Why Fixed Income Deserves a Fresh Look

Fixed income is supposed to be the boring part of a portfolio: dependable income, diversification, and a measure of stability when risk assets become volatile. In recent years, it has felt anything but boring.

After a long period of weak returns, and especially after the shock of 2022, many investors began to question whether bonds could still do the job they were meant to do. That skepticism was understandable. But we think it is important
to separate what fixed income has done over the last several years from what it is positioned to do from here.

In our view, the fixed income landscape has changed materially. The last five years were difficult, but those difficult years have also reset the opportunity set. Today, yields are meaningfully higher, income is once again doing real work, and bonds are earning a stronger case for inclusion in portfolios than they had for much of the post-2008 era.

That does not mean every part of fixed income looks equally attractive. It does mean that selectivity, flexibility, and active management matter more than ever.

Why this isn’t 2022 again

The main reason fixed income returns have struggled is straightforward: bond markets entered this period from an exceptionally low starting yield base.

For years following the Global Financial Crisis, and then again during COVID, central banks kept interest rates unusually low. Investors were left owning bonds with very little income cushion. When inflation later surged and central banks responded with aggressive rate hikes, bond prices adjusted sharply downward. That was the core problem in 2022: portfolios began from a position of near-zero yields, leaving very little protection against rising rates. That is the key difference between then and now.

Today’s environment is not without risk, but it starts from a much healthier place. As of this writing, the U.S. 10-year Treasury is over 5%, while the Canadian 10-year government bond is around 4%. U.S. 10-year yields are now at their highest levels since the early 2000s. In fixed income, starting yield is one of the most important variables for forward returns, and historically it has been highly correlated with five-year outcomes.

That matters because bonds do not require yields to fall in order to generatereasonable returns. Higher starting income can support performance across arange of scenarios. If yields decline, there may be upside from price
appreciation. If yields remain elevated, investors are still being paid meaningfully more than they were a few years ago. Even if yields rise somewhat further, today’s income provides a much larger buffer than was available in 2022.

A simple example shows how the math has changed. Consider a U.S. investment-grade bond yielding about 6% with a duration of five years. If interest rates are unchanged over the next year, an investor earns roughly 6%. If rates rise by 1%, the price falls by about 5% (the duration of five years multiplied by the 1% increase), which offsets most of the income and leaves a one-year return of roughly 1%. If rates fall by 1%, the price rises by about 5%, and the one-year return is roughly 11%. In other words, a 1% rise in rates still leaves the investor with a positive return, while a 1% decline adds meaningfully to it, because income cushions the loss, and that cushion is a direct result of higher starting yields. These figures are approximations that ignore convexity and the shortening of duration over the year.

Put simply, the comparison to 2022 fails on its most important premise. Four years ago, investors had little cushion. Today, they do.

Rates: attractive, but stay nimble

We continue to think rates are more attractive than they have been in years, though that does not mean the direction of travel will be smooth.

Being underweight duration paid off through much of the period following COVID, as rates moved sharply higher from emergency lows. That was the right backdrop for caution. But the math looks different once yields have already reset upward. At today’s levels, fixed income finally offers meaningful income again, and that changes the role bonds can play in a portfolio.

Short-term price pressure and long-term income generation are not mutually exclusive. Rising yields can hurt near-term prices, but they also allow investors to reinvest at higher rates.

There are still risks worth respecting. If inflation were to reaccelerate materially, yields could move higher. If growth remains more resilient than expected, long-duration bonds may still face pressure. But investors are now being compensated for taking duration risk in a way they simply were not a few years ago.

Credit: less compelling than rates

We are less enthusiastic about broad credit. Credit spreads remain near historic tights, even after widening a little recently amid elevated rate volatility and heavy new issuance, including significant borrowing by hyperscalers at a time when U.S. Treasury supply is also high.

In other words, investors are being asked to absorb a great deal of debt without being paid materially more for the added credit risk. Spread widening, rising defaults, and mark-to-market losses are real possibilities if the economy weakens. Higher starting yields help cushion these risks, but they do not eliminate them.

Where we see better value

The opportunity set extends beyond government bonds and traditional corporate credit. Agency mortgage-backed securities offer additional yield over government bonds while carrying government-backed or sponsored credit quality, which makes them an attractive alternative to corporate credit. Select emerging markets offer higher yields and, in many cases, have central banks that acted early on inflation, which gives investors more compensation for the risks they take.

More broadly, we see merit in a diversified, global portfolio of high-quality duration across developed and emerging markets. A global allocation helps diversify country-specific risks and policy paths, and it broadens the sources of income available to investors.

Why we prefer active management in fixed income

In equities, market-cap weighting has a certain logic: larger weights tend to go to larger, often more successful companies. In fixed income, index construction works differently. The largest weights go to the issuers with the most debt outstanding. We view that as a structural flaw.

Passive bond investing can force investors into ever-larger exposures to the most indebted borrowers, not necessarily the most attractive opportunities. That is not how we think fixed income should be managed.

We prefer active managers with deep expertise who can assess whether the compensation on offer is truly adequate for the risks being taken. We also value managers who have the flexibility to move across the broad fixed income universe, toward sectors that offer better value and away from those that do not. Duration positioning, sector allocation, security selection, and access to the global opportunity set all matter much more today than they did in the low-yield world investors grew used to.

In our view, this is an environment that rewards judgment rather than simple index replication.

Where that leaves us

The last several years have been frustrating for fixed income investors, and we do not think that experience should be dismissed. But the bond market investors face today is not the same one they owned in 2022.

Starting yields are higher. Income matters again. Duration risk is more compensated. And the case for bonds as a stabilizing, income-generating part of a portfolio is stronger than it has been in years.

That said, this is not a call to buy fixed income indiscriminately. We think selectivity remains essential. Rates are more attractive than broad credit. Mortgage-backed securities and parts of emerging markets look more compelling than many traditional spread sectors. Global diversification can improve resilience. And active management, in our view, is particularly important in an asset class where benchmark construction can reward indebtedness rather than quality. Bonds are not back because risk has disappeared. They are back because investors are once again being paid to own them.