaposition and to structural imbalances and several latent risks that could quickly upend the calm.

What could break this equilibrium in 2026? Further data disruptions building on those from the government shutdown can leave markets flying blind, increasing uncertainty around central bank responses. Fiscal pressures remain a global theme, with skyrocketing public debt, spiking deficits and booming public infrastructure spending putting upward pressure on term premia and steepening curves. AI-driven capex and leverage introduce tail risks if monetisation lags, raising the spectre of widespread credit stress and private sector balance sheet vulnerabilities.

As 2026 approaches, balance will be key. Slowing growth and peaking inflation provide an anchor (albeit a challenging one for central banks to manage), even as fiscal supply and asset price volatility risks urge caution. Liquidity and risk management strategies will be essential to navigate a world where stability can quickly give way to turbulence. The coming year is about harvesting opportunities while staying agile amid rapidly evolving developments that include shifting yield curve dynamics and the new frontier in AI and private credit that dominated headlines in 2025.

Markets will continue to swing, geopolitics will continue to surprise, and volatility will remain a fact of life. By maintaining allocations to assets that protect capital, provide liquidity, and deliver regular income, advisers can continue to meet client objectives and preserve confidence regardless of the challenges that the new year brings.