Actively beating cash

Written by

Linda RaggiHead of Macro and Multi Sector Fixed Income

If there is one fundamental truth for investors to hold onto in 2025, it’s this: no one can confidently predict what will come next.

In a world where volatility is the norm and new risks emerge with every headline-grabbing announcement from President Donald Trump, it is hard not to feel that uncertainty is, ironically, the only constant we can truly rely on.

In the US, Trump’s return to the White House has triggered a dramatic escalation in trade tensions. But this development is only one part of a much broader, unsettled picture, with political and geopolitical risks escalating across the globe.

These are symptoms of a period of “tectonic change” overturning the pillars of free trade, globalisation, and stability that underpinned the post-Cold War era (as discussed in Pictet Asset Management’s Secular Outlook 2025). The world is now in the throes of a major transformation, and the eventual destination is anyone’s guess.

Fig. 1 - Volatile times

ICE BofAML Move Index

In a volatile environment in which the dispersion of returns across different bond markets is high, flexibility pays off – as illustrated by the recent performance of our Absolute Return Fixed Income (ARFI) strategy.

The ICE BofAML Move Index – which tracks the implied volatility of US Treasuries – shows that the days of low bond market volatility are firmly behind us, along with ultra-accommodative central bank policy. The volatility spike post-Liberation Day April 2025 was one of the swiftest and sharpest since global financial crisis of 2008 (see Fig. 1).

Given recent geopolitical developments and the potentially inflationary impact of higher fiscal spending, we can expect volatility to remain elevated. The economic effects of geopolitical upheaval (tariffs and wars) will take time to be fully seen in the data so the US Federal Reserve will remain cautious until it is satisfied it can achieve its dual mandate of price stability and maximum employment.

Fact finding for a world in flux

With the world in flux, it is becoming increasingly difficult to assess future trends in inflation, economic growth, and corporate earnings – let alone their impact on portfolios. Still, a few facts stand out.

For all the talk of recession earlier this year — typically defined as two consecutive quarters of negative growth — a global downturn has yet to materialise in 2025. In other words, the economy's resilience shouldn't be underestimated.

Another inescapable fact is that borrowing costs are heading lower. The European Central Bank, for example, has already cut interest rates four times in the first half of 2025, and markets expect more easing before year end. Across the Atlantic, the Fed is holding rates steady for now but signalling a bias towards cuts as policy and trade risks mount.

Fig. 2 - Returns from cash are on their way down

Overnight deposit rates for US, euro zone and Switzerland, %

As a result, cash returns are on a downward trend, eroding the relative attractiveness of the asset class (see Fig. 2). The appeal of sitting on the sidelines is therefore fading fast, prompting investors to put their money to work elsewhere. For example, as we can see in the graph, cash yields 0% in Swiss francs.

Fig. 3 - Treasuries yielding more than S&P 500

US 10-year Treasury yield versus S&P 500 dividend yield, %

All of which creates fertile ground for actively-managed fixed income portfolios. Bonds promise reliable, income-based returns with lower drawdown risk compared to equities, alongside diversification benefits as stock market volatility intensifies. Currently, 10-year government bond yields in the main western markets (including the US) are averaging over 4% — significantly higher than the S&P 500’s dividend yield of 1.3%.

But for all the opportunity, greater scrutiny is required on fundamentals (both for corporate and sovereign bonds), particularly given the uncertain impact of fiscal policies on debt profiles and debt sustainability, and the implications of central bank actions and economic policies. The greater uncertainty and thus higher volatility will translate into steeper yield curves and higher bond risk premiums as investors demand additional compensation for the potential price swings and the lower market liquidity.

In addition to the need to perform well against cash rates, recent market swings have highlighted the value of flexibility – something that benchmark-oriented bond strategies often lack.

Active, not anchored

Unconstrained fixed income strategies such as our ARFI portfolio embed a more dynamic approach, one which we believe is better suited to navigating sudden shocks. This is best illustrated by the strategy’s historical return and volatility profile, resulting in a higher Sharpe ratio than traditional fixed income indices (see Fig. 4).

Starting from a blank slate rather than focusing on a rigid index, our mandate has a clear objective: we make allocation decisions to take duration, spread and currency risk where it serves the portfolio best; we direct capital to the most attractively-valued securities; and, just as importantly, we selectively avoid bonds or sectors as market conditions evolve. The result is a portfolio designed to actively pursue the best risk-adjusted returns versus cash across the global fixed income landscape.

ARFI’s competitive returns come with much lower volatility versus other fixed-income asset classes, reflecting our disciplined risk control and attractive returns versus traditional bond indices.

Fig. 4a - Returns on track

Annualised returns for selected Bloomberg FI indices and the global fixed income absolute return consolidated composite

Fig. 4b - Low volatility

Annualised volatility for selected Bloomberg FI indices and the global fixed income absolute return consolidated composite

Flexibility pays off

April’s bond sell-off post “Liberation Day” is illustrative of the opportunities that become accessible with an unconstrained, sector-agnostic approach – opportunities that would be missed by sticking to an anchored scenario.

By being flexible, we were able to generate returns across all three of our alpha sources:

Active duration management enabled us to increase sovereign bond exposure in response to shifting interest rate expectations as central bank signals and market sentiment clouded up.
In currency markets, the flexibility to calibrate US dollar positions allowed us to move to a short position in the dollar (from an overweight one earlier in the year), and thus to capture relative value opportunities and benefit from unusual dollar depreciation in a volatile risk-off environment.
Our spread allocation was equally nimble: by using credit index options, we could efficiently manage exposures without the need to constantly transact in and out of the underlying bond market.

Put simply, flexibility has become not merely a tactical tool but a strategic necessity. An unconstrained investment approach not only cushions portfolios against volatility and diversifies risk, but also preserves capital when risk premia are scant and seizes value amid market upheavals. Crucially, ARFI’s approach to downside protection, which hinges on diversification and active tail risk management, remained a cornerstone in safeguarding investor capital during periods of peak uncertainty, such as the one we experienced in April.

Instead of relying on being able to correctly predict what happens with the economy or how geopolitical tensions develop, we focus on valuations and position accordingly. So, for example, we note that in both the US and the Europe, the government yield curves have already built substantial risk premiums in the intermediate part of the yield curves to reflect the deterioration of government finances. Therefore, we continue to favour longer duration positions in our portfolios to reflect the more volatile outlook for the world after the implementation of the tariffs and the more favourable valuations. The big difference is that the starting point in terms of debt to GDP is much more favourable in the emerging world and in Europe in aggregate versus the US. That is why we hold most of our duration in EM and Europe, having a historically low duration in the US.

As the cycle turns, yields are attractive; yet uncertainty persists. Investors, therefore, require strategies that are both resilient and adaptable across a range of scenarios. Unconstrained absolute return fixed income stands out in these increasingly complex markets. We believe now is an opportune time for investors to beat cash by looking beyond traditional constraints. By embracing flexibility and a global opportunity set, investors can position themselves to weather uncertainty and capitalise on the most compelling opportunities, wherever they may arise.

Absolute return fixed income at Pictet Asset Management

Our absolute return fixed income strategy targets 3% annual returns over cash with lower volatility than traditional benchmarks, strategically allocating capital where attractive valuations are found across global FX, credit, and rates markets.
We deliver most of the upside in bond markets with less of the downside.
Don’t like it, don’t own it: our unconstrained “blank slate” approach lets us explore opportunities to outperform cash rates in a way that benchmarked strategies cannot.
We provide bond beta exposure but with lower volatility compared to broad markets thanks to rigorous risk management.

Acknowledgement

Andres Sanchez Balcazar contributed to this article.