Build core exposure to quality, short- and medium-maturity bonds
Benchmark government bond yields in USD, EUR, and GBP have fallen from recent highs, as inflation concerns have moderated. While yields are lower, we still think current pricing overestimates further interest rate hikes, and expect yields to fall as the year progresses. Despite ongoing fiscal and inflation risks at the long end, short- to medium-maturity quality bonds offer an appealing risk-return profile in our view, with starting yields a good proxy for longer-term expected returns.
In our view, investors have an opportunity to rebalance toward bonds after many years of strong equity performance, to bring allocations back in line with long-term plans, and to help manage potential equity risks.
Even in markets where yields remain low and inflation muted, we still think some allocation to high grade debt can make sense for adverse economic scenarios, in which government debt tends to rally and yields fall in anticipation of monetary easing.
Seek diversified exposure through select credit and equity income strategies
For a holistic and well-diversified fixed income exposure, especially for investors relying on their portfolio for income, we like select exposure to more growth-sensitive and higher-yielding bond market segments such as emerging markets (EM), high yield, or subordinated debt. Amid elevated geopolitical and sector-specific risks, investors should avoid overexposure to any single segment of the credit market.
EM bonds have benefited from resilient global GDP growth and commodity strength—enhancing their role as a key allocation. Additionally, many emerging markets have maintained restrictive monetary policy to keep inflation in check. This means real rates in the EM complex are high and should benefit from capital inflows looking for diversification away from traditional markets. Despite some expected spread widening, we believe elevated yields and supportive central banks underpin a positive outlook for EM debt, which we rate Attractive.
Investors seeking more defensive ways to access higher-yielding bonds amid uncertainty may also look at diversified exposure to subordinated debt, including corporate hybrid bonds. These are a type of subordinated debt instrument issued by non-financial companies that blend the characteristics of standard corporate bonds (paying regular interest) and stocks (often no fixed maturity date and the ability to defer coupon payments).
Looking across asset classes, we also believe equity income strategies (especially in Switzerland and Southeast Asia), yield-generating structured investment strategies, and multi-asset income approaches, which may also include derivative strategies, can support income objectives. However, investors should be willing and able to bear the unique risks of investing in options.
