Market conditions have been characterised by stubbornly high inflation trends, sharp interest rate swings, and heightened geopolitical tensions. This increased volatility has widened the gap between the best- and worst-performing areas of fixed income.
In such a landscape, strategies that can adapt quickly and capture returns from both rising and falling markets have a clear advantage. Absolute return approaches, which can invest across the full fixed income universe and position in relative value (long/short) as well as directional strategies, are perfectly designed to make the most of opportunities while managing risk.
The amount and speed of global interest rate cuts from this juncture remains uncertain, whilst stagflation risks are rising, and fiscal concerns are high. For investors seeking to reduce their interest rate risk, whilst also benefitting from volatility in the rates markets, an absolute return bond strategy can provide a suitable solution. The strategy’s duration is typically shorter than traditional fixed income funds meaning there is less directional interest rate risk, but this risk is flexibly managed allowing clients to benefit from market movements.
Economic disruption can undermine traditional strategies
Fixed income is a core allocation for most investors globally and one that has become much more attractive now that yields have risen from their ultra-low levels five years ago. But that is not to suggest that the outlook for bond markets is straightforward.
Inflation has eased somewhat, allowing central banks to end their tightening cycles. But even though it has declined, inflation is proving more stubborn than expected in many economies – and US tariff policies could push prices higher this year. This, combined with a weaker outlook for economic growth, puts central banks in a difficult position.
Slowing economic growth and softening labour markets suggests rate cuts are needed to ease the financial pressure on firms and households, but elevated inflation points in the opposite direction. Add a partial reversal of globalisation as cross-border trade becomes more complicated, high levels of government debt and geopolitical tensions, and it becomes clear the outlook for the global economy is far from settled. It is possible that we may have entered an era of structurally higher inflation, meaning that interest rates may not fall as far in the current cycle as many hope.
As a result, an overhang of economic uncertainty continues to cloud the outlook for fixed income markets. The corollary of this is that significant risks remain for investors pursuing traditional less flexible fixed income strategies, stemming from an unhealthy combination of weak growth and stubborn inflation.
Why now is the time for an absolute return bond approach
In fixed income markets, these uncertainties are expressed as persistently higher volatility and a greater dispersion of returns. This is precisely the type of environment in which investors should consider alternatives to their traditional, benchmark-focused bond funds. When there is such uncertainty over future movements in interest rates and in expectations for growth and inflation, an absolute return strategy is likely to offer a more favourable risk/return profile.
The key advantage that absolute return strategies enjoy – and that makes them well suited to today’s fixed income markets – is their unconstrained investment style. This gives these strategies a much more diverse toolkit with which to generate positive returns, whatever the outlook for market conditions.
Absolute return strategies have the freedom to invest in any part of the fixed income asset class, instead of specialising in one area, and can take short as well as long positions. In practical terms, this allows them to create a well-diversified global portfolio of fixed income assets that are relatively uncorrelated.
It also gives them the flexibility to respond quickly to opportunities that align with their goal of generating a consistent 2%-3% return above cash while smoothing performance through market cycles. Managers can respond to emerging risks by adopting defensive positioning, take short positions to benefit from falling prices where the risk/reward balance is attractive, and can rapidly increase their risk exposure when new opportunities appear.
Steady performance and diversification
These strategies aim to deliver a consistent premium over cash, but to combine that with reduced volatility so that they maintain a smoother profile suited to risk-conscious investors. In line with their focus on capital preservation, they usually set targets that limit volatility or drawdowns. BNP Paribas Asset Management’s strategy, for example, targets a maximum 12-month drawdown of just -2.5%.
These strategies also provide a valuable source of diversification on two levels.
First, their benchmark-agnostic approach provides exposure through a single vehicle to income streams from a diverse set of investments that are relatively uncorrelated. Second, their return profile often has low correlation with traditional fixed income strategies such as sovereign bonds or corporate credit. So adding an absolute return component to a portfolio is an excellent way to diversify a broad fixed income allocation, increasing resilience and smoothing volatility.
Our approach: a resilient and dynamic portfolio
Our strategy is designed to combine around 25-35 of the most attractive fixed income investment opportunities into a resilient portfolio that benefits from relatively uncorrelated sources of return. Our strategy screens opportunities across developed world sovereign bond markets, investment grade and high-yield corporate credit, structured securities, emerging market government and corporate bonds denominated in both local and hard currency, fixed-income derivatives, and to less of an extent, currencies.
Returns from the assets in this investment universe are constantly shifting, both in absolute terms and relative to each other. Our strategy’s dynamic, unconstrained approach allows us to identify the most compelling combinations of assets, maximise diversification to manage risk and so exploit the dispersion of returns across fixed income, which averages around 15 percentage points annually.
Our strategy’s exposure to duration (a measure of how sensitive bond prices are to changes in interest rates) is a good example of the benefits of our dynamic, flexible approach. We manage duration within a range of -4 years to +4 years, which gives our strategy much lower duration than most traditional fixed income products. For comparison, the Bloomberg Global Aggregate bond index has duration closer to six years. This flexible positioning means that investors can benefit from upward and downward movements in rates while avoiding significant interest rate risk.
We can also take short positions and use relative value strategies, such as yield curve steepeners, to balance long and short positions, achieving an overall neutral risk stance while capturing the yield on the long side of the trade.
Our team has decades of experience in managing these strategies and is supported by the Global Fixed Income Platform, who we collaborate closely with to generate the best ideas from across the unconstrained universe.
Risk management and portfolio construction are essential to our process, so a lot of time and resources are spent on this. The focus on combining and sizing allocations correctly, not only helps underpin the consistency of performance delivery through time but also forms the basis of capital preservation in unexpected and more challenging market environments. To achieve these outcomes, we work extremely closely with our dedicated front office risk analyst who is empowered to help us make better decisions.
Source : BNPP AM 2025
Find out more about the BNP Paribas Global Absolute Return Bond.
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