The post-GFC period was an unusually favorable environment for owning systematic fixed income risk, i.e., interest rates and credit. The emerging regime appears materially different. We believe this regime may favor a more selective approach to active management.

The yield curve is flatter than it was for most of the post-GFC period, so the carry embedded in duration positioning is less. Meanwhile, rate volatility has become more persistent and two-sided, widening the distribution of outcomes around any directional rate view. On the credit side, spreads have remained stubbornly narrow in the current regime, leaving less room for further compression and creating the potential for more asymmetric outcomes. Further, spread curves have trended flatter, offering less compensation for longer spread risk and less opportunity for carry and roll strategies.

PGIM’s Core Plus Strategy limited its systematic risk in the new market regime

Evolution of risk over time in historical representative portfolio (spread, duration, and yield curve)

Portfolio Implications

An overweight to rates and credit beta was justified in the post-GFC environment and may someday be again. But today, that environment has changed, and the balance of active risk should change with it. We believe this market regime is one where systematic risk should be employed selectively and tactically, with the bulk of excess return sourced from sector rotation and idiosyncratic security selection. In practice, we believe this argues for:

• Selective systematic exposure
• Breadth over concentration
• Disciplined risk budgeting
• Beta-aware measurement

Read the full report for our analysis of how active fixed income can adapt as the credit landscape evolves.