Three Things Investors Should Know About Today’s Bond Market

In a volatile year for U.S. stocks, the overall U.S. bond market has maintained a positive year-to-date total return throughout 2025. For investors allocating to balanced portfolios of both asset classes, bonds are likely to have played a useful role, sometimes helping offset periods of disappointing stock returns and reducing total portfolio volatility.

However, this doesn’t mean bond investors have been spared from uncertainty. Fears surrounding U.S. government debt levels and potential effects on the Treasury market have been widely publicized. Reports that proposed tax legislation could add more to the U.S. deficit in the years ahead and Moody’s recent downgrade of its U.S. debt rating have contributed to market anxiety, coinciding with the 30-year U.S. Treasury yield topping 5% for the first time since 2023.

Many predictions about the bond market will circulate, but investors should be cautious not to let opinions and resulting emotions dictate their portfolio decisions. We believe a more constructive approach for bond investors would be to carefully evaluate what you own, assess diversification and risk characteristics, and verify if current exposures are aligned with long-term goals.

To help, we offer some facts on the bond market, highlighting a few things you may not know but would likely be wise to consider.

1.Treasuries Now Make Up Half of the U.S. Bond Market

To start, let’s consider the composition of today’s U.S. bond market. This includes several sectors, like Treasuries, agencies, corporates and securitized bonds. But how much weight is in each and why?

Many may know how the equity market is measured through popular indexes such as the S&P 500® and the Russell 3000®. These indexes weight stocks by their market capitalization, giving larger weight to bigger companies and smaller weight to smaller companies.

It’s different with bonds. Index weighting is typically based on debt outstanding, which means greater exposure to the most indebted issuers and less exposure to those with lower debt levels.

The result? Considerable weight in U.S. Treasuries.

Over the last 20 years, the weight of U.S. government-issued bonds (longer-term Treasuries and short-term T-bills) has increased from about 25% of the U.S. bond market to around 50% as U.S. government debt has risen faster than for other bond sectors (Figure 1).

Figure 1 | Government Bonds Dominate the U.S. Bond Market

Panel A | U.S. Bond Market Sector Composition by Percentage Weight

Panel B | U.S. Bond Market Sector Composition by Total Value ($ Trillions)

Data from 2001 – 2024. Source Bloomberg. Municipals are bonds issued by municipalities such as states, cities, and counties. Corporates are debt instruments issued by corporations, as distinct from those issued by governments, government agencies or municipalities. Agency Mortgages are mortgage-backed securities typically issued by U.S. government agencies.

Because agency bonds and much of the U.S. mortgage bond market are also backed by the government, total government-related debt makes up more than 70% of the market today!

Giving more weight to issuers with higher levels of debt can raise eyebrows regarding risk management. Still, it can also have important implications for expected returns as Figure 2 demonstrates.

Figure 2 | Corporate Bonds Have Historically Offered Higher Growth Potential

Annualized Total Return (January 1986 – April 2025)

Data from 1/1/1986 - 4/30/2025. Aggregate bond market is represented by the Bloomberg US Aggregate Bond Index. Treasuries, mortgages and corporates are represented by the individual sectors within that index. Source: Bloomberg, Avantis Investors. Past performance is no guarantee of future results.

The annualized return for Treasury bonds since 1986 is a respectable 5.19%, while mortgages have returned a bit more at 5.42%. Corporate bonds have well outpaced both, at 6.30%, over the same period.

2. Most Corporate Bond Segments Have Historically Offered Stronger Growth Potential with Relatively Low Default Risk

Perhaps it’s not surprising that corporate bonds have outperformed Treasuries, historically referred to as “risk-free.” Don’t corporate bonds come with more risk? If risk is measured by the potential for default, then that risk may not be as large as you think.

In Figure 3, we present historical data on the trade-offs between default risk and returns across corporate bonds of varying qualities, spanning both lower-risk investment-grade corporate bonds (rated AAA through BBB) and relatively higher-risk speculative-grade or “high-yield” bonds (rated BB through CCC).

Figure 3 | U.S. Corporate Bonds Have Historically Offered Attractive Risk/Return Characteristics

Panel A | Annualized Total Returns by Credit Rating (January 1986 – April 2025)

Panel B | Corporate Bonds Average Annual Default Rates by Credit Rating (January 1981-December 2024)

Data for Panel A from 1/1/1986 – 4/30/2025. Returns source: Bloomberg, Avantis Investors. Ratings AAA, AA, A, and BBB are segments within the Bloomberg U.S. Aggregate Bond Index. BB is a segment within the Bloomberg U.S. High Yield Index. Data for Panel B from 1/1/1981 – 12/31/2024. Default Rate Source: S&P Global Ratings Research, Avantis Investors. Past performance is no guarantee of future results.

We observe that historically, returns have increased with lower credit ratings, reflecting the premium paid to investors for taking on higher expected risk. But, examining the realized default rates from higher to lower credit ratings shows that you must go pretty far out on the rating spectrum to see meaningful increases in default.

Since 1981, the annual average default rate for all investment-grade-rated bonds and even upper-tier high-yield bonds (BB-rated issues) has remained below 1%. This holds true for both U.S. and non-U.S. corporates.

3. Global Bonds Offer Another Opportunity to Enhance Diversification and Returns

While the U.S. bond market is the largest in the world, a vast opportunity set exists in global markets outside the U.S. In its 2024 capital markets fact book, the Securities Industry and Financial Markets Association (SIFMA) estimates that the total value of the global debt market is about $141 trillion, with the U.S. comprising 39%. This means global markets offer access to a far wider set of bonds, issuers and yield curves, which can provide an opportunity to enhance diversification and expected returns.

In Figure 4, we provide a snapshot of a selection of current global corporate yield curves to highlight the potential upside of expanding the investment universe beyond U.S bonds. This includes BBB-rated corporate curves for bonds issued in the U.S. dollar (USD), euro (EUR), Canadian dollar (CAD) and British pound (GBP). All non-USD curves are hedged to USD, which, in practical terms, can help to minimize the currency-driven volatility of holding foreign bonds in their local currencies.

Figure 4 clearly shows that some yield curves for non-USD currencies, when hedged to USD, offer higher yields today than comparable USD bonds. Yield is one component of a bond’s expected return. Global yield curves also tend not to move perfectly in line, allowing investors to potentially benefit from diversifying across multiple markets.

Figure 4 | Global Markets Can Offer Upside

Global BBB-Rated Corporate Yield Curves

Data as of 4/30/2025. Yield is a rate of return for bonds and other fixed-income securities. A yield curve is a line graph that shows yields of fixed-income securities from a single sector (e.g., corporate bonds) over various maturities (e.g., five and 10 years) at a single point in time. Non-USD yields are hedged to USD. FIN indicates the financial sector. Non-FIN indicates corporate sectors excluding financials. Source: Bloomberg, Avantis Investors.

That’s not to say there are no trade-offs for investors to think about.

Figure 5 illustrates that pursuing higher growth potential in bonds can come with relatively higher volatility, which may be an important consideration for investors depending on the role that bonds play in their portfolios.

The chart illustrates historical returns compared to volatility for pairings of the S&P 500 Index (60%) and various U.S. and global fixed income indexes (40%). Generally, we find that dedicated corporate exposure helps to drive higher returns but with higher volatility versus the other indexes. Global corporate bonds have shown potentially appealing risk and return trade-offs versus U.S. corporates alone.

Figure 5 | Trade-offs in Returns and Volatility in Balanced Stock/Bond Portfolios

Risk/Reward Profile for Portfolios of 60% US Stocks/40% Fixed Income

Data from 2/2025 – 4/2025. Performance in USD. Non-USD indexes hedged to USD. Source: Bloomberg, Avantis Investors. Past performance is no guarantee of future results. Diversification does not assure a profit nor does it protect against loss of principal.

However, for investors seeking lower levels of volatility, the overall U.S. bond market has provided this compared to corporate-only bond allocations. Short-term U.S. market exposure (U.S. 1-5 Yr Gov/Credit) has offered even less volatility.

The Bottom Line

Anxiety is often an unavoidable part of investing. These days, it’s easy to encounter opinions on the market and fear how they might affect our portfolios. But, in our view, investors are better served by building portfolios that can help them withstand this noise.

We may not know what markets will do next, but there are aspects of our investment journey we can control. We can establish clear long-term goals, make sure we know how our investments are helping us achieve them, and understand the levers available to us to better pursue our goals when needed.

Plus, never forget that diversification is a powerful tool for mitigating risk and managing anxiety when uncertainty arises.