Where to find value when yields look stretched

While equity valuations have drawn plenty of concern this year, parts of the bond market also look overheated. In some areas, investors seem to be overlooking potential risks, pushing valuations to excessive levels. As a result, flexible bond managers are moving carefully, steering away from the weaker spots and hunting for genuine value.

It has been a strong year for bonds overall. The average strategic bond fund has returned 5.8% year to date*. Falling US treasury yields** have lifted returns, and strong demand for corporate bonds has pushed credit spreads to historic lows. Yet, this optimism has left some areas of the market vulnerable. Many strategic bond managers are now focusing on sectors that have lagged behind the exuberance.

Growing caution around US Treasuries

One of the main areas of concern is the US Treasury market. Investors have welcomed the Federal Reserve’s recent rate cut and are already pricing in several more.

Ariel Bezalel, manager of the Jupiter Strategic Bond fund, explains: “Markets are expecting another couple of cuts by the end of the year and more next year, with rates seen bottoming out around 2.8% by April 2027.” He argues this view may be too pessimistic: such aggressive cuts imply a level of economic weakness that is unlikely to materialise.

Fiscal measures, such as the Big Beautiful Bill, could support growth through 2026, and investment spending may accelerate. Still, inflation remains unpredictable. The inflation outlook is muddy. He adds: “That is why we’ve been taking quite a few chips off in the US treasury market and taking some profits. The inflation outlook is muddy.” They have only retained positions in five-year treasuries***.

Read more: Rethinking risk in US debt

Corporate bonds: tight spreads and selective bets

Corporate bond spreads, the extra yield over government bonds, are at their tightest in decades****. This reflects strong company fundamentals, limited new issuance, and low defaults. However, such valuations leave little cushion if growth slows.

Others remain invested but are being far more selective. Eva Sun Wai, manager of the M&G Global Macro Bond fund, notes: “It feels like credit markets are universally tight, particularly in developed market investment grade, but the risks aren’t uniform there either. There are ways that active funds can take advantage of dislocations.” The corporate yield curve spikes in certain places, she says: “We’re able to move to the front end, to somewhere a bit steeper, or to floating rate notes, where there is a yield pick up over and above the fixed rate area.”

Stuart Edwards, manager of the Invesco Tactical Bond fund, remains cautiously optimistic: “Fundamentals remain relatively healthy. Issuance of investment grade corporate bonds has been strong but has been absorbed by the market and company balance sheets are robust. We are still finding some opportunities in the primary market.”

Take a closer look at the world of corporate bonds with Stephen Snowden, manager of the Artemis Corporate Bond fund, on our recent podcast.

UK gilts: undervalued insurance?

One surprising area of interest for flexible bond managers is UK government bonds (gilts). Despite fiscal challenges, several believe current yields already reflect the risks, and may even offer good value.

Bryn Jones, manager of the Rathbone Ethical Bond fund, says: “At current yields, many UK government bonds arguably offer good value. Even if their prices continue to struggle, their generous yields mean they offer very attractive ‘carry’ — the income you get from holding bonds even if their prices are volatile. Moreover, government bonds can be a valuable insurance policy against the risk of a nasty economic slowdown. If the economy were to weaken a lot, corporate bond spreads — the extra yield investors get for lending to companies versus governments — could widen sharply. And if that happened, government bonds would rally.”

Jones adds that supply dynamics are improving. The Debt Management Office is issuing fewer long-dated gilts and more short-dated ones, while the Bank of England has slowed its sales of long-dated bonds. Both measures should help stabilise the market.

Bezalel also favours gilts, expecting fiscal tightening in the November Budget to curb growth and open the door for more Bank of England rate cuts.

Emerging markets: a bright spot

In contrast to the caution elsewhere, emerging market debt (EMD) is drawing renewed interest. Eva Sun Wai says: “We like local emerging market debt. The focus has been on the fiscal profiles of the West. Emerging markets, in contrast, have been much more stable.” Bezalel agrees, highlighting Brazil and Mexico as particular standouts***.

Anthony Kettle, manager of the BlueBay Emerging Markets Unconstrained Bond fund, believes investors are overstating the risks. He says default rates for emerging markets had been higher as a result of the Russia/Ukraine war, Covid and China deleveraging, but are now ebbing. “The default rate hit around 35% in emerging markets, while it remained less than 7% in developed markets. Now, in emerging markets, the default rate has come right down, but investors are still paid a lot more to invest there”.

He says emerging market interest rates are still high, but it has been difficult to cut while the Federal Reserve was maintaining higher rates. Now that the Federal Reserve has reversed direction, there may be more scope for emerging market central banks to cut. A weaker US dollar should also help. Kettle’s fund currently yields over 10%, compared with an average of around 8% across the broader EMD universe.

Read more: What’s driving fund managers’ optimism for the next decade

The value of flexibility

Across the fixed income landscape, valuations vary widely. Some areas, like US Treasuries and investment-grade credit, look stretched, while others, such as UK gilts and emerging markets, offer more compelling risk-reward profiles. This is a market where flexibility matters. Managers with the freedom to move across sectors, maturities, and geographies can take advantage of dislocations while avoiding overpriced areas. After a strong year for bonds, selectivity is more important than ever. The best opportunities may no longer lie in the most popular corners of the market, but in those overlooked by the crowd.

*Source: FE Analytics, total returns in pounds sterling, 31 December 2024 to 15 October 2025

**Source: MarketWatch, at 16 October 2025

***Source: Jupiter Asset Management, 9 October 2025

****Source: FRED, ICE BofA US High Yield Index Option-Adjusted Spread, at 14 October 2025