In recent months, moves within the bond market have left investors wondering whether they've missed an opportunity to move out of cash and lock in attractive long-term yields. The short answer is no – in reality, it's a good time to invest in bonds. We're in the midst of the Federal Reserve's first rate cut cycle in four years, and bonds typically outperform cash during periods of rate cuts. This, along with inflation cooling over the past few months to a more neutral level, means now is the time for investors to reassess their portfolios to ensure they are thoughtfully positioned for opportunities in fixed income.

In fact, a recent survey of 143 advisors conducted in September 2024 confirmed that lower interest rates are motivating the majority of advisors (71%) to consider moving from cash into bonds. This is because rates on cash and cash equivalents are less attractive than before, and investors must accept more risk for similar returns. This, in turn, requires a more thorough assessment of portfolio risk. Today's economic environment is creating diversification across bond sectors, presenting varying levels of opportunity. High yield is one corner of the bond market that will further benefit from falling interest rates.

Once the Fed began its rate-cutting cycle in September, strong yields and the potential for price appreciation made high-yield bonds attractive. Retail high yield fund flows turned positive in 2024 after three consecutive years of outflows. Year-to-date through November, the high-yield market garnered about $17.2 billion in net inflows from retail investors, with $4.3 billion of those inflows occurring in September and October alone following a 50 basis point reduction in the Funds rate. Fed in September, according to Morningstar. While it was initially thought that the rate cut cycle would continue into 2025, the recent outcome of the 2024 presidential election has shattered market expectations.

The election of Donald Trump has resulted in much higher short-term interest rates as markets begin to anticipate the prospect of US import tariffs, which some see as inflationary, and a larger fiscal deficit resulting from an unfunded extension of the The Tax Cuts and Jobs Act. . The election result, combined with slightly elevated consumer price index reports and stronger-than-expected macroeconomic data, resulted in a reset of market expectations regarding future rate cuts in 2025. Now we we believe that the pace and totality of Federal Reserve easing will increasingly depend on the state of the labor market over the coming year.

This change in market expectations is why it's important to not only evaluate whether high yield is part of your portfolio, but also how your asset manager is managing your high yield allocation in service of your investment goals. In general, high yield bonds can yield income with lower interest rate sensitivity than other fixed income assets. They also offer the potential to produce some degree of stock market upside with limited volatility. The types of high yield spreads to which any investor is exposed will depend entirely on the investment approach of that investor's asset manager.

In common parlance, investing is a trade-off between risk and return; they must be proportionate. Technically, however, investment professionals often define upside and downside risk in the same way. This is less obvious to the typical investor, who does not consider risk symmetrically. For example, if the price of a security were to fall, the riskiness is obvious (and unfortunate); however, if the price of a security were to rise, many professionals would come back to high volatility as a risk and therefore consider the security risky. In high yield, we think it's better to focus on the downside. This is where a research-based focus on quality lending comes in handy.

For example, in a high-yield ETF we launched this fall, Colombia USA High Yield ETF (NJNK)we avoid “active” interest rate risk by not overweighting or underweighting duration relative to a common benchmark index and instead focus on quality credit selection. We partner with our core research team to evaluate and incorporate BB-rated, B-rated ideas and only the best ideas within the CCC-rated bond category, eliminating exposure to the less attractive parts of the CCC market. “Not junk” – as the NJNK marker suggests. An underweight position to riskier securities in the benchmark index means less exposure to securities likely to require repeated access to capital and a continuation of a strong economy with lower funding costs . Our base case would be that in an environment where interest rates remain high and inflation re-accelerates, the fund is well positioned against the benchmark.

Fluctuations and volatility like what's currently happening in the market today is why most investors should consider a long-term high-yield allocation within their portfolio, not just a short-term position. Going forward, more and more investors are increasingly interested in the asset class – in the same survey of advisers, a majority (61%) of respondents said the top category they would expect to increase their exposure to The fixed income ETF would be the high yield ETF. Investors are turning to high-yield bonds as an important investment vehicle in the coming year and beyond, and advisors must be ready to help their clients invest thoughtfully and purposefully in the asset class.

Dan DeYoung is a Sr. Portfolio Manager. in high yield fixed income at Columbia Threadneedle Investments

Marc Zeitoun is the North American Head of Product and Business Intelligence at Columbia Threadneedle Investments