Martin Ward, senior investment research analyst, Square Mile

Following two years of strong returns for global high-yield bond markets, investors like us are questioning whether this momentum can continue. On the one hand, credit spreads are tight, reflecting more expensive valuations. This limits the potential for further capital appreciation and makes the asset class vulnerable to spreads widening if we see bouts of volatility in 2025. Such volatility is plausible given ongoing uncertainties around global growth, the trajectory of interest rates, inflation and geopolitics.

However, one could argue that corporate fundamentals broadly appear robust and that there is a solid technical backdrop supporting the market. Additionally, starting all-in yields are attractive, offering strong income potential for clients. This income should also act as a buffer for returns if elevated levels of volatility arise from credit spread movements.

Managers are also observing increasing dispersion across the high-yield market, particularly between higher-quality companies and those with more stretched balance sheets. This underscores the importance of precise bottom-up credit selection in 2025 to mitigate the risk of capital erosion.

Our preferred choice in this space is the Aegon High Yield Bond fund, which currently has a bias toward higher-quality companies while being positioned to generate income and provide downside protection. Given the tight credit spreads and prevailing uncertainties, we believe this is a prudent approach. We also expect the managers to opportunistically capitalise on any volatility affecting corporate credit spreads. The distribution yield of 7.5% as at the end of 2024 is also a strong starting point, offering a high level of potential income.

At a headline level, we remain cautiously optimistic about returns in 2025, though they are unlikely to match the strength of 2024. Investors should prepare for potential credit spread volatility, with income expected to play a more significant role than capital appreciation in driving returns.

The portfolio manager’s view

Brent Olson and Thomas Ross, fixed income portfolio managers, Janus Henderson

High yield bonds motored along in 2024, benefiting from both their high income and a boost from credit spreads tightening, which had the effect of generating capital gains as it pulled yields lower. Recall that bond prices rise when yields fall and vice versa. We think 2025 should shape up to be another positive year for high yield, albeit with returns more likely to be driven by income as spread tightening fades and gives way to some widening.

With credit spreads towards the tight end of their range, it is becoming difficult for them to tighten much further.

Yields on high yields bonds are, however, close to the middle of where they have been trading over the past 20 years. With central banks likely to pursue further interest rate cuts in 2025, we think investors will continue to see attractions in high-yield bonds given average yields of 5.6% in Europe and 7.2% in the US.

There is some tension in the markets as we await the new Donald Trump administration and how quickly and to what extent policies are enacted. A difference to 2016 when Trump last became US president is that many high-yield bonds are trading below par value: on average 96 cents in the dollar. Much of this is a legacy effect from bonds being issued with coupons below today’s yields a few years ago. It does, however, offer a useful pull to par as the bond price rises as it gets closer to maturity.

Spreads are tight but it is not unusual for them to stay tight for long periods. This is because corporate conditions take time to change. Once they have been through a period of change they tend to settle at the extreme, ie spreads spike higher during a crisis and take some time to retreat while staying low during a period of economic stability.

The CIO’s view

Sebastiano Pirro, CIO, Algebris Investments

We suspect 2025 may be a tricky year for credit markets. In retrospect, 2022’s events created a one-off opportunity for the asset class. The combination of higher rates and wider spreads changed the yields’ landscape dramatically, and early buyers could lock in 9-12% all-in yield in high-yield markets.

Fast forward two years, and the trade has largely played out. In 2023, we saw a broad performance with quality bonds leading, and 2024 the final part of the credit cycle with high yield/low rated assets catching up and displaying strong performance – despite a mixed year for rates.

Post the big run, valuations are not compelling anymore, at least at asset class level. High-yield spreads are at five-year lows, and implied default rates are well below historical averages. Last year, there were few defaults and refinancing markets remained wide open, but the bar to outpace what is implicit in valuations is nonetheless high.

All-in yields remain high, thanks to the rates component. Carry is a double-edged sword, as it often attracts faster-moving capital at the end of the cycle, creating the potential for a fast exit should rates turn more volatile.

The search for carry is apparent in the recent outperformance of distressed indices: as investors look for yield, market dispersion has fallen fast.

Opportunities exist: in the subordinated corporate space, some issuers still pay 400-500 basis-point spreads, despite solid capital structures, particularly in financials and utilities. The real estate sector is also trading wide to index due to high interest rates. In telecommunications, some of the capital structure stands out as cheap. Other sectors are now trading too tight however, due to generalised spread tightening. For example, European autos are trading at all-time tight spreads despite falling revenues and slowly increasing leverage.

It will be difficult to make money in credit – and in high yield – by buying an index. But opportunities continue for the bond picker.

The wealth manager’s view

Will Dickson, CIO, P1 Investment Partners

High yield bonds performed well in 2024, as would be expected given rising equity markets, falling interest rates and robust economic growth in the US. However, credit spreads are now very tight, limiting the potential for further capital gains and increasing risks of weaker returns by widening spreads.

While narrow spreads can persist for prolonged periods (eg 2004-2007), sell-offs in the sector can be aggressive. Important to consider is that these periods of weakness for high-yield bonds often correlate with declines in equities. They are therefore not an attractive diversifier within a wider multi-asset portfolio.

With the prospect for capital gains limited, the potential return from these bonds is consequently capped at their current yield to maturity of around 6%. History suggests that the best returns from high-yield bonds come after periods of widening spreads, where running yields are higher and capital gains through spread tightening are more likely.

At the current time, the opportunity cost of waiting on the sidelines is low and the risk of short-term capital losses is correspondingly greater. Therefore, investors may find the defensiveness of better quality bonds, or the uncapped potential gains from equities more attractive options.

Within P1 portfolios, we retain limited exposure to high-yield bonds, preferring a barbell approach of better quality, shorter-dated fixed income – providing protection against market volatility –alongside an equity allocation skewed towards smaller companies – to benefit from rising risk assets.

This article first appeared in the January issue of Portfolio Adviser magazine

Showing some hesitancy towards the market environment, equities attracted just €136.3bn, while money markets drew €274.4bn. There are signs that the attitude towards the equity market may be ready to shift, however, as the asset class experienced the largest inflows for the month of December. Only real estate funds and mixed-asset funds experienced outflows for the year in double digits, with mixed-asset losing the most at €66.7bn.

Detlef Glow, head of Lipper EMEA research, said in the past year, some investors likely used money markets as a replacement for cash and bonds due to interest rates. The attractive interest rates could also be the reason that mixed-asset saw outflows in 2024, as Glow suspects some of that allocation may have gone towards pure bonds.

See also: 115 funds drop ESG from branding in 2024

“With regard to the still somewhat inverted yield curves for the Eurozone and other major economies in the world, it is somewhat surprising that European investors favoured bond products over the course of the year,” Glow said.

“That said, the inflows into bonds might be seen as a sign that European investors adjusted their portfolios to the new environment with regard to the interest rate policies of central banks around the globe since the major central banks have further lowered their interest rates despite somewhat different economic environments in the respective regions/countries.”

Inflows to money markets and bonds came primarily through mutual funds, but were also aided by ETF sales. However, the table flipped for equities, which saw inflows of near €200bn through ETFs, but was dragged down by a withdrawal of over €50bn from mutual funds. The trend has led to speculation that for equities, outflows are coming from active mutual funds and going into passive ETFs. However, Glow said he would not “totally agree with this assumption”.

See also: PA Live A World Of Higher Inflation 2025

“The trend toward passive investment vehicles is widely discussed by market observers and asset managers, so it is worthwhile to highlight this topic, especially as not all passive products are ETFs,” Glow said.

“In fact, the flows into ETFs (€256.4bn) were outpacing the flows into passive index mutual funds (€65.2 bn) by a large margin. In line with this, actively managed long-term mutual funds had inflows of €47bn for 2024.”

By sector, a homefield advantage did not do European assets any favours across the year, as equity Europe and equity UK faced the largest outflows. Equity UK lost €23.8bn in the year in flows, while equity Europe dropped €19.9bn. Four of the 10 sectors which lost assets were multi asset. At the other end of the table, European money markets saw the largest inflows, followed by equity global and equity US.

“Given the current market environment, it was not surprising to see so many mixed-assets classifications on the opposite side of the table since European investors seem to be readjusting their portfolios to the new environment in the bond markets after the central banks around the globe lowered their interest rates and may continue to do so in the foreseeable future,” Glow said.

“The same might be somewhat true for equity classifications since investors adapt their portfolios to a new regime of divided economic growth trends in the different major regions/countries around the globe.”

Last year, corporate bonds achieved stable returns and rocketed in popularity, following expectations of falling interest rates across most developed economies. As such, the asset class is entering 2025 at tighter spreads than markets have seen for some time, but also with more attractive yields as interest rates reached highs not seen in several years.

The performance of government bonds has been more volatile, according to industry commentators, and looks set to remain so. The election of Donald Trump as US president, combined with weaker economies across western Europe, means that while interest rate cuts are virtually inevitable, the timing and scale of them is relatively unknown.

Iain Buckle, head of UK fixed income at Aegon Asset Management, says: “We expect bond markets to remain volatile in 2025. The market currently expects a further 75 basis points of cuts from the US Federal Reserve over the next 12 months. The broader US economy still seems robust, however, and those 75 basis points of expected cuts could look optimistic if the labour market remains resilient.

“The political backdrop in the US will also drive volatility, given the market assumes a Trump presidency will lead to looser fiscal policy and higher inflation. We will learn more as he takes office, and the reality may not be what the market has implied. But it’s likely the style of his presidency will only add to the uncertainty and volatility in markets.”

David Knee, deputy CIO of fixed income at M&G Investments, agrees that Trump’s election will increase volatility across markets, as investors anticipate how his second administration pans out.

“The first Trump presidency showed what Trump said he would do and what he actually did was very different,” he reasons. “Bond markets will be watching for key policies such as tariffs, tax and immigration, which could potentially reignite inflation and limit the ability of the Fed to act, as well as add to already growing deficits.”

Over in Europe, Buckle says the outlook is “slightly more certain”. “Core European economies have been struggling for some time, negatively impacted by a weak Chinese consumer and growing competition from within China itself.

“We expect the European Central Bank (ECB) to continue to cut rates, with 125 basis points of cuts expected by the end of the year. It would take a further deterioration in the outlook for the market to price in further cuts, but that is certainly a possibility as we learn more about US tariffs early in 2025.”

To read more on the outlook for government bonds, credit, equities, emerging markets consolidation and Consumer Duty, visit the January edition of Portfolio Adviser Magazine

Pellous moves to the group from Invesco, where he spent over a decade as a high yield and emerging market fund manager. He previously held roles at Legal & General, AllianceBernstein and AXA Investment Management.

See also: Stuart Parkinson becomes Stonehage Fleming CEO

His appointment follows a series of new additions made to Aviva Investors’ fixed income team. It hired Gita Bal as head of fixed income research earlier this month, and poached Fraser Lundie as global head of fixed income in May last year.

Daniel McHugh, chief investment officer at the firm, said: “The appointment of Fabrice represents the latest step in our efforts to expand our fixed income investment team.

“Fixed Income is a central pillar of our public markets offering, and our ambition is to have a market leading offering across all major sectors of the asset class.”

PA Live: A world of higher inflation

Yes, mistakes were inevitably made. We can say (with hindsight) that central banks sowed too many magic beans in 2020. And interest rates were kept too low through 2021, when there was already evidence for rising inflation and tighter labour markets.

But most central bank criticism was grossly unfair. In 2022, the world came face to face with an unfriendly inflationary giant for the third time in two years. There was little else central banks could have done. Indeed, in 2023 the Bank of England (BoE)’s models suggested that even with a crystal ball in 2021 telling them what shocks were coming, interest rates would have needed to break double digits to keep inflation at target. Such a move would also have pushed the unemployment rate into double digits, posing grave financial instability risks.

Oh no you didn’t …

Almost three years on from Russia invading Ukraine and we see many global risk assets at record highs, credit spreads near record tights, inflation and inflation expectations close to, or at, target, and unemployment rates close to historical lows (and at an all-time low in the eurozone). Central banks’ mandates are hitting inflation targets, protecting financial stability and/or maximising employment. Investors should be casting central bankers as heroes, not the villains of the show.

But no fable is without its moment of adversity and indeed the greatest opportunities for active fixed-income fund managers come when central banks make mistakes, when markets misinterpret their guidance, or when markets behave irrationally. Right now there’s great potential for all three.

Today we have one of the greatest market and macro consensuses ever seen. Hopes for ‘US exceptionalism’ with 3% growth rates forever are rife: long US equities and tech, long US dollar, bearish US treasuries on an outright basis and/or relative to other markets. Such heroic optimism is reminiscent of the bullish emerging versus developed market narrative from 2010-12, and that didn’t end well.

To read the rest of the column, visit the January edition of Portfolio Adviser Magazine

Investors often tend to focus on the short term when it comes to investing in the high yield bond market — approaching the asset class tactically rather than with a long-term mindset.

In reality, high yield investing should be a marathon rather than a sprint. Success isn’t about who records the best time for the first mile of the race, but rather about who completes the course and crosses the finish line first.

Above all, this means managing downside risks given that defaults could lead to permanent destruction of capital. There are a few key ways that high yield investors can mitigate risk.

Incorporating sector and region views is one way investors can spot the signs of potential bubbles and avoid areas that are at higher risk of default. One such theme to avoid is AI.

Overexuberance is a danger signal

It is vital to have a healthy scepticism when other investors become overly excited. High yield investing can have an asymmetric return profile — investment in individual credits can be rewarding, but there is the potential for permanent loss of capital if a company defaults.

AI — which has seen significant levels of investment and above-trend capex— is an area with potential for another bubble to form. Should the tide turn on demand, high yield investors could find themselves exposed to default risk in issuers that have significant exposure to the AI theme. 

History has shown that during downturns, defaults tend to be concentrated in sectors undergoing increased capital supply and investment, such as the shale oil crisis in the 2010s. In the run-up to this event, we saw higher profits and prices in the sector lead to increased capital investment and competition.

The sector was ultimately exposed when demand slowed. The dotcom bubble of the late 1990s is another example that shows market enthusiasm can often come with unintended risk.

While AI is creating some compelling new opportunities and there may well be long-term winners, predicting the winners and losers of the AI boom is far from straightforward given the wide distribution of outcomes, and there will inevitably be instances of misdirected capital.

It is also worth remembering that while the valuation premium inherent in AI-related stocks creates a significant opportunity cost for equity investors, we have not seen this trend translate quite as clearly to the high yield market.

Instead, it is worth being wary around the significant levels of above-trend investment and capex that may translate to a higher risk of defaults. For now, investors should be cautious on companies with high exposure to the AI theme, such as technology hardware companies.

Finding high-quality in an inefficient market

The high yield market is highly inefficient at pricing default risk. Taking advantage of potential mispricings while minimising default risk requires significant fundamental, bottom-up credit research to uncover the highest-quality companies in terms of their underlying economic fundamentals.

Equally, it means avoiding those companies with a risk of permanent destruction of capital, as well as the sectors and regions where defaults are likely to be concentrated.

Those looking to uncover high-quality issuers should prioritise seeking out companies with proven competitive advantages or moats. While investors may be cautious on companies that have high levels of exposure to the AI theme within the technology sector, for example, there are still a number of opportunities in payment providers and software services providers with strong competitive moats like the high expense of changing providers.

Alternatively in the automotive sector, investors should be cautious on auto manufacturers where there has been a large expansion in competition and new entrants to the market.

Nevertheless, it is worth being selectively optimistic about the potential performance of auto suppliers, which often have high barriers to entry. Many of these companies have deeply integrated relationships with original equipment manufacturers (OEMs) and there are financial, technical and regulatory hurdles associated with switching suppliers, particularly in the middle of an auto production cycle, which can last upwards of 10 years.

Heightened default risk in 2025

We are currently navigating what could be a more volatile environment for markets. Provided investors avoid a default cycle — which is the base case — high yield has significant appeal for those who can undertake the necessary bottom-up fundamental research and implement a disciplined sector and country framework.

This is crucial in order to avoid issuers and sectors to have a higher risk of default, such as issuers with significant exposure to the AI theme.

Fidelity Strategic & Flexible Bond portfolio managers Mike Riddell and Tim Foster share their outlook for 2025 and provide an insight into how they are looking to position the portfolios against an evolving macro backdrop.

Looking across the global fixed income opportunity set, the picture is very mixed at the moment, with different markets pricing in very different outcomes for the global economy. On the one hand, some government bonds are still offering yields that have rarely been higher since the roaring 1990s, despite the fact that many central banks have already begun rate cutting cycles.

But on the other hand, the riskier areas of global fixed income markets offer far less enticing return prospects. A number of corporate bonds, especially those in the US, are offering among the tightest credit spreads over government bonds that have ever been seen.

What happens from here largely depends on global economic growth. If the global economy continues to chug along at or above historical trend growth rates, then riskier areas of fixed income could continue to hold up well for even longer. But any renewed signs of a global economic slowdown could see sovereign bonds deliver outsized positive returns, and corporate bonds underperform their sovereign counterparts, potentially by a substantial margin if a slowdown comes faster or deeper than expected.

But the worst outcome for most areas of fixed income is if we see another jump in inflation on the back of any global tariff or trade war. On that front it’s still too soon to tell. We will need more clarity on the details behind the measures, and expected timing of them, from the new US administration before we can form a clearer view of the inflation trajectory from here.

Positioning against this backdrop

As long-term value investors, we tend to be attracted to areas of the bond market that are historically cheap, and shun parts where valuations are trading at very expensive levels. With that in mind, there’s no question that sovereign bond yields are trading at historically cheap levels. The tougher question is whether these levels are justified in the short to medium-term.

At the global level, US imposed tariffs are likely to be stagflationary, where it’s probably more a case of ‘flation’ for the US and ‘stag’ for the rest of the world. We’re likely to get an acceleration in US fiscal stimulus too, although any stimulus could be offset by the axe that’s likely to be taken to the government sector. And even if the new US administration does deliver a fiscal boost, the US economy is already operating at close to full capacity. In that sense, additional stimulus would probably add little to GDP growth rates, but potentially a lot to inflation. A reacceleration of US inflation leaves us less optimistic for US Treasuries than sovereign bonds issued by other countries. But we think US inflation protection still looks fairly cheap.

Outside the US, government bond yields look too juicy to ignore given our expectation for a lower growth environment. Australian bonds, for example, could even benefit from aggressive US tariffs. China and the wider region in Asia would face a negative economic growth shock from punitive US policies, opening up the potential for a faster pace of rate cuts. Yet Australian sovereign bond yields have been blindly following US Treasuries higher, which now makes them a very interesting proposition. We have less conviction in currency markets at this juncture, but the Chinese renminbi could be particularly vulnerable to US trade policy and a strong US dollar.

Aside from government bonds and currencies, an area of fixed income that we think offers very slim prospects for strong returns is corporate credit. The all-in yields may look reasonable versus the last two decades, but this is entirely because ‘risk free’ sovereign bond yields are so elevated. The paltry extra spread on offer to investors for going down the credit risk spectrum is close to the lowest on record.

From a regional perspective, the US corporate bond market looks particularly unattractive. When credit spreads are as low as they are today, historical data shows that investors have barely ever achieved better returns buying US corporate bonds than similar maturity government bonds looking forward one, two or even three years. That’s because when credit spreads are so tight, they can’t tighten much more, but they can widen a lot if anything goes wrong. Spreads now seem priced for perfection, leaving the asymmetry of owning corporate bonds tilted very negatively for investors. Given this, we are not looking to own much credit risk for now until credit spreads widen to more attractive levels.

Learn more about Fidelity Strategic Bond Fund

Important information

This information is for investment professionals only and should not be relied upon by private investors. Investors should note that the views expressed may no longer be current and may have already been acted upon. Past performance is not a reliable indicator of future returns. The value of investments and the income from them can go down as well as up and clients may get back less than they invest. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in emerging markets can be more volatile than in other more developed markets. The price of bonds is influenced by movements in interest rates, changes in the credit rating of bond issuers, and other factors such as inflation and market dynamics. In general, as interest rates rise the price of a bond will fall. The risk of default is based on the issuer’s ability to make interest payments and to repay the loan at maturity. Default risk may, therefore, vary between different government issuers as well as between different corporate issuers. Due to the greater possibility of default an investment in a corporate bond is generally less secure than an investment in government bonds. Sub-investment grade bonds are considered riskier bonds. They have an increased risk of default which could affect both income and the capital value of investments. Investments should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document, current annual and semi-annual reports free of charge on request by calling 0800 368 1732. Fidelity only gives information on products and services and does not give investment advice to retail clients based on individual circumstances. Any comments or statements made are not necessarily those of Fidelity. Issued by FIL Pensions Management, authorised and regulated by the Financial Conduct Authority. Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. FIPM 8662

The global commodity market faces an of challenges that could influence its volatility, such as new Trump presidency in the US, ongoing tensions in the Middle East, and natural disasters across the coasts of Mexico and North America.

However, there is also another factor that is probably the most underestimated one — the evolving economic deterioration of China. So why and how exactly is China influencing the commodities market, and what changes can we expect in the near future?

China’s economy has peaked

China has long been considered one of the biggest world economies, but today’s forecasts are not bright anymore — many analysts think the country’s economic peak already passed in 2021.

The main reasons behind this phenomenon is excess production capacity, a downturn in the housing market, and low consumer activity. All together, they will continue to put pressure on prices.

As a result, China’s consumer prices showed no growth in September, with a year-on-year increase of just 0.4%. Core inflation, excluding volatile energy and food prices, slipped to a modest 0.1%, marking a clear sign of a broader economic slowdown.

See also: Is China at a turning point, or will it disappoint yet again?

This also coincides with China’s cheap labour resources nearing exhaustion, an increase in youth unemployment, an ageing population, and may countries in Europe and the slowing down imports their imports of Chinese goods.

The Chinese government is working to manage these changes, yet the situation remains challenging. And without further stimulus, China risks falling into a prolonged period of deflation similar to Japan’s experience in the 1990s.

These incentives will most likely be further increased in order to avoid the Japanese scenario and provide a gradual slowdown in economic growth to about 3.5 to 4.5% per year over the next three to five years.

China’s economy drives commodity markets

Economic shifts in China have a direct impact on global commodities. The country remains the world’s largest importer of key resources such as oil, and any changes in its purchasing behaviour are reflected in global markets.

The volume of China’s oil imports amounts to 11 million barrels per day, which is only slightly below the level of September last year and corresponds to the average figures for the last months. Overall, import volumes remain stable.

However, the average price of imported oil in September decreased as worries about demand from China pressured market sentiment. The oil price has since surpassed $60 per barrel.

See also: Fairview’s Yearsley: China becomes ‘story of September’

As for energy, it remains one of the key components of the Chinese economy. Despite the aforementioned economic hurdles, China has executed strategic adjustments to its energy sector that may soften its economic landing. From 2022 to 2024, the country managed to cut energy costs per unit of GDP by 5–15%.

The decrease occurred due to a few reasons. The first is linked to cheaper purchased resources since China mainly imports resources from countries in difficult economic conditions and offers them discounts of up to 30% relative to market prices.

Secondly, the country has modernized its own energy system, which has increased its efficiency and lowered prices.

How should investors adjust their strategies?

Faced with the problems within the Chinese economy, investors should pay attention to new opportunities in other regions and sectors.

It is worth looking at American companies, especially in promising areas such as energy, artificial intelligence, robotics, and big data. They are likely to increase their output, which also opens up new investment opportunities.

Indian and Mexican companies that can replace Chinese manufacturers in global consumer markets may also be promising. These two countries are actively developing their production facilities and becoming key alternative production centres.

At the same time, it is important to monitor the large volume of natural resources that China exports and look for alternative suppliers. This will help prepare for possible restrictions on Chinese exports or the introduction of export duties.

Some investors are already moving away from Chinese assets and switching to more reliable instruments such as gold or US bonds, with foreign direct investment in China turning negative for the first time since 1998. 

The data comes as bond yields hit their highest level since the financial crisis. However, in the past year, the market has shifted rapidly. While the Bloomberg Global Aggregate index fell 3.6% from the beginning of the year to its trough in May, it now has a year-to-date return of 0.82%.

Although gilt yields spiked following the Autumn Budget, they have now largely settled to levels from before the announcement. In 2024, the Bank of England made two rate cuts to reach an interest rate of 4.75%.

See also: UK inflation jumps to 2.3% for October

In the US, treasury yields also lowered as Scott Bessent was chosen as US Treasury Secretary. While the Federal Reserve has cut interest rates twice this year for a total of 75 basis points, worries of inflation under a Trump presidency have caused uncertainty on how cuts will continue in 2025.

In its 2025 outlook, Vanguard priced in a rate of 4% by the year’s end, and Goldman Sachs expects a terminal interest rate of 3.25% to 2.5% for the Trump administration.

Jeremy Leach, chief executive officer of Managing Partners Group, said: “Fixed income funds have seen increasing inflows recently and this new research shows that institutional investors and wealth managers are set to significantly increase allocations over the next 18 months.

“Particularly as we enter a period of high volatility, the benefits of diversification and a regular income means fixed income is an increasingly popular choice for institutional investors and wealth managers.”

Most investors believe their allocation to bonds will rise by 10% to 15% in the next 18 months, while near a quarter see allocations rising beyond this share. Just 10% of investors believe allocation will increase by 10% or less. Currently, just 17% of investors say they are overweight fixed income.

See also: Will bond yields stay higher for longer?

According to the latest fund flow data from the Investment Association, published last week, the IA Corporate Bond sector saw the biggest sector inflows during the month of September at £904m, far outpacing the second best-selling sector’s net retail sales of £244m.

This is no surprise given where interest rates stand relative to history, with developed market central banks now heading towards a rate-cutting trajectory. As such, however, there has been some concern over recent weeks that credit spreads are tight relative to history.

But could prospects for bonds have become even more appealing since?

While in the UK, the Bank of England’s Monetary Policy Committee voted 8-1 to cut interest rates by 25 basis points last week, it warned that policies implemented during last month’s Autumn Budget could increase inflation by up to 50 basis points at its peak. Figures from the Office for Budget Responsibility also confirmed the policies will increase inflation and impact the previous trajectory for interest rate cuts.

Meanwhile, in the US, the likelihood of inflationary policies from incoming president Donald Trump could also mean interest rates remain higher for longer. This is despite a rate cut from the US Federal Reserve last week.

See also: AJ Bell’s Hughes: Why money will keep flowing into fixed income funds

Samer Hasn, senior market analyst at XS.com, said: “We are witnessing a gradual decline in the probability of the Fed cutting rates next January, reaching 20% ​​today [13 November] after exceeding 60% a month ago. Also, if the Fed cut rates in January, the probability of further a cut in March is only 11%, after exceeding 60% a month ago, according to CME FedWatch Tool figures.

“The diminishing likelihood of a rate cut next year has driven yields on two-year treasuries—highly sensitive to shifts in short-term interest rates and expectations—up at a faster pace than 10-year treasuries. This surge has propelled two-year yields to their highest level since July, reaching 4.33% today.”

As a result, he said bond yields may “ultimately become more attractive” as investors capitalise on yields that could remain higher for longer than previously anticipated.

“Additionally, rising risk appetite in the markets, exemplified by record highs in stocks and cryptocurrencies… could lead Wall Street portfolios to shift toward a blend of high-upside stocks and high-yield bonds.”

That being said, a report from Bank of America Global research, published on the 11 November by credit strategists Ionnis Angelakis and Barnaby Martin, wanted that credit spreads have become “another leg tighter” since the US election result.

Despite this, they believe strong inflows into fixed income – namely credit – are likely to persist into 2025.

“The need for quality yield is here to stay. In a world of diminishing yields in “risk-free” proxies, like government debt and money-market funds, we think that credit will remain the asset in demand,” the wrote. “A growth shock could cause the inflow trend to wobble at times in 2025, but as long as the rates market doesn’t make a U-turn, we see strong inflows as a regular theme next year.”

Using rate volatility and the prevailing level of yields, the strategists predict that flows into investment-grade credit will be “strong” at between 5-7% of AUM in 2025, if yields continue to decline.

See also: What does the gilt yield spike mean for UK bond prospects?

“We believe high yield will also benefit, but to a lesser extent, with flows of around 2.5-5% of AUM.

“Last but not least, there will be a clear decoupling between credit and government debt funds; the latter is likely to see more muted inflows of around 1.5-3.5% of AUM.”

Elsewhere, the research team at Square Mile said “cautious optimism” remains the dominant view among most fixed income managers that they speak with.

“In a climate of economic and political unpredictability, investors are increasingly turning to fixed-income funds as a strategic play for a more stable return profile,” the team said.

“The consensus at present is one of a “soft landing”, where growth slows without triggering a significant recession, although some managers commented that a “hard landing” remains within the realm of possibility. This creates both risks and opportunities for fixed-income assets.

“Trump’s victory may have profound implications for fiscal policy given his rhetoric around aggressive tariffs and immigration restrictions. Such policies may complicate the Fed’s ability to meet anticipated rate cuts, potentially leading to higher yields. Investors should consider that, while monetary policy is used to stimulate the economy, in developed markets the rate hikes resulted in relatively benign impacts as shown by the resilience in the US. This raises the question of whether the reaction to rate cuts may also be more muted than expected.”

From a duration perspective, the team said overweight positions in US and European interest rates look to be a popular strategy.

“Asset classes in favour are high yield, particularly in Europe due to cheaper valuations over the US, as well as emerging market debt and securitised assets. These asset classes are providing incremental and attractive levels of yield despite the tight credit spread environment.

“In the coming months, excess returns are more likely to come from carry rather than additional narrowing of credit spreads, i.e. capital appreciation. With spreads already compressed, focusing on yield seems to be the path most travelled in an attempt to offer a sustainable return profile.”

In this Fund in Five, Nicolas Trindade, lead manager of the AXA Global Short Duration Bond Fund, says investors need to go back to the Global Financial Crisis in 2008 to see the high levels of yield that are currently available within the asset class.

The £742m L&G Strategic Bond, which is co-managed by Colin Reedie and Matthew Rees, predominantly invests in corporate bonds, and is able to hold either investment grade and sub-investment grade fixed-income securities, so long as they have credit ratings from a recognised rating service. The fund must maintain a net exposure of at least 80% to sterling at any one time.

Over three years, the fund has returned 10.7% compared to its IA Sterling Strategic Bond sector’s average loss of 0.8%.

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The RSMR team said: “This fund leverages the exceptionally strong fixed income platform at LGIM, benefiting from high level input from across the vast team, comprising fixed income managers, researchers and economists, as well as the meticulous bottom-up proprietary credit research carried out by the analysts.

“The managers have built a strong track record, having developed a repeatable and pragmatic investment proposition.”

Dodge & Cox Global Bond, which is an Ireland-domiciled ICVC, is $556.3m in size. It has returned 8.6% over three years, compared to its average peer in the offshore global fixed income sector’s loss of 0.4%.

The fund is able to invest across the full spectrum of global bond markets, with the team taking at least a five-year view on the securities they hold. While there are no limits on duration or currency within the mandate, other than to be regionally diverse, its investment-grade allocation is capped at 25%.

RSMR explained that Dodge & Cox is a “valuation sensitive” asset manager across all asset classes, and that fixed income “is no exception”.

“The philosophy is to be flexible and index-agnostic using three main levers: currency, interest rates and credit. It has a team-based approach run by committees of senior investment professionals with a coherent succession policy.

“Dodge & Cox offers a style of investing that will generally work well when valuation is recognised as a significant factor rather than momentum, but it is very conscious of including some diversification to provide some offsets.”

The third fund to be awarded a rating is the Dublin-domiciled Royal London Global Bond Opportunities fund, which invests across investment-grade, high-yield and unrated global corporate bonds.

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Co-managed by Eric Holt and Rachid Semaoune since its launch in 2015, the £302.8m fund has returned 10.7% over three years, compared to its IA Global Mixed Bond sector average’s loss of 3.1%.

The RSMR team said the fund was created so that the Royal London fixed income team could to apply their skills to managing “a truly global mandate that invests largely in credit, with a view to delivering a high level of income from a well-diversified portfolio”.

“We have known the highly-regarded Royal London fixed income team for many years and are impressed by its expertise and the extent to which it has produced consistently strong relative returns across a wide range of mandates on a regular basis.”