Stu Morrow, CFA | Mawer Investment Counsellor 

For decades, the investment world operated on a fundamental assumption: when equities falter, bonds provide stability. This relationship formed the bedrock of portfolio construction, with fixed income serving as the dependable counterweight to stock market volatility. Then came 2022—a year that upended conventional wisdom as both bonds and equities declined in tandem, leaving many investors questioning long-held beliefs about asset allocation. 

This market behaviour serves as a powerful reminder that fixed income operates in cycles, with today's environment requiring different approaches than those that were successful in recent decades. The good news? With challenge comes opportunity—for those prepared to adapt. 

This article, the second in our two-part series on fixed income investing, builds upon the fundamentals covered in Understanding Bond Investing: A Foundation for Investors to explore: 

• The evolving fixed income landscape
• Implications from recent market developments, and 
• Methods for investors seeking to adapt their strategies

The Basics: Why Fixed Income Still Matters 

Fixed income investments, also known as bonds, such as government and corporate bonds, are fundamentally different from equities. While stocks represent ownership in a company and offer potentially unlimited upside (and downside), bonds are a form of lending: you give your money to an issuer in exchange for regular interest payments and the promise of your principal back at maturity.  

The primary roles of Fixed Income in a portfolio include: 

• Predictable Income: Bonds offer regular, predetermined coupon payments, which are especially valuable for retirees or anyone seeking steady cash flow.
• Capital Preservation: High-quality bonds, particularly those issued by stable governments, offer a high degree of safety if held to maturity, since these entities are unlikely to default on their debt payments.
• Diversification: Traditionally, bonds have behaved differently from equities, often rising in value during periods of stock market stress, thereby reducing overall portfolio volatility.
• Liquidity: Many fixed income securities are highly liquid, allowing investors to buy and sell them with relative ease.
• Variety: Investors can tailor risk and return by choosing among different types, such as GICs (Guaranteed Investment Certificates), government bonds, corporate bonds, and various global strategies. 

(For a detailed exploration of bond fundamentals, including how pricing works and key concepts like duration, see our companion article Understanding Bond Investing: A Foundation for Investors.) 

Bonds vs. Stocks: A Fundamental Difference 

Though grouped together as "investments," stocks and bonds play dramatically different roles in your portfolio. In a company’s capital structure, bondholders stand as creditors with legal claims to interest payments and principal, while stockholders are last in line for company profits. This distinction often proves valuable during market downturns or periods of economic uncertainty, as bonds typically offer stability when equities falter. 

The Changing Landscape: Fixed Income in a New Era 

The End of the Low-Rate Regime 

As shown in Chart 1, for over two decades, investors navigated historically low (and sometimes negative) interest rates, which suppressed bond yields and complicated income generation. This era ended abruptly in 2021–2022, as central banks aggressively hiked interest rates to combat inflation. Bond yields surged to decade highs, and existing bonds plummeted in value, causing significant losses for traditional portfolios. 

Source and Notes: Federal Reserve Economic Data, Federal Reserve Bank of St. Louis. The Federal Reserve Bank of Cleveland estimates the expected rate of inflation over the next 30 years, along with the inflation risk premium, the real risk premium, and the real interest rate. Their estimates are calculated with a model that uses Treasury yields, inflation data, inflation swaps, and survey-based measures of inflation expectations. 

Bonds and Stocks in 2022: A Break from Tradition 

Historically, bonds hedged against equity downturns, often rising in value during stock selloffs. However, 2022 marked a stark exception: both asset classes posted negative returns as inflation soared and central banks tightened monetary policy by increasing interest rates. The traditional negative correlation between stocks and bonds dissolved, undermining diversification benefits. 

Between 1973 and 2021, bonds outperformed stocks in 13 of 14 major U.S. equity selloffs. In 2022, however, U.S. bonds suffered nearly four times the losses of stocks, highlighting the unique challenges of high inflation and synchronized rate hikes. 

Understanding Modern Bond Market Risks 

Why Did Bonds Seem to Struggle in 2022? 

• Inflation Risk: Rising inflation post-COVID eroded the purchasing power of fixed interest payments, making bonds less attractive and driving bond prices lower.
• Interest Rate Risk: When interest rates rose, existing bonds with lower coupons (interest payments) became less valuable, leading to capital losses for investors who needed to sell before maturity.
• Correlation Shift: In high inflation environments such as the post-COVID period, the historical negative correlation between stocks and bonds broke down, as both asset classes responded negatively to tightening monetary policy. 

Enduring Fixed Income Risks 

Beyond 2022’s anomalies, fixed income investors face several ongoing risks: 

• Reinvestment Risk: As you receive interest payments or if your bond is paid off early, you may have to reinvest at lower rates, potentially reducing your overall returns. 
• Liquidity Risk: Some bonds, especially in the private debt market, can be difficult to sell quickly at a fair price, which could force you to accept a loss if you need to access your funds. 
• Call Risk: Certain bonds can be redeemed early by the issuer, particularly when rates fall, leaving you to reinvest at lower yields. 
• Credit Risk: There is always the possibility that an issuer—whether a corporation or government—could face financial difficulties and fail to make interest payments or repay principal. 

Today’s Fixed Income Markets: Navigating New Challenges 

The current fixed income market landscape has become increasingly complex. Credit spreads—the extra yield for taking on lower-quality debt—have narrowed significantly. This means investors are being compensated less for assuming additional risk, even as global debt levels continue to rise and underwriting standards, especially in private credit (bonds or loans not trading in the open market), show signs of weakening. The result is a market where the balance between risk and reward is more precarious than ever.

Compounding these challenges are shifting political and economic dynamics, which introduce further uncertainty. The potential for inflation to re-emerge remains a concern, threatening to erode the real value of fixed income returns. Meanwhile, the surge in private credit has attracted many investors with the promise of higher yields, but often at the cost of reduced liquidity, less transparency, and greater vulnerability during economic downturns. In this environment, it is crucial to carefully evaluate whether the risks being taken are justified by the potential returns. 

Preparing, Not Predicting: A Dynamic Approach 

The most resilient approach for investors is not to try to predict the next move in interest rates or credit cycles, but to focus on preparation. Building flexibility into fixed income portfolios is key to adapting to a wide range of possible outcomes. 

One effective approach is incorporating unconstrained global credit strategies, which are designed to be dynamic and responsive to changing market conditions. 

These strategies can: 

• Shift towards higher-quality, shorter-duration securities when markets appear overvalued (more risky)
• Move into lower-quality, higher-yielding assets when opportunities arise
• Preserve capital during periods of market exuberance and deploy it when prices become attractive, avoiding the pitfalls of market timing and emotional decision-making. 

The Future of Fixed Income: Embracing Adaptation 

At Mawer, we believe that fixed income investing remains essential for many investors, offering income, stability, and diversification. While recent years have exposed some vulnerabilities—particularly to rising rates—innovative strategies like unconstrained global credit can help restore and even enhance the asset class’s value in a total portfolio.  

Success in fixed income today requires flexibility, global perspective, and a willingness to embrace new approaches while retaining the core benefits that have long made bonds a bedrock strategy of prudent investing.