For most of the past fifteen years, fixed income was a return-free risk. Yields were so compressed by central bank policy that bonds offered neither meaningful income nor meaningful protection against equity drawdowns. Investors were pushed up the risk curve whether they wanted to be or not.

That era is over. The normalization of interest rates has restored fixed income to its proper role in a portfolio — and created a genuine opportunity for investors willing to think carefully about duration, credit quality, and the shape of the yield curve.

Real Yields Are Positive Again

The most important development in fixed income over the past three years is one that gets less attention than it deserves: real yields — nominal yields adjusted for inflation — are positive across most of the Treasury curve for the first time since 2007.

This matters for two reasons.

First, it means that holding Treasuries is no longer a guaranteed loss in purchasing power terms. An investor buying a 10-year Treasury today is locking in a real return — income that exceeds inflation — for the duration of the holding period. That is a fundamentally different proposition than it was in 2021, when real yields were deeply negative and bonds were essentially a tax on capital.

Second, positive real yields restore the diversification properties of fixed income. When yields are near zero, bonds have limited ability to rally in a risk-off environment — there is simply not much room for prices to rise. With yields at current levels, Treasuries have meaningful convexity: if growth disappoints or financial conditions tighten, there is significant room for rates to fall and bond prices to appreciate, providing the portfolio cushion that fixed income is supposed to provide.

How We Think About Duration

Duration — the sensitivity of a bond's price to changes in interest rates — is the central variable in fixed income portfolio construction. Get it right and you are positioned to benefit from rate moves. Get it wrong and you are exposed to significant mark-to-market losses.

Our current view on duration is nuanced. We are not making a directional bet on rates falling sharply from here. The fiscal trajectory of the United States — persistent deficits, growing debt service costs, and a Treasury that must issue enormous volumes of new debt — creates a structural headwind for long-duration bonds. The supply of Treasuries is large and growing; the demand, while still robust, is not unlimited.

At the same time, we recognize that the economy is sensitive to the current level of rates in ways that were not true when debt levels were lower. A meaningful slowdown — which we assign a non-trivial probability — would likely bring rates down across the curve, rewarding duration exposure.

Our positioning reflects this uncertainty: we are modestly long duration relative to our benchmark, concentrated in the intermediate part of the curve (5–10 years) where we believe the risk-reward is most attractive. We are underweight the long end, where the fiscal supply risk is most acute.

Credit: Quality Over Yield Chasing

The normalization of rates has also changed the calculus in credit markets. When risk-free rates were near zero, investors had to reach far down the credit quality spectrum to generate meaningful income. That reach-for-yield dynamic compressed spreads across investment grade, high yield, and private credit to levels that did not adequately compensate for the underlying risk.

Today, with risk-free rates at current levels, investors can generate attractive income without taking on significant credit risk. The incremental spread available for moving from investment grade to high yield — roughly 250–300 basis points at current levels — does not, in our view, adequately compensate for the default risk embedded in the high yield universe, particularly given where we are in the credit cycle.

We prefer high-quality investment grade credit — financials, utilities, and select industrials — where spreads are reasonable and the underlying credit quality is strong. We are cautious on high yield and skeptical of the private credit boom, where we believe the combination of floating rates, covenant-lite structures, and elevated leverage creates risks that are not fully visible in current reported performance.

The Role of Fixed Income in the Coelho Capital Portfolio

Within our overall portfolio construction, fixed income serves three purposes:

Income generation. At current yield levels, a well-constructed fixed income portfolio can generate 4–5% annually in income, which is a meaningful contribution to total return without requiring equity-like risk.

Diversification. As noted above, the restoration of positive real yields has restored the diversification properties of Treasuries. We size our fixed income allocation with this in mind — it is not just a return source, it is a hedge against the equity risk in the rest of the portfolio.

Optionality. A portfolio with a meaningful fixed income allocation has dry powder. If equity markets sell off sharply, the fixed income component provides both a cushion and a source of capital to redeploy into equities at better prices. This optionality has real value that is not captured in simple return comparisons.

What Would Change Our View

We would become more constructive on duration — moving longer on the curve — if we saw clear evidence of a growth slowdown that was likely to prompt meaningful Fed easing. We would become more cautious on credit if spreads compressed further from current levels or if we saw deterioration in corporate earnings quality.

The scenario that concerns us most is a stagflationary one: growth slowing but inflation remaining sticky, which would put the Fed in a difficult position and potentially push yields higher even as the economy weakens. We hold some inflation protection — TIPS and commodity exposure — as a hedge against this scenario.

The Bottom Line

Fixed income is investable again. After a decade in which bonds offered neither income nor protection, the normalization of rates has restored the asset class to its proper role. We are not making a heroic call on rates falling sharply; we are simply recognizing that at current yield levels, high-quality fixed income offers a compelling combination of income, diversification, and optionality that was simply not available three years ago.

For investors who have been underweight fixed income — or who have been reaching for yield in riskier parts of the credit spectrum — the current environment warrants a reassessment.

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This commentary reflects the views of Coelho Capital Research as of the date of publication and is intended for informational purposes only. It does not constitute investment advice. Past performance is not indicative of future results.