- Fixed Income Strategist
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Despite high carry and continued spread tightening, fixed income markets generally delivered modest total returns in 2024, challenged by persistent inflation and concerns about fiscal sustainability. With central banks on the path to providing policy accommodation, and elevated yields still prevailing, we believe fixed income markets offer many compelling opportunities. Diverging monetary policies, geopolitical uncertainty, tariffs, and potentially heightened volatility ought to create attractive opportunities for sector rotation and security selection. We’re excited to share our top five fixed income ideas for 2025:
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Unconstrained fixed income: In our view, total return fixed income strategies that are less constrained by benchmarks may be best positioned to navigate this later stage of the economic/credit cycle, which we expect to coincide with heightened volatility.
As central banks chart different policy paths, we anticipate continued dispersion in economic growth and inflation, creating market dislocations. We also think it’s important for investors to stay nimble with their portfolio allocations given the uncertain market and policy landscape. This entails sizable allocations to liquidity and developed market government bonds to be able to capitalize on market opportunities as they arise.
Portfolio usage: Diversification, liquidity, derisking, total return
Funding from: Cash or derisking from equities/credit
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Intermediate government/credit: While we continue to believe core/core+ strategies can be a beneficial, even critical, part of portfolio construction, several “known unknowns” could arise in 2025. We worry about steeper curves, sticky — though lower — inflation (some of which may be related to tariffs), privatization of government-sponsored enterprises (GSEs), and tax cuts. So, intermediate government/credit may be useful as a more risk-balanced way of adding a high-quality ballast into asset allocations.
Portfolio usage: Diversification, liquidity, derisking
Funding from: Cash or derisking from equities/credit
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Securitized credit: We expect performance across securitized credit sectors to vary by subsector and borrower type. On the higher-quality side, we see three areas worth considering in 2025 either on a standalone basis or through core+ and multisector credit allocations:
- Residential mortgage-backed securities (RMBS) have accumulated enough structural support from embedded home-price appreciation and previous prepayments to withstand meaningful home-price declines.
- Commercial mortgage-backed securities (CMBS) face well-documented structural challenges, yet the market is pricing in overly pessimistic assumptions just as fundamentals are starting to stabilize and improve.
- The performance of asset-backed securities will rely on the health of the US consumer, about which we’re constructive. Though we see pockets of weakness, particularly for low-income borrowers, further material degradation should be contained, given that lending standards are tighter, growth in consumer debt is slowing, and loan structures are generally more robust. While these structures have richened significantly, we like the robust carry along with reduced equity beta.
At the same time, the cost of financing on the CLO debt stack is approaching all-time tightness, meaning investors can lock in historically low-cost, non-marked-to-market financing for the next six to eight years. Given the prospects for volatility spikes around tariffs, fiscal spending, and global conflicts, there’s a good chance equity investors will be able to exercise their option to reinvest spreads at wider levels in the coming years. As such, we believe the equity tranche is one of the most attractive points in the CLO capital structure today.
Portfolio usage: Income, total return
Funding from: Equities
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Capital securities: Capital securities are a nuanced, overlooked asset class that may present a welcome addition to a broader fixed income portfolio. Because capital securities represent a hybrid asset class that can share characteristics of both bonds and stocks, they include structural features that provide corporations with regulatory or ratings agency capital treatment without diluting common shareholders. While the underlying issuers have historically been primarily financial institutions, there has been a wider and more diverse set of issuers, including utilities and industrials, in the last several years.
Unlike most credit sectors, valuations for capital securities remain well north of historical median levels and they exhibit only moderate correlations to other markets. We think the key to capturing this alpha potential is understanding structural complexity rather than assuming material risk of nonpayment. While not germane to all strategies, many capital securities may offer tax benefits to individuals via qualified dividend income and corporations via dividends-received deduction.
Portfolio usage: Income, total return
Funding from: Equities, high yield
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Bank loans: Spreads for bank loans remain much wider compared to many other higher-yielding credit sectors and, in our view, offer an attractive carry and the potential for price appreciation. Earnings for most bank loan issuers remain relatively strong, though we prefer companies with stable-to-improving credit profiles as we observe some signs of weakness among lower-rating cohorts. Issuers with unhedged floating-rate capital structures may experience pressure on free cash flow if the Fed slows its cutting cycle. However, these issuers will experience easing pressure on earnings given the lower financing costs as the Fed moves to a more accommodative policy. We expect default rates to remain around 3% to 4%, the current long-term average, and we do not see a full-scale default cycle on the horizon. However, we are cautious in issuer selection, as we anticipate an increase in downgrade activity given weakening fundamentals.
Portfolio usage: Income
Funding from: Equities, high yield
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