Uncertainty and volatility have become the defining features of the global economy and financial markets. The Iran war shows few signs of abating, keeping oil prices high and threatening to tip the world into stagflation – an outcome that would be as bad for bonds as for stocks.
Making matters more complicated, central banks and governments have little room for manoeuvre. Policymakers can’t afford to focus exclusively on controlling inflation when economic growth is slowing. They will need to tread a narrow and treacherous path.
The only certainty is that markets will remain volatile. Investor sentiment will continue to shift rapidly between caution and optimism in reaction to each political statement or military move from the Trump administration.
The spike in the ICE BofA ML Move Index following the start of the war – a gauge that tracks the implied volatility of US Treasuries – was one of the swiftest and sharpest since the global financial crisis of 2008.
And the war is only one part of a much broader, unsettled picture, with political and geopolitical risks escalating across the globe. In markets, too, there were already waves of uncertainty, including concerns over the extent and rapidity of the AI-led rally in tech-related assets, and worries over the health of the private debt market.
In a turbulent environment that is characterised by an unusually high dispersion of returns across different bond markets, fixed income portfolios that are referenced to global benchmarks struggle to provide the stability and income that investors demand of them.
This is where an unconstrained fixed income strategy could help – one that can proactively take a wide range of positions across the global bond markets, without being constrained by a reference index.
ICE BofA ML Move Index
Source: Bloomberg, Pictet Asset Management. Data covering period 01.01.2000-31.03.2026.
Understanding today's market drivers
It is 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 a start, the world is once again experiencing a commodity-driven supply-side shock. But while the market reaction has so far been reminiscent of the last such episode – when Russia invaded Ukraine in 2022 – the economic conditions are very different this time around.
Back then, nominal GDP growth was healthy, and real interest rates were negative. Central banks could therefore afford to focus exclusively on curbing inflation, which they did by hiking rates aggressively.
This latest shock has arisen in a very different economic landscape.
Most major economies are growing at around their long-term trend levels but are at risk of slowing further due to weakening labour markets (especially in the UK and the US) and depleting consumer savings.
So far, markets have ignored the nuances of the current situation, appearing to focus mostly on the inflation threat. They have been quick to flip from expecting further interest rate cuts to pricing in the possibility of hikes. While we agree that the new regime for rates is “higher for longer”, we believe the weakening economic backdrop suggests markets have shifted too far when it comes to pricing in tighter monetary policy, paving the way for more volatility.
It’s also worth noting the diverging backdrop between different economies. Some – such as oil exporters – are on track to benefit from current developments. Among those that may suffer, there remain considerable divergences over how much support governments could provide to cushion the blow. In Europe, for example, Germany has more scope to administer fiscal stimulus than Italy, Spain, or the UK. In the US, the cost of the war will likely divert funds from other areas, while other countries may be prompted to increase defence spending.
In an uncertain world, such discrepancies can provide relative value investment opportunities for actively managed fixed income portfolios – opportunities that might not be available to strategies referenced to standard benchmarks.
Market pricing for interest rate cuts or hikes over the following 12 months, bps
Source: Bloomberg, Pictet Asset Management. Data as at 31.03.2026.
Active, not anchored
Unconstrained fixed income strategies such as Pictet Asset Management’s Absolute Return Fixed Income (ARFI) portfolio adopt a more dynamic approach, one which we believe is better suited to dealing with sudden shocks. This is best illustrated by the strategy’s historical return and volatility profile, which has resulted in a higher Sharpe ratio than traditional fixed income indices.
Starting from a blank slate rather than focusing on a rigid index as a reference point, our mandate has clear objectives:
- 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
- we selectively avoid bonds or sectors as market conditions evolve.
In implementing this process, we prioritise capital preservation; this is crucial for an absolute return fund.
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 disciplined risk control and the ability to secure returns from assets that are not accessible via traditional bond indices.
Annualised returns and volatility for Pictet's Absolute Return Fixed Income strategy and selected fixed income indices, %
Source: Pictet Asset Management, Bloomberg. Data shown in base currency of USD. Performance above one year is annualised. * Global Fixed Income Unconstrained Consolidated Composite; inception 30.09.2012. Data covering period 30.09.2012-28.02.2026.
Unconstrained fixed income strategies such as Pictet Asset Management’s Absolute Return Fixed Income (ARFI) portfolio adopt a more dynamic approach, one which we believe is better suited to dealing with sudden shocks.
Flexibility pays off
The recent bond sell-off 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 sharply reduce duration across our portfolio to reduce risk. Our average portfolio duration is now down to just 0.4 years, compared to around 4 years in February. This is the result of actively taking duration risk down, focusing on relative value trades and moving from outright duration to curve flattener positions in economies that we felt would be mostly affected by higher energy prices (such as UK, euro zone, US).
- In currency markets, the flexibility to calibrate US dollar positions allowed us to move to an overweight position in the dollar, capitalising on its positive correlation with energy prices and its consequent historic role as a safe haven during energy crises. This reverses our previous underweight position on the US currency, with the latest events eclipsing a mixed economic backdrop and longer-term concerns about the dollar’s global status.
- Our spread allocation (positions in corporate credit and in emerging market debt, which tend to trade at a premium to developed market government bonds) has also been very tactical. We remain invested in the front-end part of the market, where the carry cushion is attractive. But we are using credit index options – financial instruments that enable us to benefit from any significant widening in credit spreads or flattening of the credit curve, while limiting the scope for losses if the market goes the other way.
Put simply, flexibility has become not merely a tactical tool but a strategic necessity. An unconstrained investment approach cushions portfolios against volatility and diversifies risk; it also seeks to preserve capital and secure positive returns amid market upheavals such as the one currently unfolding.
Instead of trying to accurately predict what might happen to the economy or how geopolitical tensions develop, our absolute return fixed income strategy focuses on valuations and positions accordingly.
For example, we continue to see potential in Latin America thanks to its fiscal surpluses, improving growth prospects and strong commodity exports. However, we have reduced the size of our positions in the face of the current dollar rally.
We also see interesting relative value plays in some emerging market local currency bonds, favouring Hungary, for example, over Poland, but we have reduced our risk profile by lowering duration (the sensitivity to interest rate changes) from 1.10 years to 0.25 years.
In such a volatile environment, liquidity in portfolios will be crucial in the implementation of hedges as well as in capturing attractive opportunities. We therefore prefer to use options – enabling us to both position for a market rally and protect against the possibility of a fall – all while keeping cash in reserve.
As uncertainty persists, investors require strategies that are both resilient and adaptable across a range of scenarios. Unconstrained absolute return fixed income strategies stand out in these increasingly complex markets. They can serve as a buffer for – and complement to – a traditional fixed income portfolio. By embracing flexibility and a diverse global universe, investors can position themselves to weather uncertainty and capitalise on the most compelling opportunities, wherever they arise.
Absolute return fixed income at Pictet Asset Management
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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.
