The third quarter could be marked by three major shifts. Interest rates are going to be decidedly higher for longer. The breadth of market performance we talked about in the first half of the year began to fade through the third quarter, and the US midterm elections are now just around the corner. Here's how we’re viewing world markets and what's driving our investment decisions.
The first shift, as I mentioned, is interest rates. Entering the year, investors generally expected to continue moving lower and central banks to gradually reduce interest rates. Instead, inflation proved more persistent than expected. Rising energy prices, resilient economic growth and continued consumer spending forced markets to reconsider that outlook. The Federal Reserve reinforced that message in September with a 25 basis point rate increase, and signaled that the fight against inflation is not yet over.
Bond markets quickly responded as the US ten year Treasury rose above 5%. It's the level we haven't seen in nearly two decades. While rate increases are often discussed in terms of central bank policy, what really matters for investors are the broader implications. Higher rates increase financing costs, they reduce liquidity and raise the hurdle companies must overcome to create shareholder value.
Businesses with strong balance sheets, pricing power and durable cash flows become increasingly valuable in this type of environment, while weaker businesses face greater scrutiny. Now, the second shift is narrowing market leadership. Throughout the first half of the year, we discussed improving market breadth and broadening participation in the equity rally. While that trend was evident earlier in the year, it began to reverse during the third quarter and specifically in September. At the index level, equity markets remained relatively resilient beneath the surface, however, a different story was unfolding. Much of the market's strength became increasingly concentrated among a smaller group of companies benefiting from artificial intelligence, data center expansion and semiconductor demand, as well as digital infrastructure spending. Meanwhile, many smaller companies and interest rates sensitive sectors struggled as bond yields did move higher. In many respects, September highlighted the growing divide between companies participating in the AI investment cycle and those feeling the effects of higher borrowing costs.
This remains an important theme for us. While AI continues to create significant opportunities, we believe disciplined portfolio construction remains as critical as ever. We want exposure to long term growth trends, but we also want portfolios built around diversification, cash flow generation and reasonably attractive valuations. The third shift is in political uncertainty. As we move into the final months of the year, investors are increasingly turning their attention toward the upcoming US midterm elections.
While elections often generate significant headlines and periods of volatility, history suggests their long term impact on investment returns tends to be less important than corporate earnings, economic growth, and monetary policy; the bedrock of fundamentals. That said, the election could influence expectations surrounding fiscal policy, taxation, regulation, government spending, and trade. Markets will likely spend the coming months attempting to assess those potential outcomes, creating additional uncertainty and noise along the way.
Now, despite these crosscurrents, Matco’s Balance Fund has delivered a solid result so far in 2026. The fund returned -2% during the third quarter, reflecting the impact of rising rates. Geo policy uncertainty and a challenging environment for both equity and fixed income markets. Despite this, the fund has generated a 7.1% return year to date through September 30th and ranking in 34th percentile in its peer category.
From a portfolio management perspective, we have continued to make measured adjustments rather than significant drastic changes. Within equities, we remain focused on high quality businesses that have strong balance sheets, strong competitive moats, and the ability to grow earnings across a range of economic environments. We have selectively trimmed positions where evaluations have become stretched and redeployed capital toward opportunities, offering better valuations and just better long term risk adjusted returns.
Within fixed income rising yields have improved the attractiveness of the asset class and allowed us to enhance portfolio income while maintaining a strong focus on credit quality and downside protection. The balance funds current positioning reflects that philosophy, with approximately 38% allocated to our Diversified Income Strategy, 24% allocated to Matco’s Canadian Equity Income Strategy, 8% to our Opportunity Strategy, and 26% to Matco's Global Equity Strategy.
3% is in a mortgage investment solution and 1% allocated cash. Now looking ahead, we continue to see reasons for optimism. Corporate earnings remain strong, economic growth is positive, and investments in AI and productivity enhancing technologies continue to support long term growth. However, at the same time, the investment landscape has become a bit more challenging and a bit more selective.
Higher rates, which I've mentioned elevated geo policy uncertainty and political developments, are likely to create periods of noise. We believe this is precisely the type of environment where diversification, discipline and active investment management can add value. As always, this remains our focus, identifying high quality investments that can perform across a range of market conditions, rather than relying on any single economic outcome or investment theme.
These principles continue to guide all of our decisions we make, and remain the foundation of the balance fund itself.
