A strategy for US investors to counter domestic market risk involves buying European bonds and not hedging the currency. This combines a modest ~3% bond yield with an expected ~7% appreciation of the euro against the dollar, driven by diverging central bank policies.

After a decade of negative real returns, bonds are now attractive on a pure valuation basis relative to equities. PIMCO's CIO suggests bonds may outperform stocks over the next 5-10 years, making a compelling case for allocation regardless of their traditional role as a correlation hedge.

Counterintuitively, high-yield corporate bonds are expected to perform better than investment-grade credit. They do not face the same supply headwind from AI-related debt issuance, and their fundamentals are supported by credit team forecasts of declining default rates over the next 12 months.

In bond investing, where upside is capped at a promised return, superior performance comes from what you exclude, not what you buy. The primary task is to eliminate the bonds that will default. Once those are removed, all the remaining performing bonds deliver a similar, contractually-fixed return.

BlackRock's CIO of Global Fixed Income argues that unlike equities, fixed income is about consistently getting paid back. The optimal strategy is broad diversification—tilting odds slightly in your favor and repeating it—rather than making concentrated, high-conviction "bravado" bets on specific market segments.

With credit curves already steep and the U.S. Treasury curve expected to steepen further, the optimal risk-reward in corporate bonds lies in the 5 to 10-year maturity range. This specific positioning in both U.S. and European markets is key to capturing value from 'carry and roll down' dynamics.

The intermediate part of the curve offers the best risk-reward. Investors can capture "roll-down" returns by holding a bond as it shortens in maturity and its spread tightens. This benefit is absent in flat, long-dated curves, which also lack sufficient natural buyers.

The modern high-yield market is structurally different from its past. It's now composed of higher-quality issuers and has a shorter duration profile. While this limits potential upside returns compared to historical cycles, it also provides a cushion, capping the potential downside risk for investors.

Investors seek a sweet spot where government fiscal laxity is high enough to generate attractive yield premiums but not so extreme that it threatens the system's viability. This creates a market for lending to slightly imperfect, high-quality credits.