Where is the real value in fixed income in 2025?

Fixed income has become a viable investment option in the past couple of years as investors have welcomed the end of quantitative easing and the presence of more attractive all-in yields in the bond market.

Last year, figures from the Investment Association showed net inflows of almost £3bn into the asset class – not huge numbers but a stark change in direction from the near £5bn of outflows we saw in 2022*.

The bottom line is we have seen a degree of normality return with good yields on offer. If you want to take very little risk, you can buy short dated government bonds. By contrast, if you want a higher yield and greater capital returns, you might want to consider a corporate or even a high yield portfolio.

We have started to see some rate cuts in developed markets, but nowhere near the extent many would’ve expected at the start of 2024. Government bonds continue to offer attractive yields in excess of 4.5%, while credit spreads (the additional return you get from investing in corporate or high yield) still appear tight – meaning you are not being overly rewarded for taking greater risk.

The more credit risk in a bond, the more important the macroeconomic environment, while the value of investment grade corporate bonds, which have less credit risk, will be more influenced by the government bond yield. 

The balance is very much in favour of the government bond market at present, but with further rate cuts expected by global central banks in 2025, the outlook could easily change for credit.

One way for investors to swerve the difficulties of choosing between a gilt, corporate or high yield bond fund – and the individual challenges each sector of the bond market faces – is to use a strategic bond fund. These funds have grown in popularity in the past two decades, as they give managers the flexibility to diversify their bond holdings across a range of sectors, allowing them to shift allocations as they see fit. They can be flexible on duration, on currency, on credit risk or on inflation protection.

The Investment Association Strategic Bond sector currently has some £38bn of assets under management*. Strategic bonds often thrive on the active decision making of their managers, however, selecting the right fund can be a challenge.

With the additional flexibility offered by strategic bonds comes additional risks, and funds can vary widely on their outlook on the quality of bonds to hold, the geographies they are held in, as well as the duration of their bonds. For example, returns have been very mixed across the sector in recent years, with many managers going long duration to their own detriment as interest rates rose rapidly.

To put this into context, the manager of a plain vanilla UK equities fund typically focuses on the UK market and stock selection within it. For fixed interest managers, and particularly strategic bond fund managers, they have a myriad of issues to tackle including the global macro landscape, global interest rates, regional interest rates, central bank policy and the outlook for credit.

Research all strategic bond funds

What about the outlook today?

Jupiter Strategic Bond fund manager Ariel Bezalel currently has his portfolio defensively positioned, with over 40% in government bonds**. He believes market conditions encourage de-risking of portfolios amid the potential for market volatility. He says the current pricing of government bond yields basically reflects a goldilocks scenario where the support of central banks won’t be needed for the next couple of years.

He says: “We still think that there are some pockets of weakness (namely in the job market and in the consumption space) which could trigger a need for quicker easing at some point in the next 12 to 18 months.

“Given the above, we continue to see material value across government bonds in developed markets, particularly the US, Australia and the UK, as we believe they hold the best risk-adjusted returns prospects to investors. Stretched valuations lead us to adopt a more conservative stance in credit exposure compared to our historical approach.”

Credit markets are starting the year with attractive all-in yields, tight credit spreads, supportive technical demand, and a decent fundamental backdrop. Aegon Strategic Bond manager Alex Pelteshki says they anticipate the demand for credit to be strong in the first half of 2025. However, he believes we will see further easing of global central bank interest rates to coincide with some moderation in growth owing to restrictive monetary policy.

He says: “The combination of lower all-in yields and the limited compensation for risk should gradually become more apparent as the year moves on. In our base case, this would lead to a gradual widening of credit spreads across the board, but with an all-in still positive total return environment for corporate bonds during 2025.

“In investment grade credit, we see opportunities at the front end of the credit spectrum. Flat/inverted spread curves across dollar and euro, combined with attractive yield roll down makes us positive on this part of the curve.”

Premier Miton Strategic Monthly Income Bond co-manager Lloyd Harris says we can expect inflation-busting yields in 2025, with short-dated investment grade credit, as well as government bonds. He says: “For one to three years duration, we are getting 5-8% in investment grade, in relatively safe parts of the market.

“This is very good for the technical backdrop in credit. We are positive on real yields from relatively safe parts of the market – not a great deal of duration or credit risk.”

Lloyd says although credit spreads are tight (but in the right parts of the curve over 1-3 years),  we are being paid an awful lot for the price risk we are taking for credit duration. He says: “Even if we get a wobble in the credit market we are still in a good position if you are in the short-dated, high quality credit area. That’s the portfolio ballast for 2025.”

Invesco Tactical Bond fund manager Stuart Edwards says there are opportunities in these bond markets, citing the differentiation between the central bank cycles and the macro fundamentals in different countries and regions. For example, he has an allocation to emerging markets, pointing to attractive yields in the likes of Mexico and Brazil 

Stuart agrees that they don’t see a compelling reason to take more risk and invest in the corporate bond space when you’re getting perfectly attractive deals in government bonds.

He says: “We’re a little bit more defensive on the credit side than we were a couple of years ago, but we’ve got a little bit more duration or quite a bit more duration actually (duration was close to zero in 2022), than we did have two years ago. But we are being very flexible and very nimble with that.”

Stuart tells us more about the fund’s current positioning in a recent episode of the Investing in on the go podcast. 

*Source: Investment Association figures, February 2025

**Source: fund factsheet, 31 January 2025