Fixed income investing in an uncertain world

Key points:

• The current market for US intermediate credit may represent an attractive entry point for long-term investors as elevated yields provide a cushion against potential widening of credit spreads.
• Active managers have the potential to outperform market indices over the long-term.
• Intermediate credit offers lower sensitivity to interest rates and lower volatility compared to broad market indices.

In 2025 so far, the macroeconomic backdrop has been marked by uncertainty. Structurally higher inflation and the on-again-off-again tariff announcements from US President Donald Trump have sparked volatility and upended global trade.

Following the introduction of reciprocal tariffs in April, global stock markets fell sharply on concerns that higher import costs would erode corporate earnings and cause economic growth to weaken.

Investors can usually rely on bonds to offset some of their losses when equities are falling. However, on occasion equities and bonds can fall at the same time. This was the case following the great financial crisis in 2008 and, as the chart below shows, in 2022 when high inflation prompted central banks to hike interest rates.

This was also briefly the case in early April when yields on US 10-year Treasuries started to rise (meaning bond prices fell) at the same time as US equities were selling off. When equities and bonds are moving in the same direction, or when market volatility is particularly high, investors might feel that the ballast they thought was in their portfolio is no longer performing as expected. This doesn’t necessarily mean that bonds have lost their diversification benefits, nor does it mean that they are no longer a valuable source of income and growth. Quite the opposite.

Our view is that fixed income is a valuable portfolio diversifier regardless of the macroeconomic or political environment. But it is important to be selective and maintain a quality bias, which can only be achieved through active management.

The importance of being active

There has been a clear paradigm shift in the global economy over the past few years. The era of low interest rates, low inflation and surging global trade has given way to higher inflation, higher interest rates and protectionist policies. It’s during periods of volatility that the benefits of active management come to the fore.

This is especially true for fixed income, where less efficient market dynamics are at play. In the current environment, bond investors are likely to have better outcomes by reducing duration risk, holding quality bonds and having a diversified portfolio.

Active fixed income managers have the potential to outperform market indices by pulling on a number of different levers. Whether through fundamental analysis, security selection, sector allocations, or duration positioning, these factors can help to limit drawdowns during periods of market stress.

Unlike equities, where market capitalisation weighting results in the most successful companies comprising the largest part of indices, bond indices are weighted by the amount of issuance outstanding. This means that companies with the most debt are the largest weights in the index.

Why consider US intermediate bonds now?

Investment grade credit currently offers attractive all-in yields that are well above the 10-year average. At present, US 10-year Treasury yields at around 4.4%, compared to their 10-year average of 2.5%. While credit spreads are currently tighter than long-term averages, investment-grade credit is still yielding in the region of 5.2%.

The tight spreads we are currently observing are the result of solid issuer fundamentals, the healthy economic backdrop of the past year, and strong demand from investors. While spreads are unlikely to tighten any further, ongoing demand for yield will likely be supportive of investment grade credit.

Yield-hungry investors may find the present day to be a good entry point for this asset class even with spreads as tight as they are. The higher level of absolute coupon income should provide a cushion against negative market movement. In addition, tight spreads don’t tend to widen suddenly and instead move more gradually over time. Plus, if interest rates fall from current levels, this should be beneficial as well.

Above all, intermediate bonds can be good portfolio diversifiers because of their lower sensitivity to interest rates and lower levels of volatility. Historically, they have offered higher risk-adjusted returns compared to the broader, longer-duration bond market.

Seeking a stable return stream

We believe that an active and selective approach to investing in fixed income is the best way to try to generate returns for investors over the long term. Dolan McEniry’s in-house investment process is fundamental in nature, value-driven, and not based on interest rate or macro projections.

Instead, the investment team determines whether a bond has an attractive risk and reward profile by looking at the numbers that matter: trends in revenue, margins, earnings, cash flow, liquidity, debt levels, and other items. They focus on the generation of free cash flow and looks for companies that have wide margins of safety in terms of the number of times their free cash flow covers interest requirements.

Almost overnight, investors have found themselves in a world that looks very different to just a few months ago, which is why it’s important to focus on what can be controlled and to strip out the elements that can’t. Dolan’s team manages interest rate risk by remaining duration neutral compared to market indices rather than by speculating on interest rates. Crucially, by taking a lender’s mentality and emphasis on creditworthiness, Dolan McEniry has never faced any corporate bond default in any of the concentrated portfolios it manages since its foundation in 1997.

Core Plus strategy: unique risk and reward characteristics

In its flagship Core Plus strategy, the team at Dolan McEniry seeks to uncover value across investment-grade and high-yield bonds to enhance the yield premium, which has historically exhibited lower volatility than the Bloomberg US Intermediate Credit Index since inception.

The direct outcome is that the Core Plus, which is implemented in the iMGP US Core Plus Fund, has led US corporate bond indices with risk-adjusted returns ranked in the top 1-3% across all long-term horizons since inception, as illustrated in the chart below.