Why Fixed Income, Why Now: A Strategic Perspective

In today's complex financial landscape, investors face a critical juncture. With global markets experiencing significant appreciation since 2022 and potential economic headwinds on the horizon, the case for reassessing portfolio allocations—particularly towards fixed income—has become increasingly strong. This article explores the current market dynamics, potential risks, and opportunities that make fixed income an attractive consideration for investors seeking to optimize their portfolios in the current environment.

The Equity Market Landscape: Signs of Overvaluation

Historical P/E Ratios and Market Performance

The broad U.S. equity market benchmark (represented by the S&P 500), has seen its forward price-to-earnings (P/E) multiple reach close to a decade high of 21.5 at the end of November 2025 (Source: S&P Global forward P/E.)  The price to earnings multiple is a ratio of a company or index, market price divided by its earnings per share.  It is used to determine the relative value of a company’s shares or valuation of a stock market index by comparing price to earnings.

S&P 500 P/E-Ratios (12m fwd) & Subsequent Returns (5 years)

Source: Bloomberg and S&P Global as of Nov. 30, 2025. 

To put this in perspective, such elevated levels have only been observed two times since 1985.  This historical context raises questions about current market valuations, potential risks and return potential over the next 5 years.

Earnings vs. Index Growth Divergence

Since the end of 2019: - S&P 500 earnings per share (EPS) increased by 67% (9% annually) – while the S&P 500 index itself grew by 120% (14% annually) representing a 5% annual difference over the past 5 years¹.

This divergence has driven the P/E ratio from 15x in 2019 to its recent high of over 22x in October¹, suggests a potential disconnect between fundamental earnings growth and market valuations.  This fact could hint that the market is overvalued, with stock prices outpacing fundamental earnings growth.

Global Market Appreciation

The robust market performance since 2022 has been widespread: - U.S. markets: Up 91% - Global markets: Up 79% - Canadian markets: Up nearly 77%.

Market Index	Cumulative Return 2023/01/01 - 2025/11/30
S&P 500 TR CAD	91.37%
MSCI ACWI NR CAD	78.85%
S&P/TSX Composite TR	76.68%

Source: Morningstar Direct from January 1, 2023 to of November 30, 2025. Canadian markets represented by the S&P/TSX Composite Total Return Index, Global markets represented by MSCI All Country World Index in Canadian dollars and US markets represented by S&P 500 Total Return Index in Canadian dollars.

While these gains have been beneficial for investors, they also present a timely opportunity to reassess portfolio allocations and consider rebalancing strategies.

The Case for Fixed Income

1. Attractive Yields and Return Potential

Current yield levels for fixed income investments have risen significantly across several bond indices over the past five years, offering more attractive entry points for investors.  Yield to worst (YTW) is used in the illustration below as it helps investors understand the "worst-case scenario" for their bond's yield, ensuring they know the lowest return they might receive provided there is no default of the bond.

Name	YTW - Avg 2020-10	YTW - Avg 2025-10
Canadian Bond Index (represented by iShares Core Canadian Universe Bond ETF)	1.31%	3.34%
Global Bond Index (represented by Vanguard Global Aggregate Bond ETF CADH)	0.73%	3.67%
U.S. Bond Index (represented by iShares Core US Aggregate Bond ETF)	1.16%	4.34%

Morningstar Direct October 1, 2020, to October 31, 2025.

Elevated yield levels serve as strong indicators of what professional investors refer to as “expected returns”. For example, the Vanguard Global Aggregate Bond ETF’s yield to worst of 3.67% points to an expected annualized return of 3.7% over the next five years – a significant increase from the 0.73% level observed five years ago.

As shown on Graph 1 illustrating the S&P 500 P/E ratios – when compared to U.S. equities, bonds present a strong value proposition. The S&P 500's forward P/E ratio of 21.5 suggests a five-year expected return of approximately 3%, keeping in mind that generally equities have higher risk compared to bonds.

2. Declining Bond Correlation with Equities

Correlation is a measure of how the prices of two or more assets move in relation to each other. It helps investors understand whether assets tend to move in the same direction (positive correlation), opposite directions (negative correlation), or have no relationship (no correlation). This helps build the case for diversification of portfolios.

Recent data shows a decreasing correlation between stocks and bonds, meaning there would be enhanced diversification benefits by including an allocation to fixed income:

• Canadian bonds: 0.58 correlation with Canadian equities (over the last 2 years)
• U.S. Bonds: 0.46 correlation with U.S. equities
• Global Bonds: 0.19 correlation with global equities

Correlation Matrix

Time Period: 2023-12-01 to 2025-11-30

Source: Morningstar Direct return correlation over the last 2 years as of November 30, 2025. Canadian Bonds (represented by iShares Core Canadian Universe Bond ETF), Global Bonds (represented by Vanguard Global Aggregate Bond ETF CADH), US Bonds (represented by iShares Core US Aggregate Bond ETF), Canadian equities (represented by S&P/TSX Composite Index TR), US Equities (Represented by S&P 500 TR CAD), Global equities (represented MSCI ACWI NR CAD).

This reduced correlation underscores the potential for fixed income to provide some portfolio stability, especially during periods of equity market volatility.

3. Central Bank Policy Shifts

Both the Bank of Canada and the U.S. Federal Reserve have recently begun to ease monetary policy:

• Bank of Canada: Held interest rates at a low rate of 2.25% as of December 10, 2025.
• U.S. Federal Reserve: Reduced the federal funds rate by 25 basis points to 3.5% - 3.75% on Dec 10, 2025

These policy shifts may create a more supportive environment for holders of fixed income investments, leading to potential capital appreciation in bond portfolios.

4. Recession Risk Mitigation

Economic indicators suggest an increased probability of recession in both Canada and the United States:

• Canada: Some sources indicate the country may have entered a mild recession in the summer of 2025 and is showing low growth rate in Q3 mainly due to fiscal stimulus²
• United States: Recession probability estimates range from 30-40%³. Historically, fixed income has helped protect investor capital during recessionary periods. The combination of lower correlation with equities and higher yields strengthens the case for fixed income as a defensive allocation.

Strategic Considerations for Investors

1. Portfolio Rebalancing: Given the significant appreciation in equity markets in recent years, investors may want to talk to their advisor to see if they should be re-allocating to fixed income to maintain their target asset allocation.
2. Risk Management: The potential for economic headwinds and market volatility makes fixed income an important tool for managing overall portfolio risk.
3. Income Generation: Higher yield levels offer improved income potential, which can be particularly attractive for investors seeking stable cash flows.
4. Diversification Benefits: The reduced correlation between stocks and bonds enhances the diversification effect of fixed income within a portfolio.
5. Tactical Opportunities: Active management in fixed income may provide opportunities to capitalize on market inefficiencies and generate alpha in a potentially challenging market environment.

Considerations for investors considering Active Fixed Income

Active fixed income strategies involve professional managers making decisions on duration, credit quality, sector allocation, and security selection rather than simply tracking an index. Here are the key reasons and considerations for why you might want to choose active management over passive:

Potential Advantage.

1. Flexibility in Changing Markets
   • Active managers can make adjustments as interest rates change. They can shorten or lengthen the time frame of the bonds they hold and shift positions along the interest rate curve. This flexibility helps manage risk and capture potential opportunities when markets are uncertain or rates move up or down.
   • If the bond portfolio allows, these managers can shift between government bonds, corporate bonds, and other sectors to capture potential opportunities or reduce risk.
2. Credit Selection and Risk Management
   • Active managers analyze issuers (companies that have issued bonds) to avoid defaults and identify mispriced securities, which can add value beyond what an index provides.
   • This is particularly important in corporate and high-yield bond markets where credit risk varies widely.
3. Potential opportunity to add value beyond the market
   • Active managers look for mispriced bonds and adjust positions when markets are unsettled. By making tactical choices and selecting individual securities, they can add value beyond what an index delivers—especially when bond prices vary widely.
4. Risk Mitigation
   • Active managers can respond quickly to macroeconomic changes, geopolitical risks, and liquidity challenges—something passive strategies cannot do.

Credit risk is the possibility that a borrower—such as a corporation or government—will fail to make interest payments or repay the principal on a bond or loan. In other words, it’s the risk of default, which can lead to a loss for investors.

 

Considerations and Trade-Offs

1. Higher Fees
   • Active strategies typically cost more than passive because they involve research and analysis and higher trading costs as managers try to outperform the market, so investors need to weigh potential performance against fees.
2. Manager Skill Matters
   • Success depends on the manager’s expertise and process. Not all active managers outperform consistently.
3. Tracking Error
   • Active portfolios may deviate significantly from benchmarks, which can lead to periods of underperformance when compared to those benchmarks.

Bottom Line

Active fixed income can make sense for investors who:

• Want professional oversight in volatile markets to help ensure quality of their bond portfolio.
• Value credit research and risk management.
• Are comfortable paying higher fees for potential added value.

However, active management does not guarantee of outperformance, and investors should evaluate the manager’s track record, philosophy, and fit within their overall portfolio, while remembering that past performance is no indicator of future performance.

Conclusion

While equity markets have delivered strong returns in recent years, current valuations and economic indicators suggest that now may be an opportune time for investors to reassess their fixed income allocations. The combination of attractive yields, improved diversification benefits, and potential economic uncertainties make a strong case for increasing exposure to fixed income strategies.

However, it's important to note that market conditions can change rapidly, and individual investor circumstances vary. Investors should consult with their financial advisor to determine the most appropriate asset allocation strategy based on their specific goals, risk tolerance, and investment horizon.

By thoughtfully incorporating fixed income into their portfolios, investors may be able to enhance stability, generate income, and position themselves to navigate the evolving market landscape more effectively.

Sun Life Active Fixed Income Solutions for consideration:

Our three key active fixed income solutions offer access to seasoned sub-advisors with deep domestic and global fixed income experience providing access to hard-to-reach fixed income assets including private credit, bank loans, high-yield bonds, and narrowly syndicated credit.

Sun Life Core Advantage Credit Private Pool Ticker: SLCA	Sun Life MFS Global Core Plus Bond Fund Ticker: SLGC	Sun Life Crescent Specialty Credit Private Pool Ticker: SLSC
Sub-advised by: SLC Management	Sub-advised by: MFS Investment Management	Sub-advised by: Crescent Capital Group
Category: Canadian Fixed Income	Category: Global Core Plus Fixed Income	Category: High Yield Fixed Income
Management fees: Series A:  0.93% Series F & ETF Series: 0.43%	Management fees: Series A:  0.93% Series F & ETF Series: 0.43%	Management fees: Series A:  1.20% Series F & ETF Series: 0.70%
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