Higher yields restore bonds’ role as key diversifier

Text transcript

Welcome to Advisor to Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject-matter experts themselves. 

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Leslie Alba, head of portfolio solutions, total investment solutions, CIBC Global Asset Management 

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In our CIBC Managed Solutions, government bonds are still a core diversifier. Over full economic cycles, the data does show that bonds have historically helped reduce overall portfolio volatility. But from a portfolio construction perspective, the key is really to set realistic expectations for how they behave in different environments, and also complementing them with alternatives when additional diversification can strengthen that portfolio resilience. 

There have been some periods, such as the onset of the Iran conflict in late February of this year, and the 2022 inflation spike following Covid, when bonds didn’t provide the offset that many investors expected. And that’s because inflation concerns dominated the market narrative. When inflation risk as a primary shock, yields can rise and bond prices can fall, at the same time, equities are under pressure. 

But the important thing really is that bonds diversify best in growth scares and recessions, and so are very useful over the full economic cycle. But bonds diversify less in inflation-driven sell-offs. And that’s not a failure of bonds. It’s simply how duration or bond price sensitivity responds when inflation expectations shift. Government bonds continue to act as an important ballast in our multi-asset portfolios. And broadly speaking, the setup for fixed income now is meaningfully better than it was for most of the last decade, and that’s largely because starting yields are higher. 

At the end of March 2026, Canada’s 10-year government yield was 3.47%, and the U.S. 10-year treasury yield was 4.32%. We can compare that to the 2012 to 2022 averages of about 1.7% in Canada, and 2% in the U.S. So meaningfully higher today. 

When yields were very low, bonds provided limited income and had limited ability to compound returns. Now, more of the expected return is visible upfront through coupon income, which does also help buffer portfolios in choppy markets. 

I want to mention that the bulk of our expected return for bonds over the long term does come from income, rather than large price gains. And that’s important, because with inflation still somewhat stubborn and policy rates closer to what we view as neutral, we do see less room for yields to fall compared to the last year, which does reduce the odds of large bond rallies. 

But all in all, we still view government bonds as an essential foundation, you know, an anchor for balance and liquidity. That said, we don’t rely on them as the only line of defense or diversification in our portfolios. And an important thing here is, we shouldn’t think of a diversifier as something that’s always up when equities are down. But rather, we should be thinking of diversifiers as something that improves portfolio outcomes across a range of shocks. And bonds still do that, just not perfectly in every scenario. 

In our CIBC Managed Solutions, we broaden diversification in our portfolios with alternatives that can behave differently when traditional stock/bond diversification is under pressure. And it’s really not a bonds-versus-alternatives debate. It’s really bonds plus alternatives, with an alignment to the risks we’re managing — whether it’s growth risks, inflation risks, [or] liquidity shocks, to name a few. But there are certainly other examples of risk that we look to manage over the long term.  

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Despite corporate bond spreads near historically tight levels, we remain confident with our strategic overweight to investment-grade credit in CIBC Managed Solutions. Corporate bonds offer higher yields than government bonds because investors do take on incremental default risk. But for high-quality issuers, that risk has historically been low, and investors have generally been compensated for taking that risk over the long term. 

Also, because corporate bonds tend to carry shorter maturities than most government bonds, they can also come with lower duration or interest-rate sensitivity and, therefore, lower volatility. But our conviction really is not based on the idea that spreads will tighten further. It’s based on the level of all-in yields, and the way high-quality credit tends to behave over full cycles. 

To help put things into perspective, Canadian investment-grade spreads are near the lowest level since the global financial crisis. At the end of March 2026, spreads were around the 4.3^rd percentile since the end of 2010 — so from 2010 to the end of March 2026. And U.S. investment-grade spreads were similarly tight, around the 9.8 percentile. In that context, we’re not counting on further tightening to really drive the returns in corporate bonds, but really we’re counting on the income. 

And as of mid-April, our confidence in corporate bond returns really does lie in the following: First, all-in yields remain attractive, and over longer time horizons, the data shows that bond returns are closely linked to starting yields. And so, today’s higher yield environment supports a constructive outlook, even if spreads are tight. 

Second, it helps to remember that although spread widening can be uncomfortable, it has historically been recoverable for long-term investors. And here’s a concrete example: an investor who bought Canadian corporate bonds near the tightest spreads at the beginning of 2020, still earned about 3.2% annualized through to the end of December 31, 2025, despite a temporary drawdown of roughly 12.7%. So, corporate bonds tend to recover very sharply following drawdowns. 

The third reason we maintain our confidence in corporate bond returns today is actually based on an observation on geopolitics, which is especially relevant. And it’s too simplistic to say credit spreads don’t react to geopolitical events. But the data does show that, often, spreads react less to the headlines themselves, and more to how those events transmit into growth, inflation and financial conditions. 

And CIBC Global Asset Management’s base expectation, in light of the geopolitical conflicts right now, is for near term de-escalation in the Iran conflict. In our CIBC Managed Solutions portfolios, we size credit thoughtfully, and we’re leaning into higher-quality issuers, strong diversification and liquidity, while maintaining that strategic, constructive view on corporate bonds overall. 

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We’re thoughtfully diversifying our AI exposure to capture upside, while managing volatility and valuation risk. We’re really approaching AI as a long-term theme that can have a markable impact on various asset classes. But we also have the expectation that the path itself won’t be linear, and that winners and losers won’t be evenly distributed. And we got a taste of this repricing between perceived winners and losers and volatility in the market earlier in the quarter, where U.S. software was down 24% in U.S. dollars through the first quarter, and we also saw sentiment shift very quickly in both public and private markets. 

Our CIBC Managed Solutions diversify AI exposure across two key dimensions. 

First, across asset classes. We don’t express AI only through a narrow slice of public equities. We really do think of AI as both a capex cycle, and as a productivity cycle. One leg is in the infrastructure build out, and the other is in enterprise adoption and efficiency gains overall. And those are unlikely to move in lockstep so we’re looking for exposure where AI is a revenue driver, and also where it’s a productivity catalyst, and where it’s a part of the infrastructure stack. But importantly, we sanity-check those narratives with real economic signals. 

We’re also diversifying our AI exposure across regions. We diversify geographically to reduce reliance on any single policy path, single-rate environment or single regulatory direction. The AI value chain is global, so diversification here is both risk control and opportunity capture. 

We remain constructive on the United States given structural advantages, such as innovation leadership, that’s both on the development side, but also on the adoption side. The U.S. also has very deep capital markets to continue to finance innovation, as well as strong profitability across sectors. 

But at the same time, we acknowledge China’s progress in technology and production capacity, and how that’s reshaping the competitive landscape. China has notable strength in tech clusters and tech activity centres. China also has scale manufacturing in areas like electric vehicles, and solar, and AI infrastructure. And China is increasingly competitive in AI research. 

But the risks to investing in China are also real. For example, geopolitics, state intervention and persistent valuation discounts remain, so this push-pull between [the] U.S. and China, and their potential leadership in the longer-term innovation landscape is exactly why geographic diversification matters. 

In practice, a balanced approach to portfolio construction helps us capture AI’s potential, while staying resilient through drawdowns, evaluation resets and broader macro shocks. 

Importantly, our CIBC Managed Solutions are invested in a very broad range of AI beneficiaries, and that’s across public and private markets. This strategic positioning means that even if the AI trend accelerates or negatively impacts certain segments, other parts of the portfolio should benefit and provide a natural ballast for continued resilience over the long term. 

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We’ve seen market sentiment improve from the end of the first quarter of 2026 into mid-April. Throughout 2025 and into the first quarter of 2026, in our CIBC Managed Solutions, we did lean a little bit more defensive as geopolitical risks rose. But as conditions stabilized near the end of the first quarter and into the middle of April, we did start to add risk back very gradually, and we are continuing to do so, but very much at the margins. And these are measured tilts that we’ve made and continue to make, rather than wholesale shifts. 

We are proceeding with caution because the balance of risks remain skewed to the downside. At CIBC Global Asset Management, our base case is for near term de-escalation in the Iran conflict. But the Strait of Hormuz remains a key choke point with potential spillovers to oil prices and inflation. So while markets appear rather sanguine, we’re continuing to tread pretty carefully. 

In many of our Managed Solutions, where applicable, we maintain allocations to low-volatility, high-dividend strategies, and that’s to help mitigate downside risk, while preserving our participation in equity markets. And those strategies have done very well year-to-date, having proven resilient throughout market leadership rotations at the beginning of the quarter, and the Iran war near the end of the quarter. 

Of course, we continue to monitor geopolitics, but we do focus on what matters most for markets, which is the range of outcomes for growth, inflation, financial conditions, and importantly, how those really map into earnings expectations and discount rates. 

All that to say, we continue to lean into opportunities where the risk-reward is improving, but always in a measured and very much balanced way.

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