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Over the past couple of weeks, I’ve been blogging about our new theme for fixed income investing: A Normal Rate Setting Calls for Active/Passive Fixed Income. Against that backdrop, and as we head into 2025, I thought it would be prudent to expand a bit on the underlying premise behind this approach.

With negative and zero interest rates now well in the rearview mirror, investors are witnessing what we would consider a “normal” U.S. interest rate setting. For many market participants, this backdrop is a relatively new development, and some adjustments in their portfolio decision-making process may be in order, in my opinion. Indeed, even with the Federal Reserve cutting rates, overall yield levels will likely remain elevated compared to the years leading up to and including the Covid-19 pandemic. In other words, U.S. Treasury (UST) yields returning to 1%, or even 2%, is very unlikely barring any unforeseen developments.

So, how did bond investors navigate the fixed income landscape when UST yields were in the 4%–5% range, investment-grade corporates were 5%–6% and high-yield was north of 7%–8%? Oftentimes, the aforementioned active/passive strategy was embraced. With this approach, investors could combine the benefits of obtaining basic market exposure (passive) while also potentially achieving above-benchmark total returns (active).

What’s different now? The expansion of fixed income ETFs. Arguably, most bond investors are probably well aware of the fixed income ETFs that proliferated earlier on in the process, but the lion’s share of these instruments were basically passive in nature, i.e., just tracking some type of benchmark, such as the Agg. In fact, if a bond investor wanted to focus more on active investing and potentially enhanced total returns, fixed income fund managers filled that slot.

Now, bond investors can turn to the more user-friendly ETF structure for their fixed income active needs and can achieve their active/passive balance accordingly.

Conclusion

With the Fed’s monetary policy being highly data dependent, the money and bond markets, by extension, will also remain highly data dependent. As we have seen over the course of the last year or so, this can create a volatile interest rate backdrop. But, one could argue, with volatility comes opportunity. I’ve discussed many times the virtues of the time-tested barbell strategy for fixed income investing. Typically, investors look at it from a rate/duration perspective, but it can also apply to allocations between various fixed income assets, such as interest rate and credit sensitive instruments.

Now let’s add another layer to the barbell approach: active and passive fixed income.