Making fixed income work in modern portfolios

Please note, this interview was recorded Thursday, 9 April, 2026

In this topsy-turvy world, markets are sending mixed signals. Growth has proven more resilient than expected, inflation remains sticky, and geopolitical risks continue to inject volatility. Yet perhaps the most important message is coming from fixed income, where traditional defensive assets have struggled to do their job.

For investors, that creates a big problem because if bonds are no longer reliably defensive, how does portfolio construction need to evolve to address this new reality?

That was the focus of my conversation with Andrew Canobi, Director of Australian Fixed Income at Franklin Templeton, who argues that the industry needs to rethink its reliance on benchmarks and conventional approaches.

“The bond market has been saying for some time now, ‘I’m not going to have you back,’” he says, pointing to repeated periods where bonds and equities have fallen together.

In this interview, Canobi shares his thoughts on why traditional diversification is breaking down, how persistent inflation is reshaping fixed income, where risks are building in private credit, and how an absolute return approach can help rebuild resilience in portfolios.

The breakdown of traditional diversification

A central theme in Canobi’s framework is that the historical relationship between bonds and equities has materially weakened. What was once a reliable hedge has instead become a source of correlated risk, with Canobi highlighting how inflation-driven shocks have led both asset classes to fall together.

That breakdown poses a significant challenge for investors who rely on sovereign bonds as a defensive anchor. The expectation of a “flight to quality” has repeatedly failed to materialise, even during periods of geopolitical stress.

Rather than treating this as a temporary anomaly, Canobi sees it as a structural shift that demands a rethink of portfolio construction.

Momentum over prediction

Rather than attempting to forecast long-term equilibrium outcomes, Canobi’s process focuses on the momentum of macroeconomic indicators.

Over the past year, those signals have pointed to stronger-than-expected growth. Despite restrictive monetary policy settings, both Australia and the US have exhibited resilience, with some evidence of reacceleration heading into recent volatility.

That momentum, however, now faces new headwinds. Geopolitical disruptions, particularly those affecting energy markets, risk introducing another layer of inflation pressure at a time when core inflation remains elevated. As Canobi notes;

“We’re injecting another layer of cost pressure into developed market economies… at a time when we’ve had core inflation up around, if not higher than 3%.”

The implication is that even if shocks prove short-lived, their inflationary impact may persist longer than markets expect.

Where markets are mispricing risk

Canobi sees one of the most notable disconnects in private credit, where rapid inflows have compressed risk premia.

From his perspective, the issue is not that private credit is fundamentally flawed, but that the balance between risk and reward has shifted. Investors are increasingly focused on headline yields, often overlooking the underlying risks.

He expects a period of adjustment rather than a systemic crisis, describing it as a necessary reset after a period of excess enthusiasm.

“We think private credit’s here to stay… but we’ve just seen so much money flood into that space. We need to have a bit of a reset.”

While not forecasting a disorderly unwind, he does expect further repricing as markets reassess the true level of risk.

Rethinking fixed income through an absolute return lens

The Franklin Australian Absolute Return Bond Fund is built on a simple premise: if the benchmark is flawed, it should not anchor portfolio construction.

Rather than hugging traditional indices, the strategy seeks to deliver returns with low correlation to growth assets by removing benchmark constraints altogether.

“If the structure of bond benchmarks is just such that we dislike most of it, well, we should get rid of the benchmark altogether,” Canobi explains.

This flexibility allows the team to allocate selectively across credit markets while actively managing downside risks. Given that credit can behave like equities during stress events, protecting against drawdowns is a core focus.

The fund uses derivative overlays, including index-based protection strategies, to help offset losses when spreads widen. These tools are designed to smooth returns rather than eliminate risk entirely.

Positioning for a higher-for-longer world

In terms of current positioning, Canobi highlights a lack of high-conviction opportunities in duration. Interest rate markets have been range-bound, and pricing already reflects a meaningful tightening cycle.

As a result, the fund maintains limited exposure to duration and remains cautious on long-end sovereign bonds, particularly in the US.

“We think four and a half to five is a much more reasonable destination path for a 10-year than four,” he says, explaining the fund’s short positioning in longer-dated US Treasuries.

At the same time, credit spreads remain tight, supported by solid corporate fundamentals and strong investor demand for yield. However, that dynamic introduces its own risks, as spreads may not fully compensate investors for potential downside.

To manage this, the portfolio emphasises diversification, typically holding more than 150 positions and avoiding concentrated bets. The objective is to generate consistent, risk-adjusted returns rather than relying on a small number of high-conviction calls.

Managed Fund

Franklin Australian Absolute Return Bond Fund

Australian Fixed Income

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