With Interest Rates Elevated, It’s Time for Fixed Income
Art by OYOW
With interest rates at levels not reached since 2007 and expected to stay elevated despite a series of Federal Reserve rate cuts last year, fixed income investments have increasingly become an attractive asset class for allocators that, in recent years, have been under-allocated to some sections of rates and credit investments.
“The good news for investors is that higher rates bring higher yields,” says Van Hesser, chief strategist at the Kroll Bond Rating Agency. “Arguably, for the first time in 17 years, fixed-income yields are attractive, making good on its promise to do what investors expect [and] provide income and diversification benefits to the 60/40 portfolio.”
In a bid to capture some of those higher returns, asset owners are increasing their allocations to fixed income after years of scant results from Treasurys and other securities in the asset class.
Our asset mix continued to shift toward a higher exposure to fixed income, where return opportunities remain attractive,” wrote Jonathan Simmons, chief financial and strategy officer at the Ontario Municipal Employees Retirement System, in a report detailing investment returns.
Among public pension funds, allocations to fixed income grew to 26.1% in the first half of 2024, up from 19.7% a year earlier, according to a recent survey commissioned by the National Conference on Public Employee Retirement Systems.
“We believe that the outlook for fixed income investors is positive when considering prospective returns as well as providing effective diversification to equities within multi-asset investment frameworks,” said Alexander MacKey, co-CIO, fixed income at MFS Investment Management, in a recent report.
Fixed-Income Outlook
What fixed-income securities do strategists recommend? Anders Persson, CIO for fixed income at Nuveen, recommends aiming a bit below investment grade; he also suggests areas like leveraged loans, collateralized loan obligations and certain other categories of securitized assets.
“Within securitized, we are stressing areas like CMBS and ABS—we’re still finding some dislocations there,” Persson says. “We are also stressing to think a little bit outside the traditional kind of investable universe and consider private placement, so private fixed income, from an investment grade perspective, parts of the private credit world, as well as a diversifier, making sure [investors are] leveraging the full opportunity set that fixed income is offering at this point.”
Margaret Steinbach, fixed-income investment director at Capital Group, says the firm is seeing increased interest in core and core-plus fixed-income offerings.
“It’s been an area where a lot of pensions have been under-allocated for the last several years because yields were much lower, and now with where yields are and the compression that we’ve seen in terms of risk premium across different credit categories, a lot of plans are increasing their allocations to core and core-plus,” Steinbach says.
Other areas of increased interest, Steinbach says, include multi-sector credit or flexible credit strategies, as well as multi-asset credit.
Mortgage-backed securities are also among the attractive options, according to Kevin Flanagan, head of fixed-income strategy at WisdomTree.
“U.S. corporate bond spreads reside at historically tight levels, but continued economic growth and a less restrictive Fed policy makes us neutral in the credit space,” Flanagan says. “We see better a valuation opportunity in securitized assets and are overweight agency mortgage-backed securities.”
Flanagan touts an active/passive fixed-income approach as WisdomTree’s theme for 2025.
“The passive cornerstone consists of Treasury floating rate notes, which offer income in a relatively flat yield curve setting without the potential volatility that has been heightened in fixed-coupon securities,” Flanagan says. “The active weight can focus on enhanced yield options or be more total-return-based.”
U.S. Fixed Income Preferred
Many strategists and asset managers see the U.S. bond market as a standout opportunity. Morgan Stanley, in its 2025 global fixed-income outlook, wrote that the most attractive opportunities in fixed income lie in securitized credit, particularly U.S. mortgage-backed securities.
“U.S. households with prime credit ratings maintain strong balance sheets, which should continue to support consumer credit and ancillary structures, especially as housing prices remain firm and the unemployment rate stays low,” the Morgan Stanley report stated.
Emerging markets bonds, however, are likely to face headwinds, the firm wrote: “Stronger U.S. growth, coupled with higher rates for an extended period of time and weaker global trade linkages, is typically not conductive to strong [emerging market] performance.”
Echoing this sentiment, Nuveen’s Persson says, “We’re favoring a little bit more of the U.S. over non-U.S. opportunity, and we’re comfortable going into that credit part of the opportunity set, given that we are not expecting default rates to be picking up.”
WisdomTree’s Flanagan also touts a U.S. focus. “Our focus would be more on U.S.-based solutions for fixed income. This helps mitigate some of the uncertainty surrounding currency risk and gives fixed-income investors the opportunity to take advantage of the return to a more ‘normal’ rate setting here in the U.S.”
While Europe offers opportunities in fixed income, the U.S. is preferred, Persson notes: “We think Europe could offer some good rates, we’re comfortable going longer duration, given the ECB is cutting rates in Europe pretty aggressively, but generally from a credit perspective, we’re more comfortable staying in the U.S.”
Capital Group’s Steinbach concurs: “I think the U.S. is really standing out from both a growth and relative value perspective, so that’s what is causing people to have those views. It is likely that U.S. exceptionalism continues into the future. However, there are select opportunities within say, emerging markets. But from developed market relative value, the United States continues to stand out in terms of being most attractive.”
Inflation and Fed Policy
With the Federal Reserve signaling that interest rates may remain elevated, inflation remains top of mind for many market participants, who are also evaluating the impact of President Donald Trump’s policies, including tariffs. “The big question mark is policy implications coming out of the new administration,” Steinbach says.
“We do expect that there will be some upward pressure on core PCE related to what the final tariff impact is,” Persson says.
How are investors approaching policy?
“Persistent inflation not abating, along with rising debt concerns voiced by bond vigilantes, has made domestic participants hesitant to purchase much on the long end of the curve,” says Michael Ashley Schulman, partner in and CIO of multi-family office Running Point Capital Advisors.
“Based on the macro/inflation outlook and prospects for a less aggressive rate cutting policy from the Fed, we are neutral with respect to duration,” Flanagan says. “We would highlight how extending too far out in duration has proven to be a fleeting strategy and do not see that situation changing any time soon.”
Related Stories:
Is the Shine Coming Off of Private Credit’s ‘Golden Age’?
 |
Is the Shine Coming Off of Private Credit’s ‘Golden Age’? |
 |
Investors Move More Into Alts Following Stock Surge |