Matthew Rees, L&G’s head of global unconstrained fixed income and manager of L&G’s Strategic Bond fund, discusses how the fund navigates volatile markets, increasing exposure to US corporate hybrids and short-dated GBP IG credit and why fixed income is currently preferable to equities.
The Monday Manager series covers fund managers that have worked on their fund for over three years, and where fund assets are over £100m.
Can you explain the fund’s approach to investment and what it is trying to achieve for investors?
L&G Strategic Bond fund is the UK flagship offering in our £5bn unconstrained bond fund range, which is managed by the Global Bond Strategies team. The fund leverages the best of L&G’s £500bn global fixed income platform to provide clients with a diversified one-stop solution to fixed income investing. The fund seeks to meet the needs of investors looking for a competitive level of return without compromising on risk.
The fund differentiates itself from several other peers by being truly global in nature and investing across multiple sectors of credit. Diversification is at the core of our philosophy, and the strategy utilises experienced L&G individual asset class expert teams to manage sub-pot exposures across the fixed income spectrum.
Unlike some strategic bond funds, we take an active and differentiated approach to duration management. We recognise that accurately forecasting macroeconomic conditions is extremely challenging. Instead of relying on broad economic predictions, we dynamically adjust duration to hedge credit exposures, responding to changing correlations between credit spreads and government bond yields.
This flexible approach aims to reduce downside risk and avoid large drawdowns, as demonstrated by the strong track record. We believe this strategy positions the fund well to navigate increasingly complex and volatile fixed income markets.
Which areas of the bond market are you most excited about right now, and which are you avoiding? Both in terms of asset class and sector
The team has been adding exposure to US corporate hybrids and short-dated GBP IG credit, while selling down EUR IG.
US corporate hybrids offer compelling risk‑adjusted returns – delivering higher spread with less duration, stronger structural protection, and more targeted exposure to AI‑related infrastructure (eg utilities) than senior hyperscaler debt. For USD IG, the team retains an underweight versus our strategic asset allocation model. Despite higher yields driving strong flows, the team is concerned by the impact of the large hyperscaler issuance, particularly at the long end of the curve.
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In addition, we have been selling down EUR IG, where spreads screen tight and do not, in our view, adequately compensate for asymmetric downside risks. With Europe more exposed to geopolitical escalation and growth shocks, and euro spreads trading unusually close to dollar spreads, the risk‑reward looks less balanced. Consistent with this, the team has moved to only a small exposure to EUR IG while reallocating towards GBP opportunities, particularly at shorter maturities where yields now trade at attractive levels.
What is the fund’s average rating and duration at the moment? Has this changed over recent months and, if so, why?
Average rating: BBB-
Duration: 4.2 years
The fund’s average credit rating has remained relatively stable over recent months.
The team takes an active approach to duration management by harnessing the expertise of dedicated rates specialist sat in the team.
The team increased duration exposure in February to 5.5 years, reflecting a view that disinflation dynamics were becoming more credible. Anchored US wage growth and improving productivity were seen as supportive of well‑contained inflation, while AI-driven equity narratives were judged more likely to be disinflationary than inflationary – particularly underappreciated in Europe. This backdrop supported the case for a more helpful negative correlation between rates and risk, and therefore a stronger role for duration as a hedge.
In early March, however, as soon as the Iran war started, the team reduced duration exposure towards three years as the underlying conditions shifted. Rising oil prices increased the likelihood of a positive correlation between spreads and yields, undermining the insurance value of duration within the portfolio. More broadly, inflationary sentiment began to pick up across markets, raising the risk that price action would be increasingly driven by inflation concerns rather than growth.
What are the biggest headwinds bond investors have to contend with at the moment? How are you mitigating these?
Correlation dynamics – a return of inflationary fears: Since the global financial crisis, duration has been seen as the primary hedging tool for credit risk and also providing support in a multi-asset portfolio. Our analysis shows between 2008 and 2020, the correlation between credit spreads and government bond yields has often been helpfully negative, for example when credit spreads widen amid a risk-off environment, this would typically be accompanied with a decline in government bond yields, thus cushioning the negative effect from the credit spread widening.
However, this correlation has fundamentally changed and became positive following the return of inflation in 2021. The changing value of duration as a hedge challenges the assumption that duration is something to ‘buy and hold’. We have found that when market inflation expectations rise above 3%, the correlation becomes increasingly unhelpful and positive.
Duration can be a powerful hedging tool in times of broader credit market distress. However, it can also be a considerable source of risk for credit portfolios and can cause issues for unconstrained bond strategies that seek to smooth out long-term investment returns. In today’s world, we believe fixed income investors need an active and dynamic approach to managing duration in portfolios.
We will make changes to our duration exposure based on changes in the correlation dynamics between government bonds and credit spreads, as well as the inflation regime and investor sentiment around recession or inflation expectations.
Hyperscaler issuance: Artificial intelligence has re‑emerged as a key driver of market narratives, following a temporary diversion caused by geopolitical risk. The defining feature of this theme is the scale of capital expenditure required by hyperscalers to build AI infrastructure, and the associated surge in investment‑grade bond issuance needed to fund it. Almost $200bn has already been issued in recent months, against market estimates of up to $1.5trn by 2030.
This volume of supply is exerting widening pressure on spreads at both individual issuer and index level, particularly within US investment‑grade credit. Markets have begun to price in ongoing issuance at higher spread levels, while concentration risk is also increasing as hyperscalers grow their share of benchmark indices. Importantly, while AI is expected to produce clear winners, there is increasing debate around long‑term returns on capital, margin sustainability and balance sheet outcomes across the sector.
The L&G Strategic Bond fund is positioned to capitalise on opportunities created by AI‑related issuance while actively managing concentration, valuation and macro risks.
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Within credit, the fund is highly selective in its exposure to hyperscalers. The scale of issuance is creating opportunities in new bonds at more attractive spreads, but participation is driven by bottom‑up fundamental analysis rather than benchmark weightings.
Concentration risk is actively managed. As hyperscalers are expected to grow from a small share of US investment grade markets towards a materially larger weighting over time, passive strategies will increasingly embed exposure to a single structural theme. The Strategic Bond fund’s unconstrained approach allows differentiation between issuers and avoids automatic exposure to AI‑related risk where fundamentals do not justify it.
Credit spreads remain near historically tight levels despite elevated and recurring geopolitical risks: Geopolitical uncertainty has increased materially in recent years, with repeated and often sharp spikes in risk stemming from conflicts and political events. While these episodes generate short‑term volatility, credit markets have, so far, remained notably resilient, driven by strong technicals as yields remain attractive: we estimate that around 70% of US investment grade investors buy according to yield, and not the level of credit spreads.
History shows that geopolitical shocks do not produce uniform market outcomes. In many episodes, traditional hedges such as CDS or duration have delivered inconsistent protection, depending on whether markets interpret events as short‑lived shocks or longer‑term macro risks. At the same time, tight starting valuations leave less margin for error, increasing the importance of downside protection, liquidity and disciplined risk management should sentiment turn.
Over the next six months, this tension between elevated geopolitical risk and tight valuations is likely to remain a central market theme. Investors face a landscape where carry remains attractive, but potential drawdowns can be sharp and sudden if risks escalate or inflation expectations re‑emerge.
Capital preservation is central to the fund’s approach in an environment where spreads offer limited compensation for rising risks. Rather than relying on a single hedge, the fund uses a broad risk‑management toolkit built around three core levers: liquidity, duration and credit default swaps (CDS).
What are the benefits of investing in fixed income at the moment as opposed to equities?
In the current environment, fixed income offers a more attractive balance of return potential and resilience than equities, driven by a strong technical demand due to elevated all‑in yields. Markets are increasingly recognising that today’s opportunity in credit is largely yield‑led rather than spread‑led, a dynamic that materially supports fixed income outcomes even in the face of macro uncertainty.
The technical backdrop for fixed income remains exceptionally supportive. Investor flows into bonds continue to be strong and broad‑based, reflecting a sustained shift by allocators towards dependable income after a prolonged period of equity‑market dominance. Global bond inflows are now well‑established, underpinned by real‑money investors such as insurers, pension funds and global wealth managers, who are structurally allocating more capital to fixed income as yields have reset higher.
Although credit spreads are tight in a historical 20-to-30 year context, yields are not and screen as relatively cheap over that long-term timeframe. This means that returns are less dependent on further spread compression and more anchored in income, improving the reliability of outcomes relative to equities, where many indices are expensive and returns remain highly sensitive to earnings expectations and sentiment.
Equity markets are increasingly exposed to concentration risk and valuation sensitivity, particularly around US technology and AI‑linked themes. Fixed income, by comparison, benefits from a more diversified return profile. Hyperscaler issuance is starting to increase concentration in credit markets, however this will not reach equity-like levels and an unconstrained approach allows us to selectively take exposure instead of discriminately soaking up supply from the large tech companies.
Private credit has been a huge topic of contention recently. How much risk does the private credit market pose to investors? Why?
We’re taking a more measured view on private credit and do not believe it poses a systemic risk to markets. Recent headlines and price moves may not be entirely justified, but they do reflect some real underlying concerns. The uncertainty around AI and software (which represents around 20% of private credit lending) is likely to create pressure over time. While the impact may unfold slowly, it still represents a risk that managers will need to navigate.
Business lending also appears to be working through a post pandemic adjustment period. We expect to see increased non-performing loans as the effects of stimulus fully wash out and where some underwriting standards were loosened in the race for asset growth. Private credit lenders do seem generally prepared, but it’s not something to dismiss. Given the environment, we lean toward the larger Business Development Companies (BDCs) with longer track records and exposure to bigger middle market companies, where underwriting standards tend to be more established.
A lot of the recent focus has been on investor withdrawals, which principally affects non-traded BDCs. Nevertheless, these BDCs represent only around 15% of the sector, which generally is funded by longer-term institutional capital that is locked in for a few more years. These BDC vehicles do have liquidity buffers and the 5% quarterly tender limit does restrict the pace of asset sales, that otherwise would have exacerbated the asset quality issues that are slowly arising. Therefore, the situation underscores the importance of liquidity management and the potential for sentiment-driven pressure.
