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new environment of persistent inflation, shorter and less predictable cycles, and heightened geopolitical risk is challenging the assumptions that have
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BONDS reimagined
Flexibility with focus: how to position fixed income for volatility
Credit: the power of flexibility in an uncertain world
Time for credit selection to shine
A new approach to bonds
Beyond the benchmark: a new approach to bonds?
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In this context, flexibility and discipline may be equally important. Whether it’s navigating policy divergence, responding to mispriced risk or reassessing how income and capital are balanced, the ability to adapt is taking precedence over static positioning.
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underpinned bond investing for over a decade. Forecasting has become more challenging, market consensus more fragile and dispersion between regions and sectors increasingly pronounced.
At the same time, active credit selection is moving back into focus. With greater differentiation among issuers, the case is growing for strategies that go beyond broad exposures and rely on deep fundamental analysis to identify value.
For professional investors only
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assumptions that have underpinned bond investing for over a decade. Forecasting has become more challenging, market consensus more fragile and dispersion between regions and sectors increasingly pronounced.
ixed income markets have gone through a painful transition, but the outlook is now a lot more positive. Volatility and risk are far from off the
This exclusive Spotlight explores a potential turning point in fixed income—from rethinking the role of duration and liquidity to identifying opportunities in a more cyclical, uncertain world.
Diving into the new world of credit
Opportunities in high yield: ready, steady, pounce?
A new economic era: Three reasons to revisit bonds
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Connor Fitzgerald, CFA, Fixed Income Portfolio Manager at Wellington Management, explores the challenges and opportunities facing credit investors in an era of heightened interest-rate volatility
In an era of increased central bank policy divergence, fixed income investors face a new, more volatile reality. Several underlying forces are driving this new regime of higher inflation and cyclical volatility—among them are the deteriorating fiscal picture in the US, a consumer who is potentially running out of excess savings and the impact of escalating geopolitical risk on supply chains.
Credit investing in an era of higher rate volatility
Connor Fitzgerald, CFA, Fixed Income Portfolio Manager
Against this backdrop, it is difficult for central banks to set policy with conviction, especially as tariffs command the world’s attention. At the same time, the ability of these central banks to stimulate their economy from the monetary angle may be more limited than in past years given stubborn inflation and their large balance sheets.
“Today’s more volatile backdrop is a timely reminder that investors cannot predict the market environment”
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Bonds are back, although risks persist
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The case for a global fixed income approach
The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional or accredited investors only.
Justin Webb, Head of Investment Solutions
Relocating the fixed income opportunity — the case for going global
Blue bonds: long-awaited innovation or yet to make a splash?
For fixed income investors, we believe a key implication of this environment has been rising interest-rate volatility. In the US, volatility has moved to the highest levels of the post global financial crisis era following the significant rebasing of US inflation in March 2022 . Income-orientated strategies that hold large, static exposures to credit markets have felt the unsettling impact of this new era of higher US interest-rate volatility. (Figure 1).
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PAST INDEX OR THIRD-PARTY PERFORMANCE DOES NOT PREDICT FUTURE RETURNS.
Figure 1: US interest-rate volatility
Faced with these market dynamics, it has become increasingly important to mitigate the risk of volatile interest rates while seeking to capture the opportunities available from the fluctuating performance of the US credit sector relative to US Treasuries. In my view, rotating between US credit sectors and US Treasuries as valuations evolve is a potentially compelling way of navigating this environment.
To capitalise in this way, being selective across sectors counts. I favour issuers with sound balance sheets and positive fundamentals and then seek the security structure likely to benefit from capital appreciation relative to the downside risk. Particularly in an environment such as today with elevated uncertainty for businesses and consumers, it is important to focus credit selection on issuers who have durable business models, free cash-flow generation and a clear liquidity runway for the next several quarters.
Ready when markets reprice
In March, as markets began to reprice securities in the US high-yield index given concerns around a growth slowdown and a recession, I believe there were certain industry-leading companies who had their credit spreads pulled out in sympathy with the rest of the market to more attractive prices. This is where I lean heavily on our research analysts to understand what companies fit the mould of stable fundamentals and industry leaders.
Today’s more volatile backdrop is a timely reminder that investors cannot predict the market environment. However, they can control the process by employing a resilient and consistent framework to continually assess the upside and downside risks of every decision and possible price outcome.
Carving out resilient and consistent outcomes
By doing so, investors can seek to achieve a more “all-weather”, total return experience and meet varied objectives through their credit allocation, for example:
As a return enhancer/diversifier to duration/liability-matching allocations within a fixed income growth allocation. As a tactical complement to core fixed income and income/credit-focused allocations. As a return-enhancing replacement for an intermediate credit allocation.
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Above all, I believe that by assessing the range of potential outcomes based on changes in the forward path of interest rates, credit spreads and the broader economic environment, a dynamic and flexible approach to credit investing has the potential to achieve attractive total returns across a range of market environments.
Source.
(1) Bloomberg US Treasury Index, 30 September 2008 – 30 April 2024.
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Interest-rate volatility has doubled since the COVID period…
…leading to a larger dispersion in total return when combined with credit excess returns
12-month excess return for Bloomberg US Credit Index (%)
12-month trailing volatility for Bloomberg US Treasury Index (%)
Martin Harvey, Fixed Income Portfolio Manager
(1) Wellington Management, Refinitiv. 2.5% represents change in yield-to-redemption on the ICE BofA Global High Yield CCC and lower index between 31 October 2023 and 31 December 2023. (2) Wellington Management, Refinitiv. 8% represents current yield-to-redemption on the ICE BofA Global High Yield index.
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Connor Fitzgerald, Fixed Income Portfolio Manager at Wellington Management, explores how bond investors can harness uncertainty to their advantage
the case not only in spite of greater uncertainty, but in some instances, because of it. This is because, in my view, uncertainty can create opportunity for fixed income investors, provided they can achieve the right balance between flexibility and discipline.
oday’s fundamentally different economic era—defined by structurally higher inflation, greater volatility and more frequent market cycles—can present compelling opportunities for active fixed income investors. I believe this to be
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How bond investors can harness uncertainty
Positioning amid uncertainty
We tend to view fixed income markets as a constantly evolving equation. Simply put, this means there's a good result (outcome A) and a bad result (outcome B). But I believe trying to predict the right future outcome and position your portfolio accordingly is futile, especially given the inherent unpredictability of the new economic era.
How might this approach work in practice? Two examples come to mind. The first relates to the consumer finance sector in 2023. Going into 2023, the market was concerned about outcome A—the impact of interest-rate hikes by the US Federal Reserve (Fed), believing that consumer finance companies would be particularly at risk if recession fears materialised. While we couldn’t dismiss the possibility of a recession, we hypothesised about the probability of outcome B—the US consumer was in a far healthier state than the market realised, interest-rate hikes were having less of an impact on consumers than had been feared and small businesses were not as dependent on regional banks as the market seemed to think they were. Working closely with sector-specific experts and diligently analysing alternative data meant we were able to position portfolios to capitalise on this mispricing and uncertainty.
“Uncertainty can create opportunity for fixed income investors, provided they can achieve the right balance between flexibility and discipline”
A live example presents itself to us right now. I think uncertainty around the impact of the Trump administration’s policy mix can also be viewed through this lens.
“An unconstrained approach has a greater ability to capitalise on opportunities than a benchmark-oriented approach”
Green bonds remain the most popular form of use-of-proceeds bond, but investors are increasingly interested in blue bonds, which aim to support projects related to ocean protection and conservation.
onds that finance specific sustainability-focused projects or activities – also known as use-of-proceeds bonds – are on the rise.
B
John Butler, Macro Strategist
Instead, I find more value in identifying a crowded trade—where the probability of outcome A is perceived to be much higher than the probability of outcome B—and analysing why outcome B may be more likely than market consensus and pricing imply.
Source: Bloomberg Index Services Ltd. Rolling monthly price change for cumulative principal and income returns for Bloomberg US Intermediate Corporate Index. Data from May 2021 to December 2024.
FIGURE 1: The importance of paying attention to total returns
Fourth, consider multiple perspectives. As fixed income investors, we naturally scrutinise central bank movements, inflation levels and macroeconomic indicators. But bond investors have much to gain from perspectives that might not immediately come to mind, such as looking at issuers with an equity investor’s lens or assessing the potential impact of geopolitical shifts.
Fifth, retain enough liquidity without waiting for negative market events to occur so that it’s possible to take advantage of opportunities as they arise. Maintaining a high level of “dry powder” while spreads are tight can offer investors the potential to buy on dips when spreads are relatively more attractive.
When you apply this way of thinking, uncertainty can create opportunities for bond investors to capitalise on mispricing. The current market environment—featuring greater performance dispersion across regions, sectors and issuers, as well as higher inflation and greater cyclicality—presents us with many such opportunities.
If outcome A is that the Trump administration’s policies have a positive impact on US growth and lengthen of the economic/credit cycles and outcome B sees the policies trigger a negative growth shock and tighter financial conditions in the US, I think the latter could be more likely than the market expects.
Trump’s re-election seems to be accelerating underlying trends around weaker labour supply and a deteriorating fiscal backdrop. While tariffs may turn out to be a negotiating tool, I see them as the only significant “source of funds” in his economic plan. In other words, the administration may need tariffs to fund tax-cut extensions and further stimulus. What this misses, of course, is how disruptive this posturing is for global trade.
Tighter immigration policies could also be growth negative. Immigration has not only been a positive catalyst for labour-supply growth but also a stimulant for demand. With fewer people seeking housing, food, goods and services, will prices adjust downward? The effects could be especially acute in the housing sector, as the US has been aiming to close a structural housing-supply deficit.
So how can bond investors leverage uncertainty to their advantage? We think the following five considerations may help.
Positioning for uncertainty
First, bond allocations need to be flexible enough to take advantage of dislocations as they occur. An unconstrained approach has a greater ability to capitalise on opportunities than a benchmark-orientated approach.
Second, we believe flexibility must be paired with discipline. An unconstrained approach can capitalise on opportunities, but it can also leave investors exposed to unnecessary risk. Employing a resilient and consistent framework to continually assess the upside and downside risks of every decision and possible price outcome can help investors seek to achieve an “all-weather” total return experience.
Third, focus not only on income but on total returns. Investors who focus too much on yield risk overpaying for income and underestimating the impact of price volatility on returns. Comparing a bond's cumulative return from income versus its rolling price change over time serves as a good illustration of the importance of paying attention to total returns (Figure 1). An income-based investor who does not pay attention to total returns could see periods where they face a drawdown of close to 20% on some of the bonds in their portfolio. On the other hand, an investor who takes more of a total return approach and who is able to be flexible can potentially seek to monetise uncertainty by responding to changes in market conditions, ultimately aiming to avoid most of the initial drawdown and instead participate in a subsequent rally.
Today’s more volatile backdrop is a timely reminder that investors cannot predict the market environment. However, volatility can be a boost rather than a hindrance to performance if one is willing to think critically about the ever-evolving probabilities in fixed income markets and dynamically move their portfolio to perform well across a market cycle.
Bright spots exist, if you can capture them
Price volatility can lead to significant drawdowns for income-focused bond investors
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Cumulative principal and income returns (%)
Fixed Income Portfolio Manager Martin Harvey and Investment Director Marco Giordano of Wellington Management highlight why they believe a flexible, globally diversified approach to fixed income is essential in navigating today’s volatile and uncertain market landscape
Amid the recent resumption of market volatility, bonds continue to provide capital appreciation along with still high income. However, the path ahead may require skilful navigation, given stubborn inflation, growing differences in economic growth trajectories across countries and divergence in policymakers’ responses. Shifting geopolitics— exacerbated by the actions of US President Donald Trump since his return to the White House—present another factor of unpredictability, as illustrated by the recent market turmoil. How should investors think about repositioning their portfolios for this prevailing uncertainty?
A less stable economic environment with more frequent and shorter cycles; Higher and more volatile inflation; Increased geopolitical rivalry and divergence as globalisation slows and, in some areas, even reverses; and Structurally higher government intervention and fiscal spending.
• • • •
fter the inflation shock of 2021 – 2022 triggered a rapid rise in interest rates across most developed markets, cash and bond investors enjoyed a welcome boost in income thanks to the return of attractive yields.
Today’s uncertain outlook reflects a structural regime change that we believe investors need to be attuned to. The key features of this new economic era include:
Adapting to a structurally different macro background
Central banks are no longer acting as a source of stability, as they are caught between the need to contain inflation and the desire to avoid engineering the economic slowdown that may be needed to bring inflation durably back in line with their targets. This dilemma could be exacerbated by the impact of US tariffs as governments may have no other choice than to loosen the purse strings. Monetary policy decisions may well catch investors by surprise, with central banks taking potentially very different paths. For instance, given the major ramifications of US tariffs on the European economy, the European Central Bank (ECB) may end up cutting rates meaningfully below current market consensus. On the other hand, wage and inflation data in the UK may hamper the Bank of England’s efforts to continue its rate-cutting cycle. While a risk, this divergence also constitutes an opportunity for investors to capitalise on.
While short-term cash deposit accounts have done well over the past few years, we think they now come with a significant reinvestment risk, given declining rates. Unlike bonds, cash instruments do not benefit from the uptick in bond valuations that typically accompanies rate cuts, and income resets at lower levels, suggesting diversification into fixed income may be overdue. Many investors have already switched part of their cash holdings to domestic government bonds—with several governments now actively targeting retail investors—or other “safe-haven” instruments. However, in our view, further steps could now be warranted. While there is an important role for domestic government bonds in portfolios, complementing single-country exposure with a diversified high-quality global bond portfolio could:
Going beyond cash or single instruments
Mitigate reinvestment risk and help shield portfolios from excessive volatility; Diversify the significant beta risk embedded into a single-country issuer, which may become pronounced in today’s uncertain environment; and Offer the potential for capturing higher yields that may be available elsewhere.
Targeted diversification does not necessarily mean having to take on significant duration or credit risk. In fact, we think that in an uncertain environment, flexibility can be a bond investor’s best friend. Specifically, we think high-quality, unconstrained approaches offer an attractive avenue to complement existing portfolios as they have limited average duration and credit exposure while offering diversification across the full gamut of countries, sectors and themes.
Adopting a flexible fixed-income approach
And we think the signs are encouraging for flexible fixed-income strategies to continue their positive trajectory in today’s diverging world, offering both significant scope for downside protection and opportunities for upside potential amid market dislocations. These sudden readjustments in market sentiment are likely to be a constant feature of this new economic era.
For instance, at this stage, the US administration’s policy programme is likely to lead to structurally higher inflation, heightened volatility and a potential reversal in global capital flows, as well as a slide in the US dollar. Elsewhere, Japan and the UK appear to be pursuing monetary policies that are still in dissonance with the economic data, while the euro area remains hobbled by political constraints in France, concerns about debt sustainability—only partially offset by Germany’s fiscal measures—and the continued impact of the war in Ukraine. Across the board, US tariffs and the risk of a surge in Chinese imports to non-US markets are now key areas of concern for policymakers and investors. On the opportunity side, countries like Australia, New Zealand and Canada boast low levels of public debt but high private debt, meaning their central banks may be better equipped to deal with any financial instability and more sensitive to a deterioration in the cycle. They could deliver higher and more stable total returns given high starting points in yields as well as acting as alternative “safe havens”.
• •
We believe investments in fixed income should seek to achieve three key objectives:
Bottom line
Reliable and recurring income, with a growth component Enhanced diversification and liquidity Capital preservation over the longer term
In today’s more unpredictable environment, we think these objectives can be best achieved by adopting a more flexible approach that targets a global opportunity set within robust risk constraints. In our view, having greater flexibility on duration, country and sector selection can help protect both income and capital during periods of heightened volatility. As such, we think this can be a powerful addition to most portfolios, helping to smooth the impact of volatility on single country or region allocations by diversifying exposures across diverging economic and policy cycles.
“In an uncertain environment, flexibility can be a bond investor’s best friend”
Marco Giordano, Investment Director
“Central banks are no longer acting as a source of stability, as they are caught between the need to contain inflation and the desire to avoid engineering the economic slowdown”
In practice, there are a wide range of unconstrained strategies available in the market and investors will need to ensure that the chosen approach meets their specific requirements. Given the uncertain environment, one avenue investors may wish to pursue is allocating to flexible fixed income strategies that place a higher emphasis on capital preservation and liquidity—through higher allocations to select high-quality government bonds—but still provide the potential for positive long-term returns through exposure to a rich, global opportunity set.
spectrum, but doing so may involve proactively revisiting widely held assumptions.
e believe that in this more cyclical era, bond investors can capture attractive income across the quality
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