Navigating the New Fixed Income Paradigm: Strategic Approaches for RIAs in a Structurally Changed Bond Market
Click here for a pdf version of this commentary.
Executive Summary
The fixed income landscape has undergone a fundamental transformation that challenges decades of portfolio construction orthodoxy. This white paper examines the structural forces reshaping bond markets and presents actionable strategies for registered investment advisors navigating this new paradigm. We analyze how massive government debt, sticky inflation, and a Fed with less control over long-term rates have created a regime where traditional fixed income strategies may no longer provide the returns and stability that investors once expected from bonds.
The Structural Shift in Fixed Income Markets
The End of the Great Moderation
For nearly four decades, fixed income investors benefited from a secular decline in interest rates that provided both capital appreciation and portfolio diversification. This era has definitively ended. The iShares 20+ Year Treasury Bond ETF has declined approximately 47% over the past five years through mid-2025, representing a real purchasing power loss of more than 70% when adjusted for the 25% rise in consumer prices over this period.
This dramatic repricing reflects more than cyclical adjustments—it signals a regime change in how fixed income functions within your investors’ portfolios. The relationships that supported the traditional 60/40 stock/bond portfolio have broken down. In fact, stocks and long-term bonds have moved in the same direction in 19 of the last 40 quarters, fundamentally undermining the diversification benefit investors relied on.
The Fiscal Challenge
U.S. government debt has exploded and now exceeds 120% of GDP, with projections for continued expansion. This represents a secular headwind for bond markets. Responses to the financial crisis of 2008-09, and then the pandemic-era stimulus are part of the increase, but new structural spending commitments across infrastructure modernization, healthcare expansion, and energy transition initiatives are fueling massive increases in federal spending. Whatever the political parties promise, persistent fiscal deficits will keep long-term bond yields elevated.
The Federal Reserve’s response to this fiscal expansion has been constrained by its competing dual mandates to: a) maintain stable prices, and b) maintain full employment. There is always some tension between these two goals, but that tension is coming into sharp relief in 2025. Despite cutting short-term rates by 100 basis points in 2024, long-term rates actually rose. This clearly shows the Fed can push down short-term rates but longer-term rates are set by global markets and debt concerns. The 10-year Treasury yield approaching 4.5% and the 30-year nearing 5% reflect not Fed policy but rather the global market’s assessment of fiscal sustainability and inflation risks. Meanwhile, tariffs have the potential to slow economic growth, putting upward pressure on prices, and downward pressure on labor markets. A difficult period of “stagflation” can’t be ruled out.
This disconnect reveals a fundamental truth about the current environment: the Fed’s influence over the long end of the curve has diminished substantially. Market forces, driven by supply and demand dynamics for Treasury securities, now dominate bond yield evolution. As concerns about US debts continue to mount, foreign central banks have begun reducing their Treasury holdings, while domestic investors demand higher term premiums to compensate for duration and inflation risks. The result is a structurally higher rate environment that appears likely to persist regardless of near-term Fed actions. The days of near zero interest rates are not coming back.
Technical Analysis: Understanding Duration Risk in the Current Environment
The Asymmetry Challenge
The current fixed income landscape presents a dilemma for investment managers. Downside risks are much greater than opportunities for gains. This asymmetry has to be top of mind in thinking about structuring and managing clients’ portfolios.
Bond market swings that once happened rarely now occur frequently, making old risk measures unreliable. The MOVE index, which measures bond market volatility, has experienced multiple regime shifts that create non-linear risks poorly captured by conventional metrics. In 2024 alone, we observed eight days with price moves exceeding one point in the 10-year Treasury note, a frequency matched only during the global financial crisis. This compares to historical norms where such dramatic single-day moves might occur once or twice annually, if at all. The clustering of these volatile episodes creates path-dependent risks that fundamentally alter the risk-return profile of fixed income portfolios.
Furthermore, the term structure of interest rates has exhibited unprecedented instability. The yield curve experienced nine directional reversals in recent months, each creating winners and losers based on positioning rather than fundamental analysis. This instability stems from the market’s struggle to price multiple competing narratives simultaneously: fiscal expansion versus potential recession, persistent inflation versus Fed credibility, and domestic growth versus global weakness. Traditional duration measures assume relatively stable term structures and don’t fully reflect today’s risks.
Finally, the behavior of credit spreads adds another layer of complexity. Corporate credit spreads, both investment grade and high-yield, remain historically tight despite mounting fiscal concerns and rising recession risks. This creates an asymmetric risk profile where spreads have limited room to tighten further but substantial room to widen. The compression of credit spreads reflects a search for yield that has pushed investors further out the risk spectrum, potentially creating systemic vulnerabilities when risk appetite eventually reverses.
Quantitative Framework for Risk Assessment
Some advisors have taken the view that this will all blow over and that markets will soon return to “normal.” We believe that is wishful thinking. The recent bout of high inflation and the lack of fiscal discipline exhibited by both political parties makes that highly unlikely. Hoping for the best is fine, but as financial advisors you owe it to your investors to prepare for the worst.
At FolioBeyond we have developed an analytical approach that employs a multi-factor model that goes beyond simple duration and credit metrics to incorporate the full spectrum of risks facing fixed income portfolios. We consider both short-term and longer-term lagged factors, as well as forward-looking factors based on market observables.
For example, inflation expectations based on market-based measures derived from TIPS spreads often diverge significantly from survey-based measures, or “expert” predictions. Volatility is also assessed based on backward looking measures of observed price changes as well as forward looking values derived from embedded option values. We explicitly consider default costs as a way to deflate nominal credit spreads, to get to a true risk-adjusted return for all sectors of the fixed income universe. Mortgage prepayment and corporate call risks are measured carefully and incorporated into fully-adjusted expected return forecasts. In this way we have a robust way to measure relative value across sectors and individual securities.
Strategic Implementation Framework
Dynamic Risk Budgeting
The inadequacy of static allocations and mechanical rebalancing strategies in the current environment demands a more sophisticated approach to portfolio construction. Dynamic risk budgeting represents a paradigm shift from traditional strategic asset allocation, requiring continuous assessment and adjustment based on evolving market conditions.
The foundation of this approach rests on a careful assessment of an investor’s risk capacity. Each investor is different, and the same attention to risk needs to be paid to fixed income as advisors commonly give to equities. The notion of carefully assessing equity risk, and then casually adding a static or plain-vanilla fixed income sleeve no longer works. For example, maturity ladders are seen by some advisors as a way to incorporate fixed income into the overall portfolio. But the “fund it and forget it” approach behind that strategy has produced large losses, regardless of the maturity bucketing.
There are two parts to this exercise: 1) assessing your investors’ risk appetites; and 2) devising strategies that are consistent with those assessments. In the new fixed income environment, advisors owe it to their investors to put the same effort into the fixed income allocation they have always done for equities.
Additionally, markets oscillate between risk-on and risk-off states, each demanding different portfolio positioning. During risk-on periods, credit spreads compress, yield curves steepen, and correlation between risk assets increases. These environments favor credit risk over duration risk, sector rotation over static positioning, and tactical opportunities over strategic allocations. Conversely, risk-off periods see flight-to-quality flows that temporarily benefit Treasuries despite fiscal concerns. However, these rallies have become increasingly short-lived and shallow, reflecting the structural headwinds facing government bonds.
It isn’t necessary to develop a precise prediction for each point on the yield curve, or for each market subsector. But it is essential to have a realistic, market-based view about where we are in the cycle. Advisors also should carefully and regularly measure the duration and credit risk of each investor’s portfolio, to see where that stands in relation to the investor’s target.
Expanding the Opportunity Set
The traditional fixed income universe of Treasuries and investment-grade corporates no longer provides sufficient opportunities to meet investor objectives. Expanding into alternative sectors requires understanding not just their risk-return profiles but also their behavior under different market regimes and their role within broader portfolios.
Floating rate securities can play an important role for investors concerned the impact of rising rates on their fixed-rate bond holdings. Bank loans and collateralized loan obligations reset periodically based on short-term rates, providing natural hedging against rate increases. However, these instruments carry credit risk that must be carefully evaluated. The leveraged loan market has expanded dramatically, but lending standards and covenants have weakened. Selective exposure focusing on higher-quality issuers and senior positions in the capital structure can provide attractive risk-adjusted returns while maintaining interest rate protection.
Asset-backed securities offer another avenue for diversification. Consumer ABS backed by auto loans, credit cards, and personal loans provide exposure to consumer credit with shorter durations than corporate bonds. Commercial ABS, including equipment leases and franchise loans, offer differentiated risk exposures. The key advantage of ABS lies in their structural features, including credit enhancement and cash flow prioritization, which can provide better downside protection than unsecured corporate debt.
Municipal bonds deserve renewed attention, particularly for high-net-worth clients in high-tax jurisdictions. The tax-equivalent yields on quality municipals often exceed those of comparable Treasuries, while credit risk remains manageable for most state and local issuers. State and local governments generally have more limitations on their ability to issue debt, and so municipal credit does not have the same excess issuance concerns as those we see for federal debt. Furthermore, the infrastructure spending authorized by recent federal legislation provides fundamental support for many issuers.
High yield bonds require careful consideration in the current environment. While spreads have compressed from their widest levels, it may be possible to include high yield even in a relatively low risk portfolio, when the risk-reward profile justifies it. It is important to monitor the sector to be prepared to allocate to add diversification and income opportunity.
Real estate debt, accessed through both commercial and residential mortgage REITs, plus mortgage-backed securities (MBS) provides another differentiated source of returns. These instruments offer higher yields than traditional bonds while providing some inflation protection through their connection to real assets. However, they also carry leverage and liquidity risks that must be carefully managed. The commercial real estate sector faces particular challenges from changing work patterns and retail dynamics, requiring particular attention to the strategy of any fund product focusing on this sector. All other considerations aside, we suggest most advisors avoid the commercial single-asset, single borrower sector entirely at this time.
Active Management Strategies
The new environment strongly favors active over passive management in fixed income. Passive strategies worked well during the 40-year secular bull market in bonds that ended in 202. But going forward, advisors willing to engage in more active strategies will attract and retain assets.
The single biggest decision is over how much interest rate risk in the form of duration to take. Secondarily, yield curve positioning can be useful, but unless an advisor has specific expertise and access to specialized analytics, this managing this can be challenging. As a first order approximation, simply thinking about exposure to a steeper or flatter yield curve can be enough.
Sector rotation has become increasingly important as correlations between fixed income sectors have declined. The relative value between Treasuries, corporates, mortgages, and alternative sectors shifts based on factors including supply dynamics, Fed policy, and risk appetite. Active managers who can identify these shifts early and position accordingly can generate significant alpha. This requires not just analytical capability but also the operational flexibility to move quickly when called for.
Credit selection at the security level can be a source of potential alpha, particularly in inefficient market segments. But unless an advisor has the expertise and access to granular data, we recommend that sector views be expressed via ETFs.
Case Studies: Innovative ETF Solutions
RISR: Alternative Income and Interest Rate Hedge ETF
The FolioBeyond Alternative Income and Interest Rate Hedge ETF exemplifies how innovative approaches can address the challenges facing traditional fixed income. This fund, which has earned a 5-star Morningstar rating and ranks second among 253 alternative fixed income ETFs, employs a strategy that fundamentally reimagines management of interest rate risk for retail and high-net worth investors.
RISR brings an institutional, hedge fund-style strategy to the advisor market. RISR invests in a specific type of agency-backed MBS known as “interest-only securities” or IOs. MBS IOs receive only the interest portion of thousands of underlying mortgage payments, creating a unique risk-return profile. When market interest rates increase, mortgage prepayment speeds typically decline as homeowners become less likely to refinance. This extends the life of the interest cash flows, causing their values to appreciate—exactly opposite to the behavior of traditional bonds. This so-called negative duration characteristic provides natural hedging against rising rates while the underlying mortgage payments generate current income.
The elegance of this approach lies in its ability to profit from the very forces that damage traditional bond portfolios. Since inception in October 2021, during one of the most challenging periods for fixed income in decades, RISR has delivered a cumulative return exceeding 82%, with three-year annualized returns of 13.65%. This performance came during a period when long-duration Treasuries lost nearly half their value, demonstrating the power of alternative approaches in challenging environments.
The risk management characteristics of RISR deserve particular attention. The fund has historically exhibited positive convexity, meaning it tends to appreciate more when rates rise than it declines when rates fall. This asymmetric return profile reflects the interaction between prepayment speeds, discount rates, and the structural features of IO securities. Additionally, because the underlying mortgages carry agency guarantees from Fannie Mae, Freddie Mac or Ginnie Mae, credit risk is minimal, allowing investors to focus on the interest rate dynamics.
RISR also adds tremendous diversification to the rest of an investor’s portfolio. Besides negative correlation to Treasury, municipal and corporate bonds, it has very low correlation to stocks, including the tech sector to which many investors are already heavily exposed.
Finally, it achieves this while also delivering very attractive current income from dividends. The interest cash flows from the underlying mortgages are passed through to investors, RISR currently yields 5.39%, and offers a stabilized dividend rate.
We believe RISR deserves consideration as core holding for a broad range of fixed income or balanced portfolio investors.
FIXP: Enhanced Fixed Income Premium ETF
The FolioBeyond Enhanced Fixed Income Premium ETF represents a different but complementary approach to the fixed income challenge. Rather than focusing on a single strategy, FIXP employs sophisticated quantitative techniques to dynamically allocate across the entire fixed income universe.
FIXP dynamically evaluates twenty-four different fixed income sectors across multiple dimensions. Risk-adjusted yield analysis goes beyond simple yield comparisons to incorporate default probabilities, duration risk, volatility and liquidity considerations. Momentum indicators identify sectors experiencing favorable technical trends, while correlation analysis ensures true diversification benefits. Liquidity metrics prevent excessive allocation to sectors that might be difficult to exit during stressed conditions, and volatility regime indicators adjust positioning based on market conditions.
This multi-dimensional approach allows FIXP to adapt to changing market conditions in ways that static strategies cannot. When credit spreads are tight and offer inadequate compensation for risk, the model can shift toward government securities or structured products. When technical factors favor certain sectors, the model can increase exposure while maintaining risk controls. This dynamic allocation has allowed the fund to navigate the challenging environment since its January 2025 launch while maintaining positive returns.
The option overlay strategy employed by FIXP adds another dimension to returns. By systematically writing options against portfolio holdings, the fund captures premium income that enhances yield. The incremental return contributed from the option overlay will vary over time based on market volatilities, but the option strategy is carefully calibrated to balance income generation with upside participation, avoiding the trap of capping returns too severely in exchange for current income.
Implementation Considerations for RIAs
Client Communication Framework
The transformation of fixed income markets requires RIAs to fundamentally rethink how they discuss bonds with clients. The traditional perspective of bonds as the "safe" portion of portfolios no longer matches reality. Instead, advisors must articulate a more nuanced view that acknowledges both the risks and opportunities in fixed income.
This reframing begins with education about the structural changes in markets. Clients need to understand that the four-decade bull market in bonds was an historical anomaly, not a normal state of affairs. Indeed, by historical standards, current bond yields are pretty typical. A conversation about inflation risks, and likely effects of massive government spending can help clients understand the role of fixed income in their overall portfolio. The “income” element of fixed income is still a very important part of most investors’ long-term returns.
The conversation must then shift from safety to strategy. Bonds still play important roles in portfolios, but these roles have evolved. Instead of relying on bonds for capital appreciation and crash protection, investors should focus on their ability to generate income, provide liquidity, and offer diversification across different economic scenarios. This strategic positioning recognizes that while bonds may not be "safe" in the traditional sense, they remain essential portfolio components when properly utilized.
The message for advisors and investors is clear: the old playbook no longer applies, but a new one is being written. Those who can adapt and learn will find that fixed income can still play a valuable role in portfolios, albeit a very different one than in decades past. The transformation is challenging but navigable for those willing to adapt their approach to match the new reality.
About FolioBeyond
FolioBeyond is an innovative investment management firm specializing in fixed income solutions for the modern market environment. Our quantitative approach combines decades of market experience with cutting-edge analytical techniques to deliver strategies that address the challenges facing today’s investors.