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2021 has been a difficult year for fixed income investors, particularly those exposed primarily to high quality government bonds. Even short duration investment grade fixed income, widely regarded as the poster child for conservative fixed income investing, is on track to deliver a negative return for the first time in nearly thirty years.

Why is this happening? Low yields from developed market bonds have failed to offset the negative price return from bonds in a rising interest rate environment. The road ahead is a challenging one from a total return standpoint; likely to be characterized by low absolute [albeit rising] yields and negative price returns as central banks move to normalize policy rates in a post-pandemic recovery.

There is light at the end of the tunnel, however. As central banks near the end of the hiking cycle, bond investors will benefit from much higher yield levels that better absorb any shocks from further increases in interest rates.

To bridge the gap between the current environment of meager yields and low returns and a future state where yields are high enough to better cushion against losses, we believe investors need to move away from a siloed approach to fixed income markets and embrace flexibility. This can be accomplished either by broadening their investable universe to include more countries, sectors and instruments or by allocating to flexible fixed income strategies that are actively managed across these different dimensions. The combination of an expanded opportunity set, and diversification of return sources can play an important role in helping protect fixed income portfolios.