Rethinking fixed income in a more volatile world

For generations, fixed income assets served as a reliable stabilizer in diversified portfolios. In the classic 60-40 mix, equities drove growth while bonds played defense by generating income and acting as a cushion against market swings. A stable rate environment and a relatively predictable economic backdrop supported this approach and made fixed income a dependable foundation for investors.

Today’s landscape presents a different challenge. Inflation pressures, shifting central bank policies and geopolitical uncertainty have increased volatility and clouded the growth outlook across fixed income markets. Interest rates now move in both directions, and often quickly, making outcomes harder to predict. And while bonds remain an essential component of a diversified portfolio strategy, investors must take a more deliberate approach to achieve their goals. 

The fixed income landscape has changed significantly over the past several years. The pandemic triggered shocks that pushed inflation higher and forced central banks to act aggressively. At the same time, unresolved conflicts in energy-producing regions, including Russia and the Middle East, along with ongoing trade disputes, continue to drive price pressures across the global economy. Investors must now interpret a broader set of economic signals while anticipating how policymakers may respond in real time.

As a result, fixed income markets have become more volatile and less predictable, as new events prompt larger swings in bond prices and wider dispersion across sectors. Bonds still provide diversification benefits, but they may not offset equity risk as reliably as in prior cycles. Outcomes now depend more heavily on how investors position their fixed income portfolios, as well as the effectiveness of their decision-making.

When assessing portfolio positioning, interest rates remain the primary driver of returns, but their behaviour has grown more complex. Central banks influence rates in the short term, while longer-term yields respond to inflation expectations, fiscal policy and structural factors such as demographics that are harder to predict. In turn, uncertainty and risk have increased, particularly in longer-duration bonds.

In this context, short-term bonds can offer a more practical balance between risk and return. They provide clearer visibility into policy direction and reduce sensitivity to large rate moves. At the same time, a relatively flat yield curve limits the benefit of extending duration in pursuit of additional income, reinforcing the case for a more measured approach.

Credit selection also plays a critical role when positioning portfolios. Higher borrowing costs do not affect all issuers the same way. Large, well-capitalized organizations, such as big banks and insurers, have generally demonstrated resilience. In contrast, more leveraged borrowers face growing pressure as financing costs rise and growth slows. In fact, early signs of stress have appeared in areas such as private credit, where companies often have less flexibility to absorb higher rates.

Beyond rates and credit, other risks –including liquidity, transparency and complexity – also require attention. Investors who focus solely on yield may overlook these factors and encounter challenges when conditions tighten. A resilient portfolio considers not only income potential, but also how easily positions can be valued and adjusted.

Taken together, these dynamics call for a more selective approach. In this environment, how a portfolio is managed can make a meaningful difference in outcomes. Yet many investors continue to rely on a static framework, often setting a fixed allocation to interest rate and credit risk, then leaving it unchanged over time.

This “set it and forget it” mindset no longer reflects how quickly markets move. It also overlooks the opportunities that volatility can create. Markets evolve continuously, and portfolios need the ability to respond just as quickly. Active managers can adjust duration, reposition credit exposure and take advantage of pricing dislocations as they arise. They can lean into opportunities when valuations improve and step back when risks increase. Without that flexibility, portfolios risk missing these moments.

“It’s a bit like choosing your footwear,” says Roger Rouleau, Vice President & Portfolio Manager at Dynamic. “The climate changes quickly, and what works in one season won’t work in another. Flip-flops make sense in July, but not in January. Fixed income markets behave in much the same way, so portfolios need the flexibility to adjust and dial risk up or down as conditions change.”

Too often, investors overlook the need for adaptability in their portfolios. They lock in exposures and miss opportunities, leaving potential returns on the table. Fixed income remains a core component of diversified portfolios, but its role has evolved. Investors who prioritize flexibility, focus on the quality of their decision-making and embrace active management will be better positioned to navigate today’s market and capture the opportunities it presents.

Roger Rouleau is a Vice President & Portfolio Manager with the Specialized Credit Team at Scotia Global Asset Management and Dynamic. Visit his bio to read more insights from him or learn about his investment solutions.