Despite bond market volatility in the 2nd quarter, the Fidelity Fixed Income team remained patient for investment opportunities and used securitized funds to enhance diversification. Looking ahead, high yields and potential U.S. Federal Reserve (Fed) interest rate cuts may create attractive bond investment opportunities.
What did Q2 mean for bonds
Markets reacted sharply to tariff announcements in early April. Stock markets fell dramatically and a few days later, U.S. bond markets sold-off, as prices fell and yields rose. However, the market stabilized shortly after the administration announced a 90-day pause for many of the impacted countries on April 9th. Notably, the yield on the 10-year Treasury closed the month exactly where it began, at 4.17%.
During the month of May, investors became worried about the nation’s economic trajectory as the latest tax bill made its way through Congress. By late May, long-term (30-year) Treasury yields had risen above 5%, reflecting concerns about debt sustainability. On May 16, Moody's became the last of the three large U.S. credit-rating agencies to downgrade U.S. Treasury debt. All three now give U.S. debt their second-highest rating.
The bond market, however, rallied in June, helped by stable monthly inflation metrics and expectations around the Fed’s cutting cycle. Treasury yields declined across most of the curve during the month, with intermediate segments seeing the largest moves. For the full quarter, the yield curve steepened, as shorter rates fell slightly, the 10-Year Treasury was flat, and longer rates edged up.
How we positioned our client’s accounts
In response to increased uncertainty following April tariff announcements, we slightly increased our exposure to cash. Holding U.S. Treasuries and cash in the strategy allows us flexibility to add to other sectors when attractive opportunities arise.
During the April volatility, investment grade (IG) corporate spreads initially widened, but quickly reversed course.1 Their quick recovery surprised investors, given the extent of the stock market sell-off. As a result, we did not see this as a big opportunity to add risk to client portfolios. For now, we remain patient and are positioned to be able to take advantage of more attractive opportunities in the future.
We believe that market volatility can often create opportunities, especially if you can take a long-term approach. Volatility may create dispersion in bond prices and as professional investors with a well-resourced investment team, we think that we can take advantage of this by being prepared to react. We also think it is important during periods like April to evaluate how sizeable the opportunity may or may not be, and to remain disciplined if we do not see compelling valuations.
While we do consider potential market events, we are long-term investors that have navigated various regime changes over time. In some ways, this is what clients are paying us to do, to be a steady hand on the portfolio. Sometimes, the hardest decision is opting to be patient. Of course, we have the resources to dig deep and evaluate if there are opportunities to add risk when we see volatility in the market.
Enhancing SMA strategies with securitized funds
We use a dedicated mutual fund in our Limited Duration strategy for securitized exposure, whereas our Core Bond strategy uses a publicly traded ETF.2 The use of funds within SMAs is a common approach across the industry, particularly in fixed income and international equity strategies. These funds, often referred to as completion vehicles, are designed to complement direct holdings by providing access to segments of the market that may be difficult to reach through individual securities alone.
Using securitized completion funds may offer several benefits including:
- Greater diversification: These funds provide access to a wider range of bonds, potentially helping to reduce portfolio risk and/or take advantage of a broader opportunity set.
- Increased accessibility: Securitized bonds often come with minimum denomination requirements, which can limit access for smaller individual accounts. Additionally, many securities in this sector are typically only available to qualified institutional buyers. By using securitized completion funds within an SMA, individual investors can gain exposure to these types of bonds—many of which can offer higher yields than government bonds—without facing the usual barriers to entry.
- No additional costs: There are zero additional fees for SMA investors, since completion funds are specifically designed to be used exclusively within SMA strategies.
Types of bonds held in your securitized fund
Fidelity’s securitized funds offer SMA clients diversified exposure to a broad set of investment-grade securitized bonds, including mortgage-backed securities (MBS), commercial mortgage-backed securities (CMBS), collateralized mortgage obligations (CMOs), and other asset-backed securities (ABS). These holdings include both government-issued and non-government securities.
Securitized funds help deliver targeted exposure to securitized bonds while preserving many of the benefits of directly owning individual securities. They also support more efficient risk management, yield enhancement, and trading execution within professionally managed accounts.
Specialized expertise in securitized bonds
The securitized market is highly diverse, with unpredictable prepayment behaviors, and a structure that is largely traded over the counter.3 This means that prices aren’t always transparent and can shift quickly. Additionally, there are frequent pricing inefficiencies which creates investment opportunities.
Given this backdrop, we believe there is great potential for active management to add value in the securitized market. We work closely with the Fidelity Securitized Team which is dedicated to managing our securitized products. This well-resourced team consists of analysts, traders, and portfolio managers who work in tandem to help create portfolios designed to meet the strategy objectives.
What’s next for bonds
As we enter the second half of 2025, we expect to see more tariff policy developments, which may drive volatility. If the economy shows signs of weakness, we expect the Fed may resume rate cuts.
The combination of relatively high current yields and the likelihood of lower interest rates ahead may deliver attractive total returns (a combination of income and price appreciation) for bonds. As a reminder, bond prices have an inverse relationship to interest rates. When interest rates fall, bond prices usually rise, and vice versa.
In this dynamic market environment, we continue to find pockets of value, based on our view of pricing and fundamentals. Our goal remains to achieve our investment objectives by working with our experienced investment teams to try to find attractively priced bonds for the portfolio while maintaining a disciplined approach to risk management. We remain focused on the long term and follow a process that is analytical, logical and grounded in empirical data.
It is important to reiterate that these actively managed portfolios are constructed with a careful and intentional emphasis on diversified security selection, especially with consideration to liquidity and financial resiliency. Investing is a long-term endeavor, and we’re focused on generating strong risk-adjusted performance over a full market cycle through our disciplined, risk-aware approach.