After an extended period of low interest rates, fixed-income yields remain historically attractive and offer investors an opportunity to reassess their portfolio allocations. We believe the opportunity for the asset class, as a significant part of long-term asset allocations, is compelling. What might be the best way to balance those fixed-income allocations in today’s volatile and uncertain rate environment? Here, we will focus on a particularly attractive opportunity in investment-grade, floating-rate strategies.

The Rate Environment Has Changed

There was a tactical rush to bonds in late 2023, as markets responded to falling inflation readings and dovish commentary from U.S. Federal Reserve (Fed) officials by quickly pricing in over six 25-basis-point rate cuts before the end of 2024.

As 2025 progresses, inflation has continued to moderate and economic data has remained resilient. Signs of softening employment figures have prompted the Fed to begin easing, with market expectations for two more 25-basis-point rate cuts by year-end, reflecting investors’ reassessment of the Fed’s balancing act between supporting the labor market and managing inflationary pressures.

While uncertainty persists, the current environment of elevated yields remains supportive of higher bond allocations. Take a look at Figure 1, based on data from institutional consultant Callan. Investors with fixed return targets were forced out of low-yielding fixed income over the last 15 years, opting instead for higher-risk options in public and private equity and real estate. With today’s attractive yields, investors can potentially hit return targets with much less volatility by incorporating a higher proportion of fixed income.

Where those fixed-income allocations belong should be a primary consideration.  Traditionally, investors have opted for the relative safety of high-quality investments for fixed-income allocations, choosing something similar to the Bloomberg US Aggregate Bond Index, popularly known as the “Agg.” The Agg is comprised of nearly all fixed-rate instruments, largely U.S. Treasuries and agency mortgages, maturing over a range of dates but with average lives around five-to-seven years. 

What this means is that most of the risk in traditional fixed-income portfolios is interest-rate risk. A standard risk model shown in Figure 2 highlights that movements in the yield curve contribute nearly all the volatility to the Agg.

Why does that matter? Over the last 40 years, having nearly all your fixed-income risk coming from interest-rate risk has been a positive. Rates have been in secular decline, providing a tailwind to returns, and rates-based fixed income has moved in the opposite direction of equities, providing valuable portfolio diversification. In an uncertain environment, however, those tailwinds are not likely to continue. 

Investment Grade Floating Rate as a Complement to Agg Exposure

We strongly advocate for diversifying fixed-income exposure to balance risk and earn the higher yields available in corporate bonds and securitized products. Floating-rate exposures are a particularly effective way to bring balance to a portfolio that relies too much on rates. These instruments limit interest-rate risk by adjusting coupons to the prevailing rate environment. The result of this, from a risk allocation perspective, is dramatic. In Figure 3, we see that a floating-rate note index has completely different drivers of volatility than the Agg.

Probably more interesting is the result on returns and experienced volatility. Figure 4 shows that during a period of significant interest-rate volatility, returns on the Agg predictably suffered—notably at the same time equities were doing poorly as pricing adjusted to the new rate environment—while the floating-rate index performed extremely well with limited volatility.

Conclusion

The last few years have seen the creation of several investment products focused on investment-grade, floating-rate assets. We favor an active, flexible approach to the space that can adjust to various market environments by rotating among corporate bonds and securitized sectors, as well as adjusting industry and quality exposures. At Lord Abbett, we have a deep and experienced team of investment professionals who have been investing in floating-rate corporates, collateralized loan obligations, asset-backed securities, commercial mortgage-backed securities, and other floating-rate asset classes for decades.

The case for fixed income as a core component of long-term asset allocation remains strong. Attractive yields offer an opportunity to potentially achieve return targets with less volatility. Yet, how those allocations are constructed matters. In today’s volatile and uncertain rate environment, investment-grade, floating-rate strategies may offer an opportunity to complement Agg exposure through lower interest-rate risk, while also tapping into the attractive yields and differentiated risk drivers of corporate and securitized credit.