After another year that confounded rate and recession forecasts, many advisors are rethinking what fixed income should do in client portfolios in 2026. Resilient growth, sticky inflation, and tighter credit spreads have complicated the traditional “rates fall, bonds rally” narrative, forcing a reassessment of where to take risk, how much duration to own, and how to make real income work harder without overreaching on credit or structure.
Erik Aarts, senior fixed income strategist at Touchstone Investments, shares his perspective on how advisors can position across core, credit, and real-yield opportunities in a post-pandemic economy that no longer fits the old playbook.
CM: Looking back at 2025, what surprised you most about fixed income performance, and how should that shape advisor positioning for 2026?
EA: What surprised me most in 2025 was how well fixed income markets held up despite persistent macro uncertainty—and how broad the performance was across sectors. We entered the year with concerns around inflation stickiness and delayed Fed easing, yet high-quality bonds still delivered meaningful income and acted as portfolio ballast over the course of the year. At the same time, credit-sensitive sectors also performed well as resilient growth and tightening spreads supported returns. In other words, both interest rate–sensitive and credit risk segments contributed, which is relatively rare outside of strong disinflationary environments.
For 2026, that reinforces an important message for advisors: income matters. With yields still historically attractive, bonds don’t need aggressive rate cuts to generate solid returns. Positioning portfolios to harvest income, while maintaining exposure across both high-quality core bonds and select areas of credit, should remain a priority rather than trying to precisely time the next policy shift.
In this environment, active management becomes increasingly important. As issuance patterns shift, dispersion rises, and concentration risk builds in certain sectors, active managers can selectively capture income opportunities while managing duration, credit quality, and liquidity risks in a way that index-based exposure simply cannot.
CM: How would you frame the macro backdrop—growth, inflation, and the Fed—for advisors as they make fixed income decisions today?
EA: I would describe the macro backdrop as resilient but increasingly nuanced. Growth has moderated yet remains constructive—and given the scale of corporate capital expenditure tied to AI infrastructure and data center buildouts, a near-term re-acceleration wouldn’t be surprising. At the same time, markets may face turbulence around the nomination and confirmation process for the next Fed Chair, which could introduce uncertainty around the Fed’s reaction function and policy path.
Inflation is moderating, but it’s unlikely to fall in a straight line. A future wave, whether driven by fiscal dynamics, supply constraints, or renewed demand, remains a risk. For advisors, that argues against extreme positioning. Fixed income portfolios should emphasize balance: maintain quality income, avoid aggressive duration bets, and stay diversified in a backdrop where both growth and inflation surprises are still possible.
CM: You’ve emphasized “resilient growth” as a key theme. What indicators give you confidence that the economy can sustain that resilience?
EA: One important factor is productivity. While it’s notoriously difficult to measure in real time, we’re seeing signs that capital investment, particularly in AI, automation, and process efficiency, is allowing companies to generate output with less incremental labor. That matters in an environment where labor supply may slow due to demographic pressures and potential net negative immigration. If productivity offsets softer labor force growth, the economy can continue expanding even with muted hiring.
We’re also watching the K-shaped consumer dynamic. Higher-income households remain financially healthy and continue to spend, even as lower-income cohorts face more pressure. That divergence may widen inequality, but it can still support aggregate consumption. Finally, corporate earnings are expected to grow in 2026, reinforcing solid balance sheets and stable credit fundamentals—another key pillar supporting economic resilience.
CM: In that context, why do you think many portfolios remain too defensive or underinvested in core fixed income?
EA: Many portfolios are still positioned for the aftermath of 2022. The sharp drawdowns in core fixed income during that period left a lasting impression, and the rapid rise in policy rates made cash and money markets unusually attractive. When investors can earn elevated yields in very short-term instruments with minimal price volatility, the incentive to extend into core bonds naturally declines. In addition, some active managers struggled during the rapid rate adjustment, which further dampened confidence in core allocations.
But the environment today is very different. Starting yields are meaningfully higher, and income once again represents the dominant driver of forward returns. Core fixed income offers the potential for competitive total returns without requiring investors to take on materially more risk. In this environment, active management becomes increasingly valuable—tactically managing rate risk and navigating sector allocations, can help advisors capture income while maintaining discipline.
CM: How should advisors think about duration right now—are we closer to a risk of rates backing up, or is there still value in extending?
EA: This is less about being broadly long or short duration and more about where to take exposure along the curve. The front end has limited price sensitivity by design, and while cash has offered attractive income in recent years, it underperformed other parts of the curve last year as intermediate maturities benefited from both income and price appreciation. At the other extreme, the long end is more exposed to shifts in term premium tied to inflation expectations and fiscal concerns. I’m not predicting a buyers’ strike or an inflation spike, but investors should ask whether they’re being adequately compensated for those lower-probability risks.
That’s why we favor the intermediate part of the curve. With a more positively sloped yield curve, the “belly” offers attractive carry—the income earned by holding the bond—and rolldown—the potential price benefit as bonds age and move down the maturity curve. It’s a balanced way to capture income while limiting exposure to policy and term premium volatility.
CM: Real yields remain meaningfully positive by historical standards. How is that changing the case for high-quality bonds in client portfolios?
EA: Positive real yields change the investment equation. While inflation remains a concern, today’s starting yields, after accounting for inflation, are attractive across many fixed income sectors, allowing investors to grow purchasing power without having to take excessive risk.
CM: Credit spreads are relatively tight by historical norms. How does that influence your stance on taking credit risk in 2026?
EA: Spreads are tight by historical standards, but that largely reflects strong corporate fundamentals, improved index quality, and robust investor demand. The high yield market today is structurally higher quality than in past cycles, with a materially larger share of BB-rated bonds and more secured issuance. At the same time, many weaker issuers have migrated to leveraged loans and private credit markets. That means headline spreads may appear compressed, but quality-adjusted compensation is more reasonable than it looks at first glance.
Timing entry points into credit is notoriously difficult, so rather than trying to tactically trade spread levels, we believe it makes sense to maintain exposure with experienced active managers. In this environment, where dispersion is rising and issuance patterns are shifting, active, multisector fixed income strategies can help manage risk, allocate opportunistically, and adjust exposure as conditions evolve.
CM: You’ve highlighted rising concentration risk in certain parts of the credit market. Where is that most evident, and why does it matter?
EA: Concentration risk is becoming more evident in investment grade credit, particularly as we anticipate significant bond issuance tied to AI infrastructure, data centers, and large-scale technology investment. The sheer size of expected issuance from a relatively small group of issuers has the potential to meaningfully alter sector weightings in passive benchmarks. When index composition shifts due to supply rather than fundamentals, investors may take on more concentrated exposure than they realize.
We’re already seeing volatility ripple through areas disrupted by AI, such as software and parts of the technology ecosystem. That reinforces the need for prudence. Active managers must carefully assess the risk-adjusted return potential of new issuance and determine whether compensation adequately reflects long-term disruption risks.
CM: If you had to leave advisors with one or two key portfolio actions for 2026, what would they be to make fixed income work harder, but smarter, in this environment?
EA: First, return to a full strategic allocation to fixed income. Many portfolios remain overweight cash and equities after the equity market’s strong run and the prior attractive yields in money markets. But cash yields may fall further if the Fed eases, and equity valuations leave less room for error. Today’s bond yields allow advisors to lock in real income and rebalance portfolios without meaningfully increasing risk. Fixed income should be fully funded—not treated as optional.
Second, be intentional about where and how you take risk. Favor the intermediate part of the curve to capture carry and roll-down and maintain credit exposure with an emphasis on quality and active flexibility. In a market shaped by shifting issuance patterns, tighter spreads, and rising concentration risk, active multisector approaches can help advisors take smarter risk— not simply more risk.
The post Making Fixed Income Work Harder in 2026 appeared first on Connect Money.
