Why short duration bonds may offer attractive opportunities in 2025

Investors have been turning more and more to short duration bonds over recent years.  We believe the reasons for this are threefold:

1: Step out of cash

With central bank rates declining, the yield available on cash is also reducing. Short duration bonds, with potentially higher returns than cash, lower volatility and a naturally liquid profile, could be an interesting option for investors.

2. Risk-adjusted returns

After the large bond sell off in 2022, many investors have been reconsidering their longer dated bond portfolio. Instead, they have been looking at short duration which, given their characteristics, offer a potential safe haven during volatile markets. Alongside this, yield curves are relatively flat, therefore the potential risk-adjusted returns coupled with a lower risk profile make short duration bonds appealing when compared with longer dated bond options.

3. Flexibility to generate alpha

Short duration bond strategies have the ability to generate alpha thanks to the many ways they can be reflected in portfolios. Whether it is sectors, geographies or asset classes, there are plenty of options available to meet investor needs.

We have managed short duration strategies for over 25 years and have a broad offering across the full fixed income risk spectrum.  Short duration bonds are not homogenous and can help investors with different outcomes beyond the three mentioned above. We will look in greater detail at some of these outcomes and potential approaches later on. 

Why are short duration bonds attractive for 2025?

For investors, it is a challenging backdrop largely to due to the economic policies of the Trump’s administration and concerns on the inflationary and growth impacts that the tariffs they are imposing could have. Short duration can be used as a defensive tool in the broader mix of a portfolio and is therefore appropriate in the current environment.

First reason for this is that interest rates are beginning to move down as inflation moves back to central banks’ targets. However, there are differences across the board: the Federal Reserve (Fed) is on hold at the moment until there is more clarity on the impact the Trump administration’s policies have on the economy. Nevertheless, the market still expects rates to come down and if this is the case then that should be good for short duration performance.

In Europe, the European Central Bank (ECB) has been more aggressive and now interest rates and inflation are at the same level making real rates effectively zero. In the short term, we expect the ECB to cut rates as they react to the tariffs. This should also create a positive tailwind for bonds. Likewise, in the UK, we expect to see further rate cuts that should also be positive for bonds’ total return performance.

When you look across fixed income at where opportunities may lie, one thing that is striking is that yield curves are still relatively flat. This means the difference between the yield for short and long duration bonds is quite small from historical standards. The longer end of the curve is often more volatile as it is more interest rate sensitive. As the yields are similar to those of short duration bonds, this makes short duration bonds more attractive as they tend to be less volatile. For those looking for additional yield, they can use short duration bonds to access higher yielding fixed income asset classes such as high yield and emerging market debt.

Short duration bonds also tend to reflect the interest rate policies of central banks. Central banks usually provide guidance about what their next policy moves are going to be meaning there are less shocks. This results in more stability for yields as we have more visibility on what to expect. This is not the case for long duration bonds as there are so many more influences on the long end of the curve. What that means is more volatility in the total return performance for longer dated securities.

Therefore, assuming central banks do not produce any surprises, we expect short duration to offer attractive opportunities for investors in 2025.

Investment approaches to meet outcomes

Diversification: Unconstrained Global Short Duration

When taking a global approach to a short duration allocation, we believe it is important to have flexibility so as to dynamically invest across different sectors, regions and asset classes.  Our global unconstrained strategy uses that flexibility to bring the best ideas from across the full fixed income universe.  This allows broad diversification across developed and emerging markets as well as asset classes and credit ratings.

Not only does a flexible approach enable investors access to diversification, we believe it also helps us to respond tactically to shifts in the market. An example of this was 2022 when we increased our exposure to sterling investment grade market. Despite being a small market, with local expertise it is possible to identify opportunities. After the mini budget when gilt yields rose and credit spreads widened, we increased our exposure to look to benefit from attractive valuations.

For these reasons, we believe an active allocation approach is important for global short duration strategies in order to be able to benefit from the best worldwide opportunities.

Step out of cash / growth: Euro credit

Despite spread compression, the yield on offer in euro investment grade and high yield remain attractive from a historical perspective. For short duration euro credit therefore, investors can access historically attractive yields with lower volatility.

For investors looking for a step out of cash, the euro investment grade short duration market offers a defensive option. The euro investment grade universe as a whole is substantial and so provides short duration investors with access to consistent liquidity and ample diversification.

For those looking for growth, euro high yield short duration could be worth considering. Through a euro high yield short duration strategy, an investor should still be able to capture a significant part of the total return of the overall euro high yield market while seeking to limit the volatility.

With both approaches, having a robust investment framework, including a strict sell process, we believe, is key to successfully reflecting opportunities across the euro credit short duration universe.