Fixed income managers outline what an attractive fixed income portfolio currently looks like
Each month at BPM, we offer a slate of articles and content pieces that go deep on a particular topic. This month, we're exploring fixed income as an asset class and the critical components that make up institutional portfolios.
Fixed income managers remain cautious heading into the next quarter of 2026. With credit spreads hovering near 20-year lows, geopolitical risk flaring, and the USMCA renegotiation looming over Canada, the question for institutional investors isn't whether to own bonds – it's how to own them without getting caught flat-footed.
Soami Kohly, investment officer and fixed income portfolio manager with MFS Investment Management, notes one of the most important ingredients in a bond fund right now is duration – the sensitivity to interest rate changes. That might seem counterintuitive when the cutting cycle appears finished and the next Bank of Canada move could be a hike. But Kohly argues the logic comes back to what a bond fund is supposed to do.
"The purpose of a bond fund is to provide income, and ideally, income higher than your dividend yield," he said. "And then, two, to reduce the volatility in case of an economic slowdown. If we run into a recession, bonds should provide some upside to offset the negatives that you're going to get on the equity side of your portfolio. And to get that second part, you need duration.”
On the income side, he favours corporate bonds for their combination of yield and duration, with provincial bonds as an attractive government-space option. Securitized products generate income but lack the duration component, while high yield and emerging markets can also play a role.
The challenge is that credit spreads remain tight by historical standards, though Kohly sees that as a reflection of a broadly positive economic outlook for Canada in 2026, supported by fiscal spending and accommodative monetary policy. The USMCA renegotiation, however, is "a very binary thing. It's either going to trigger some sort of recession or things are going to be great, frankly," he said.
Given that backdrop, he argues investors should still own corporate bonds but stay disciplined, favouring higher quality names and keeping allocations toward the lower end of their allowable range.
"If an issuer is issuing a 30-year bond and a 10-year bond, you may prefer the 10-year bond right now because it'll be less sensitive to the price movement, it'll be less sensitive if and when credit spreads do widen,” said Kohly.
Kristian Sawkins, managing director, senior portfolio manager, and co-head of the PH&N Fixed Income team at RBC Global Asset Management, agrees that economic tailwinds remain intact, noting fiscal spending in both Canada and the US, lagged effects of monetary policy easing, and AI capex but also stressed that the environment demands constant recalibration.
"I think what it really means for this year is really being nimble with positioning, understanding the relationships between duration and credit spreads and risk assets and duration. And they're not static relationships like they used to be," he said.
To that end, Sawkins’ current positioning is built for a base case of decent economic momentum, with inflation still a live risk. In that setup, his team keeps a modest overweight to investment-grade credit. The credit tilt is concentrated in higher-quality, less cyclical issuers, backed by ongoing, detailed credit work.
He also leans toward provincial and quasi-government exposure, not because spreads are cheap, but because supply discipline and the supply-demand balance can still support relative value even when overall spreads are tight.
"We still think that there is value to be had in owning the carry benefits for the most part of credit over the near term," he says, noting that overweight is tilted firmly toward quality. "We're tilting towards higher quality, less cyclical companies, higher up in the credit quality spectrum. So your single A's rather than your triple B's," he said.
To balance that credit risk, the portfolio is paired with a modest short-duration stance. In a benign outcome, growth holds up and rates drift modestly higher and he expects that combination to work because credit can keep earning carry without spreads blowing out.
But Sawkins emphasized that outcomes are wide and not “one size fits all”: if rates surge too far - whether from inflation persistence or deficit or issuance concerns - risk assets and credit could both suffer. In that scenario, the short-duration position is meant to do double duty: add alpha when the rate view is right, and act as a partial hedge if the macro regime turns against credit, explained Sawkins.
Adrienne Young, senior vice president and director of Canadian corporate credit research for Franklin Templeton Fixed Income, notes that government yield curves in Canada and the US have returned to a positive slope after the inversion of recent years.
While yields have come off their peaks as rates started to decline, they remain attractive by historical standards, she said, highlighting that the Canadian IG corporate index sits around 3.9 per cent while the US sits near 4.9 percent.
That, combined with a long list of reasons to be nervous – Iran, Russia-Ukraine, a slowing Europe and Asia, USMCA uncertainty, and the weight of Canadian household debt – has kept money flowing into fixed income, Young suggests. As a result, Canadian corporate spreads have tightened to near 20-year lows, levels not seen since before the 2007 financial crisis. Meanwhile, the Iran conflict has barely nudged them.
“What does the attractive fixed income portfolio look like? I would say it is conservative about duration. It is conservative about credit quality. It is as well diversified as humanly possible. It diversifies beyond Canada, if humanly possible. It is active where that is an option,” said Young.
Young favours tilting fixed income allocations toward corporate bonds and away from both government debt and private credit. The corporate space, she argues, offers a spread cushion that helps absorb rate volatility, particularly relevant with inflation risk lingering at the long end of the curve.
Meanwhile, government bonds lack that buffer, and private credit carries a different problem entirely.
"I would argue for less private credit because that's a Hotel California situation. You can get in, but you may not be able to get out," she said.
She argues that that fixed income should serve ultimately serve as a ballast, not a source of incremental return.
"I think investors want fixed income to allow themselves to sleep at night, not to get extra juice, not to make an extra return," she said, adding a selective approach to corporates can be far more valuable than reaching into less liquid corners of the market.
“If you're not in an active fund, you should be because your portfolio manager should be prepared to take a more cautious stance now in order to pounce when markets have these ridiculous risk-off milliseconds. And later this year, I suspect spreads will widen, and we will have more than milliseconds. You want to be able to take advantage of when those bonds go on sale,” said Young.
