Innovest Thought Leadership: Insights from Leading Fixed Income Managers
Written by Peter Girard and Natalie Miller
At Innovest, we believe navigating today’s dynamic markets requires proactive research and direct engagement with best-in-class investment managers. In line with that commitment, our Investment Committee recently reached out to several of the industry’s top fixed income managers to gather their perspectives on what many consider one of the most compelling fixed income environments in years.
Their insights revealed key opportunities and the frameworks they are using to position portfolios for long-term success. Below is a summary of those conversations and the common themes that emerged as a result.
1. Caution in Credit, Opportunity in Quality
A consistent message across managers was a cautious stance toward credit risk, particularly given historically tight spreads. One manager captured the sentiment well, saying “We remain cautious about taking on substantial credit risk as broad credit spreads are historically tight.”
Reflecting that view, their portfolio emphasizes shorter-duration, higher-quality bonds while increasing allocations to Treasuries and securitized assets, such as high-quality asset-backed securities.
Another manager echoed the focus on quality, highlighting agency mortgage-backed securities (MBS) as a key area of value. As their team noted, “In this asset, you get paid to wait for an eventual remediation in the price and spread as interest rate volatility subsides.”
A third manager added a global perspective, pointing to high-quality, income-generating assets such as agency residential mortgage-backed securities (RMBS) and selective emerging market debt. “With equity valuations stretched and volatility elevated, fixed income provides a compelling risk-adjusted return profile,” they said.
2. Rates, Yield Curve Positioning, and Policy Uncertainty
All managers we spoke with are closely monitoring central bank policy and yield curve dynamics. Most are positioned with moderate duration and a bias toward intermediate maturity. One portfolio remains “slightly longer than the benchmark’s duration,” reflecting expectations for slower growth and lower long-term rates.
Another is taking a more pronounced approach, maintaining longer duration while underweighting the 30-year. “Our overweight duration positioning and curve steepening bias will benefit in either case,” they observed, emphasizing the need for flexibility as data evolve.
A third is similarly cautious, favoring shorter to medium-duration bonds and emphasizing that “careful duration management” is essential given the U.S. fiscal circumstances and potential for upward pressure on long-term yields.
3. The Fiscal Backdrop and Market Volatility
The U.S. fiscal outlook was a shared concern. One manager raised their 30-year yield forecasts by 25 basis points, citing “increased term premia driven by domestic fiscal challenges and other global factors.”
Another views the U.S.’s reserve currency status as a stabilizing force but still expects “increased volatility, higher term premiums, and steeper curves.” A third added that large borrowing needs “necessitate careful duration management to mitigate interest rate risk” and argued for prioritizing credit quality and liquidity.
4. Lessons from Recent Market Dynamics
Managers also reflected on surprising developments in recent years. One highlighted the “magnitude of performance,” contrasting the Bloomberg U.S. Aggregate Bond Index’s 13% decline in 2022 with its subsequent rebound. They also pointed to the level of volatility in interest rates and the unexpected steepening of the yield curve.
Another underscored the long and variable lags of monetary policy: “Monetary policy works like a dimmer, not like a switch,” they said, cautioning that the full effects of prior hikes – and future cuts – are still unfolding.
A different manager noted structural market shifts, including the rise of portfolio trading and passive flows, which have created wider bid-ask spreads and, at times, more price insensitivity across segments.
5. Inflation and Real Returns
Despite inflation concerns, managers see compelling real return potential. One pointed to today’s “decade-high yield environment” as a strong foundation for attractive returns. Another noted that “real rates are higher than they’ve been since ’08,” with 10-year Treasuries offering a 2% real rate of return. A third emphasized the value of inflation-linked bonds and active management in preserving purchasing power.
Conclusion: Quality, Flexibility, and Patience
The overarching themes from these conversations are clear: focus on quality, maintain flexibility, and exercise patience amid uncertainty. With spreads tight, fiscal risks mounting, and policy lags in play, managers are positioning defensively but opportunistically. In a market defined by both risk and opportunity, these insights reaffirm the value of active management and the importance of adapting portfolios to ever-evolving market dynamics.