Recent shifts in global bond markets mean investors need to rethink their approach to fixed income. Amid ongoing volatility and uncertainty, flexibility is key.
A rise in geopolitical tensions has created turbulence for fixed income investors. The interplay between economic growth, price inflation and monetary policy remains difficult to predict, while the deteriorating fiscal position in many major economies has only served to amplify this uncertainty.
However, volatility in fixed income, such as sovereign bonds, remains relatively low whilst spread assets continue to trade at rich valuations. We expect levels of dispersion to rise as US consumption and the labour market weakens further and the risk-on environment becomes tested. Approaches that offer flexibility and selectivity, may become more relevant for investors in the current environment.
This is where absolute return strategies can help. Unlike traditional bond funds, which measure success against a benchmark index, these strategies typically take a dynamic approach to allocation across the fixed income spectrum. They tend to focus on capital preservation and do so with a lower correlation and enhanced risk-return profile compared to traditional fixed income segments.
The case for unconstrained bond strategies
By dynamically allocating capital across different regions, sectors, maturities and currencies, the flexible and unconstrained approach allows the investment team to position the strategy according to their views on current market conditions and expectations over the short, medium and long term.
They are not tied to a specific index benchmark or type of security and so have the freedom to seek out value from across the whole of the fixed income universe. They can also position to benefit from interest rates rising or falling, or corporate bond spreads widening or tightening due to their flexible duration ranges.
For investors, the potential benefits are considerable. An unconstrained, global approach usually has a low level of overlap with traditional bond strategies. It can therefore add meaningful diversification, both within investors’ fixed income holdings and in their wider investment portfolios.
This diversification can help enhance the resilience of the strategy throughout the market cycle by opening up multiple potential income streams, limiting drawdowns and delivering positive returns even during turbulent periods. Meanwhile, by actively managing risk, absolute return strategies are well placed to preserve investor capital across the cycle.
Managing interest rate risk
Because absolute return bond strategies are not required to maintain pre-defined allocations to certain types of securities on a specific benchmark, they may have limited structural allocation to interest rate risk.
These strategies typically use a zero allocation to duration risk (sensitivity to changes in interest rates) as a neutral position. From this starting point, managers may then opt to take an over- or underweight approach to global duration, depending on their reading of market conditions.
Managers of absolute return bond strategies can also combine long and short positions – in the latter case, through the use of derivatives – to optimise their exposure to specific parts of the fixed income market and to provide protection against downside risk. This can help deliver smoother, less volatile returns over the longer term.
Tapping into a broad fixed income universe
In contrast to strategies that hold only corporate bonds or government debt, absolute return bond investments have the ability to tap into income streams from across the fixed income universe.
US agency mortgage-backed securities (MBS) are a good example of an asset that is prone to being overlooked by more mainstream bond strategies, but which can add a lot of value to investor portfolios.
These securities have a high credit quality as they are backed by the US government, and their values can fluctuate due to prepayment risk. They make up a significant proportion of the global bond market, meaning the asset type offers deep liquidity. At the same time, they generate income streams that have a low correlation with the performance of other fixed income sectors, making them an ideal source of diversification within absolute return bond strategies.
In recent years, US agency MBS have offered higher yields than US investment-grade corporate credit, with lower credit risk. For investment managers looking to be adequately rewarded for the risk they take, this is a compelling opportunity.
The value of global expertise
Absolute return bond strategies have numerous levers at their disposal to manage risk and volatility with the aim to deliver smooth returns over the cycle. Managers can vary their exposure to credit, duration and currency risk depending on their views on market developments and they do not have to be invested in any particular sector. When conditions show signs of deterioration, they can respond quickly and adopt a more defensive stance.
However, successfully running such a strategy requires in-depth understanding of a wide range of sectors and macroeconomic conditions. At BNP Paribas Asset Management, we are able to call on global fixed income teams whose research and insight helps us to identify the parts of the market offering the greatest risk-reward.
This broad-based expertise, incorporating individual security analysis and risk modelling, allows us to react quickly to – or even anticipate – changes in markets in an agile and flexible way. This in turn helps us to manage risk, preserve capital and seize opportunities.
In recent months, for example, we have increased our exposure to duration risk in countries where we believe markets have been overly pessimistic in pricing in interest rate increases. We have also positioned portfolios to benefit from the steepening of the yield curve that our research teams expect to result from further monetary easing by the US Federal Reserve.
In corporate credit, meanwhile, we believe rich spreads are vulnerable to a sell-off, but we are ready to take advantage of individual opportunities on a case-by-case basis if we see spreads – the gap between corporate bond yields and the risk-free rate – start to widen.
A different kind of certainty
Elevated inflation and a slowly weakening US growth and labour market have caused a high degree of economic uncertainty, which has been amplified by geopolitical turmoil and friction in international trade.
As 2026 progresses, we expect volatility to increase. The certainties that have characterised fixed income investment in the past – such as the negative correlation between equity and bond performance – are increasingly being called into question. Investors need to rethink their exposureto the asset class to take account of the changed environment and maintain the resilience of their portfolios.
Absolute return bond strategies offer an adaptable, risk-aware approach that looks ideally suited to market conditions, both today and in the foreseeable future. The additional layer of diversification and resilience they bring to portfolios can play a central role in investors’ fixed income allocations. It should therefore not be overlooked.
Source : BNPP AM 2026
At the time of writing 16/2/2026, the Middle East conflict has not warranted any major changes to our base case macroeconomic outlook or investment recommendations. To follow our analysis of the events driving asset markets, go to Viewpoint at https://viewpoint.bnpparibas-am.com
