This is a sponsored article from L&G.

Author: Matthew Rees, Head of Global Unconstrained Fixed Income, L&G

The new world disorder

Global financial markets have experienced considerable turbulence in recent years, reflecting events such as the COVID-19 pandemic and the Ukraine war, both of which had significant impacts on the global economy. This turbulence has continued in 2025, due to the geopolitical and economic backdrop.

We believe various underlying and often interconnected issues are currently unfolding, adding to the volatility. These include:

• The polarisation of domestic politics across the globe
• Rising geopolitical tensions
• The far-reaching consequences of technological change, including developments in artificial intelligence (AI), which could lead to short-term economic dislocation and job losses
• The impact of climate change on economies and societies
• Concerns about government fiscal sustainability

While every era is marked by unexpected developments that can cause short-term dislocation or even market shocks – such as the global financial crisis in the 2000s, or the rise of computing and the opening up of China’s economy in the 1970s – the kind of disruption we are currently seeing, with so many dynamic and pressing factors colliding, is rare. Moreover, the unpredictability of the impact of factors such as climate change, AI and increasing geopolitical tensions makes it extremely difficult to predict the direction of the global economy.

However, we believe most of the current trends, whether geopolitical or economic, could prompt upward pressure on prices and are thus associated with the risk of higher interest rates. That has clear consequences for the fixed income sector.

In our view, these factors are also likely to deliver shorter – and possibly sharper – economic and market cycles. That would create a very different backdrop for investors, particularly those in fixed income, than has been seen in the recent past. Inevitably, it will lead to greater volatility and make it harder for investors to predict the direction of interest rates and asset prices.

The benefits of an unconstrained bond strategy in this environment

Given this uncertain outlook, we believe nimble strategies that quickly adapt to changing circumstances can outperform their constrained, benchmarked counterparts. Rather than focusing on one region or sector, given all the idiosyncratic risks facing markets, we think it is best to adopt a truly agnostic and pragmatic approach, seeking out the best opportunities across various fixed income markets globally.

We believe our unconstrained approach, which is benchmark-agnostic, can help investors navigate this environment and capture a wider opportunity set. An unconstrained bond strategy, with the flexibility to invest in a wide range of fixed income securities, both within and outside traditional benchmarks, can help investors navigate the uncertain outlook for global markets. Such a strategy takes a highly diversified approach to generating income, aiming to produce returns from credit selection, duration management and overall risk management. The strategy, for example, provides the managers with the flexibility to target good, profitable companies in whichever sector or part of the world they may be located.

Dynamic approach to managing interest-rate risk and duration

Interest rate risk is one of the main risks facing fixed income investors. In an uncertain and volatile world, that risk is likely to be heightened. An unconstrained approach, however, can lower the risk significantly, in our view. This is because unconstrained strategies do not have a benchmark level of interest rate risk they are expected to take.

We also believe the duration of fixed income portfolios should be managed in a more dynamic fashion in 2025, and an unconstrained approach certainly allows for this. Over the 40 years to 2021, duration was something to ‘buy and hold’. However, a more volatile, shorter-cycle backdrop will require a sharper focus not only on duration management for the entire portfolio, but also on its interaction with risk assets.

Our team includes interest rate experts who look at the dynamics between interest rates and credit spreads to actively manage duration. We actively position duration with a view to the correlation of returns between government bonds and credit spreads. Without this, investors could face large capital losses.

A key challenge facing investors in this environment is how to achieve global diversification. It can be tempting to simply buy the bonds with the highest yields, but that can result in dangerously high concentrations of risk. Asia-based investors should also be aware that they are buying dollar-based debt, which introduces currency risk. Sometimes, however, that can work in investors’ favour: the dollar has fallen by around 10% since the highs of mid-January, a decline that an unconstrained fund can take advantage of.

Lessons from the past

2022 proved an extremely difficult year for all investors, with interest rates rising sharply from the near-zero levels seen during the pandemic and causing sharp reversals in global bond markets. Both equities and bonds fell in value, with the Global Aggregate Bond index losing around 12%, making 2022 one of the worst years on record for bond investors. However, investors in unconstrained strategies that had the ability to avoid or even negate duration risk were able to successfully navigate this period.

Current opportunities and risks

We believe US investment grade currently looks expensive, and there are also concerns about the unpredictability of US policymaking and a potential tax on foreign holders of US securities. As such, we are reducing exposure to that sector. We are also currently underweight in Chinese high-yield property companies. By contrast, we favour subordinated debt of well-regulated banks, which can provide investors with higher yields than those of low-quality, high-yield companies. We are also looking for attractive yields in shorter maturities in select emerging markets, such as Sri Lanka.

Risks that investors should be aware of

We believe it is very difficult to predict the outlook for variables such as economic growth, inflation and interest rates, particularly in the current uncertain environment. Therefore, we prefer to consider what the market is concerned about and use that to position our duration, accordingly, thinking about duration as a hedge against our credit positions rather than as a source of returns. This is because, over the long term, interest rate risk management does not generate significant returns.

Navigating the new uncertainties

The levels of volatility experienced by financial markets so far this year have taken most analysts by surprise. We expect this turbulence to continue at least into next year. In this new age of uncertainty, fresh thinking is required, including the use of an unconstrained approach that searches for the best opportunities in fixed income worldwide. An unconstrained approach can potentially guide investors through this challenging environment, helping to protect and grow their wealth while aiming to generate income. 

The key to success lies in the ability to cut through the headlines and focus on what matters most over the longer term. A thoughtful but nimble approach, we believe, is required to balance opportunity-seeking and risk-taking in this newly unpredictable world.

Click here to learn more about L&G’s unconstrained bond strategies.
 

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Key risk warnings
The value of investments and the income from them can go down as well as up and you may not get back the amount invested. Past performance is not a guide to future performance. The details contained here are for information purposes only and do not constitute investment advice or a recommendation or offer to buy or sell any security. The information above is provided on a general basis and does not take into account any individual investor’s circumstances. Any views expressed are those of L&G as at the date of publication. Not for distribution to any person resident in any jurisdiction where such distribution would be contrary to local law or regulation.

Issued by:
Hong Kong: Legal & General Investment Management Asia Limited, a Licensed Corporation (CE Number: BBB488) regulated by the Hong Kong Securities and Futures Commission (“SFC”). This material has not been reviewed by the SFC.

Singapore: LGIM Singapore Pte. Ltd (Company Registration No. 202231876W), regulated by the Monetary Authority of Singapore (“MAS”). This material has not been reviewed by the MAS.

This is a sponsored article from L&G.