Rethinking Bonds: Why Credit Matters More Than Duration in 2025

However, it hasn’t worked out according to plan. Yields have risen on the backs of concerns.

This has increased risk and provided less diversification from the asset class. To that end, rethinking how investors position their bond portfolios this year is paramount. According to asset manager BlackRock, the key might not be duration but credit.

Traditionally, the relationship between bond yields and interest rates is easy to understand. The relationship usually is as good as gold. When rates rise, bond prices decline. This pushes up yields as existing bonds on the market fall to match the yields on newly issued ones. The inverse is also true.

This is why investors started to add duration to their portfolios as the Fed began cutting rates.

But that relationship hasn’t held. During the last months of 2024, the Federal Reserve managed to lower benchmark rates by a full 1%. However, the yield on the 10-year has managed to rise, jumping from 3.65% in September 2024 to 4.61% at the start of 2025. Today, the 10-year still sits elevated at 4.46%. ¹

This chart from BlackRock shows this isn’t normal. Looking at the 10-year yield during the first three months after the Fed’s rate cuts, you can clearly see that 2024 is an outlier.

Source: BlackRock

The surge in rates hasn’t helped duration performance. For 2024, the Bloomberg US Aggregate Bond Index (Agg) returned 1.31%. That means that bond prices declined, and the index yield managed to produce a positive return. This is certainly not the outlook many bond investors hoped for when inflation broke and the Fed was poised to cut rates.

So, what’s going on? The answer is that different risks have entered the chat — namely, fiscal and geopolitical woes.

Thanks to tariffs, tax changes, and other Trump Administration plans, the budget deficit of the U.S. is expected to surge even further. Currently, the U.S. national debt stands at $36 trillion and represents a full 124% of GDP. This compares to the $6 trillion at the start of 2000. With various proposals, tax cuts, and other measures in planning stages, the nonpartisan Congressional Budget Office (CBO) is projecting the debt to increase over the next 10 years.

That has many bond investors spooked. Many investors are becoming cautious on U.S. debt and demanding more yield to overcome the potential risks.

The problem is, inflation hasn’t gone away and the economy isn’t exactly stagnating. This presents a new issue: the Fed not being able to cut rates further, creating an environment where bond volatility is rising and longer-duration bonds may not provide the same stability investors are used to. According to BlackRock, the diversification of core bonds just isn’t there.

But there are ways investors may be able to navigate this bond market volatility, lack of diversification, and higher risk from duration. The answer? Underweight duration and looking toward credit for returns.

Most investors have overweighed duration by adding long bond exposure when they are overweight to duration in the first place. Looking at the Agg, more than 42% of the index is allocated to bonds with 10+ years to maturity.

For investors, the answer is to shorten their duration via short-duration or limited-duration bonds. Another choice, according to BlackRock, could be to focus on credit.

Moving away from Treasuries and into investment-grade corporate bonds and high-yield sectors could do wonders for investors, and allow them to capture higher yields while still providing diversification benefits and lower durations. For example, the Markit iBoxx USD Liquid High Yield 0-5 Index — which focuses on junk bonds maturing in under five years — currently yields north of 7%. And yet, its effective duration is just over 2 years.

For investors not willing to go to junk bonds, credit can still play a part in navigating the bond market. A bond issued by Microsoft or Walmart still has investment-grade credit ratings, while providing higher yields than U.S. Treasuries.

By switching up their bond holdings, being flexible, and focusing more on credit rather than duration in order to get yield could provide serious wins for bond investors in the new year. For investors focusing on core bonds, they may find returns to be lacking, and even negative, as the year goes on.

With that in mind, it may be time to look elsewhere when building bond portfolios. The Agg may not cut it anymore, with rising risks and the continued rise in duration for the index. Shortened duration and looking at credit could be the answer. BlackRock’s research has found that multi-asset bond funds and those looking at credit versus the Agg have managed to outperform the index by a wide margin and provide less risk/drawdowns

So how to do it? Well, you could take the easy approach and buy a so-called core-plus bond fund. Here, active managers can move within the investment-grade universe at will. Many managers have shortened duration and loaded up on non-U.S. government bonds to boost yield.

Another choice would be to get short with your durations — either in U.S. Treasuries or via credit.

The best part is that all of these strategies can be had via many low-cost ETFs, both active and passive. Investors can look at their goals and timelines and plan accordingly. In the end, taking on credit risk is better than duration risk going forward.

These ETFs were selected based on their low-cost exposure to active bond management. They are sorted by their YTD total returns, which ranges from 0.08% to 3.1%. They have expenses between 0.18% and 0.71% and assets between $3B and $29B. They are currently yielding between 4% and 7.6%.

These ETFs are selected based on their ability to tap into short-term duration bonds at a low cost. They are sorted by their YTD total return, which ranges from 1% to 2%. Their expense ratio ranges from 0.03% to 0.57%, with yields between 3.4% and 7.3%. They have AUM between $849M and $58B.

All in all, long bonds aren’t the deal they were a year ago. Continued risks have driven up yields despite the Fed’s recent rate cuts. That problem is for investors who are overweighting duration and those in the broader Agg Index. The answer is to seek returns in credit rather than duration. Shortening up our portfolios can help reduce volatility as well.

Investors have added duration and long bonds as the Fed has started to cut rates, but that’s proving to be a poor trade. With risks hurting long bonds, focussing on credit might be a better alternative.

¹ BlackRock (January 2025). Navigating the Bond Market Today: What Investors Need to Know in 2025