Why short duration bonds may offer attractive opportunities in 2025

Investors have been turning more and more to short duration bonds over recent years. We believe the reasons for this are threefold:

1: Step out of cash

With central bank rates declining, the yield available on cash is also reducing. Short duration bonds, with potentially higher returns than cash, lower volatility, and a naturally liquid profile, could be an interesting option for investors.

2. Risk-adjusted returns

After the large bond sell off in 2022, many investors have been reconsidering their longer dated bond approaches. Instead, they have been looking at short duration which, given their characteristics, offer a potential haven during volatile markets. Alongside this, yield curves are relatively flat, therefore the potential risk-adjusted returns coupled with a lower risk profile make short duration bonds appealing when compared with longer dated bond options.

3. Flexibility to generate alpha

Short duration bond approaches may generate alpha thanks to the many ways they can be reflected. Whether it is sectors, geographies or asset classes, there are plenty of options available to meet investor needs.

Short duration bonds are not homogenous and can help investors with different outcomes beyond the three mentioned above. We will look in greater detail at some of these outcomes and potential approaches later on.

Why could short duration bonds be attractive for 2025?

For investors, it is a challenging backdrop largely to due to the economic policies of the Trump’s administration and concerns on the inflationary and growth impacts that the tariffs they are imposing could have. Short duration may be used as a defensive tool in the broader mix and could therefore be appropriate in the current environment.

First reason for this is that interest rates are beginning to move down as inflation moves back to central banks’ targets. However, there are differences across the board: the Federal Reserve (Fed) is on hold at the moment until there is more clarity on the impact the Trump administration’s policies have on the economy. Nevertheless, the market still expects rates to come down, and if this is the case, then we believe that could be good for short duration performance.

In Europe, the European Central Bank (ECB) has been more aggressive and now interest rates and inflation are at the same level making real rates effectively zero. In the short term, we expect the ECB to cut rates as they react to the tariffs. This could also create a positive tailwind for bonds. Likewise, in the UK, we expect to see further rate cuts that could also be positive for bonds’ total return performance.

When you look across fixed income at where opportunities may lie, one thing that is striking is that yield curves are still relatively flat. We believe this means the difference between the yield for short and long duration bonds is quite small from historical standards. The longer end of the curve is often more volatile as it is more interest rate sensitive. As the yields are like those of short duration bonds, this may make short duration bonds more attractive, in our view, as they tend to be less volatile. For investors considering options for additional yield, they may look to short duration bonds to access potentially higher yielding fixed income asset classes such as high yield and emerging market debt.

Short duration bonds also tend to reflect the interest rate policies of central banks. Central banks usually provide guidance about what their next policy moves are going to be meaning there are less shocks. This results in more stability for yields as investors have more visibility on what to expect. This is not the case for long duration bonds as there are so many more influences on the long end of the curve. What that means is more volatility in the total return performance for longer dated securities.

Therefore, assuming central banks do not produce any surprises, we expect short duration to offer attractive opportunities for investors in 2025.