The broken anchor

Why bonds stopped working as a shock absorber – and what investors are doing about it

Most investors hold bonds for four reasons: income, diversification, stability, and capital preservation. The fixed income sleeve is supposed to be the anchor - the part of the portfolio that holds steady, or even gains, when equity markets fall. For most of the last four decades, that is what bonds did.

Then came 2022. The S&P 500 fell 25%. Investment-grade corporate bonds fell 24%.¹ For the first time in a generation, the anchor dragged with the ship. That single fact should prompt any investor to ask a basic question: is the fixed income allocation I hold today actually doing its job?

As Head of Asset-Backed Finance at Pacharbor Capital Group, I have a clear interest in the conclusion I am about to reach. That said, I’m acknowledging that upfront because I believe the only version of this argument worth making is the intellectually honest one.

Fixed income has become less reliable as a shock absorber

The data from the three biggest stress events of the last 20 years tells a clear story. In the Global Financial Crisis, equities fell 57% and bonds fell 13% - bonds absorbed the shock.² In the COVID crash, equities fell 34% and bonds fell 15%.³ In 2022, equities fell 25% and bonds fell 24%.⁴ The diversification that underpinned 40 years of portfolio construction appeared to break down completely.

The cause is straightforward. When inflation is the dominant risk, rising interest rates push both equities and bonds lower simultaneously. The 12-month rolling correlation between investment-grade corporate bonds and US equities averaged roughly 0.13 from 2010 to 2020 - low enough to genuinely reduce equity risk. Since 2020, it has averaged 0.63.⁵ This may not be a temporary spike. We believe the forces reshaping fixed income - persistently elevated inflation, rising government debt levels, and structurally higher rate volatility - look more durable than cyclical.

The underlying reason matters. Corporate bonds and equities are both claims on corporate earnings. When rate volatility becomes the dominant variable, both typically move together. The more a fixed income portfolio consists of corporate bonds, the more it runs a single bet on rates and inflation - dressed up as diversification.

There is also a concentration problem that often goes unnoticed. The top 100 issuers account for 65% of the entire investment-grade bond market, and 55% of the index is concentrated in just three sectors: financials, technology, and healthcare.⁶ Owning an investment-grade bond index is not a diversified slice of the economy, it is a portfolio tilted toward the same sectors as an S&P 500 index fund.

“The fixed income allocation was designed to solve four problems simultaneously: income, diversification, stability, and capital preservation. In the current environment, it is struggling to solve any of them reliably.”

As markets shift, asset-backed finance is gaining ground

Private capital is playing a larger role in financing the real economy, creating opportunities for investors to access different types of borrowers, assets, and sources of cash flow historically beyond the reach of traditional fixed income.

One area drawing increasing attention is private asset-backed finance, or ABF. Here the lender is secured by real collateral such as loans, leases, and financial assets, rather than a single corporate borrower’s promise to pay. While traditional corporate bonds are backed primarily by the financial strength of a single issuer, ABF is supported by pools of underlying assets and contractual cash flows, which may include consumer loans, equipment leases, receivables, and other forms of real-economy credit.

As a result, performance is tied less to the fortunes of a single company and more to the cash flows generated by the underlying assets themselves. In many cases, those investments are structured with features designed to provide additional layers of protection and create different risk and return drivers than traditional corporate credit.

The ABF asset class has grown significantly over the last decade. Early growth in the asset class was accelerated by two temporary forces - regulatory pressure on bank balance sheets and the rapid interest rate rises of 2022 - but the more durable driver runs deeper. In public markets, asset-light companies trade at significantly higher valuations than their asset-heavy peers - roughly twice the price-to-book multiple.⁷ This creates an enduring incentive for banks and asset-originating businesses to move capital-intensive holdings off their balance sheet: originate assets, retain the customer relationship, and partner with long-term investors who hold them. We believe that incentive is durable across regulatory regimes and rate environments.

We believe the most important question for investors evaluating ABF is not whether the asset class offers attractive risk-adjusted returns. The question is which managers will capture those returns in a competitive environment. In our experience, the banks and finance companies shifting to asset-light strategies are not necessarily looking for the highest bidder on a one-time sale. They want a capital partner with the scale to absorb large, ongoing origination volumes, the reliability to be there across market cycles, and the expertise to act as a genuine long-term partner. This programmatic partnership rewards platforms with deep origination relationships that are difficult to replicate on price alone. It also amplifies the need for fundamental underwriting and asset management skills: ABF requires assessing the quality of the underlying assets and the integrity of the originator managing them - protections that no deal structure can substitute for.

Credit quality in asset-backed finance is structurally different

The credit quality argument for investment-grade ABF is grounded in 30 years of data. Over the three decades from 1993 to 2024, investment-grade rated structured finance assets - auto loans, student loans, credit card receivables - experienced significantly lower cumulative default and impairment rates than investment-grade corporate bonds.⁸ The reason is structural: an asset-backed transaction has multiple layers of protection built in - more collateral than debt issued, cash flows that typically exceed what investors are owed, junior tranches that absorb losses before senior ones, and exposure spread across thousands of individual loans rather than a single corporate borrower. Same credit rating - fundamentally different loss experience over 30 years.

One important caveat: private ABF is not a substitute for liquid fixed income in portfolios that require daily liquidity. The potential illiquidity premium is real because the illiquidity is real.

“Same credit rating — but significantly lower cumulative defaults over 30 years. The structural protections built into asset-backed securities create a fundamentally different credit profile than a corporate bond.”

Rethinking the anchor, not replacing it

In our view, public fixed income, as currently structured, struggles to simultaneously deliver income, diversification, stability, and capital preservation. The correlation data, the drawdown data, and the concentration data suggests that what has worked for most of the past forty years may no longer do so. This is an observation about what has already happened, not a prediction about what might.

Discussions fixated on choosing between traditional fixed income and private credit miss the point. Public bonds can, and will, remain essential, particularly for investors with liquidity needs or shorter investment horizons. The real shift is more subtle: investors reassessing how to best pursue the objectives that fixed income was designed to achieve, as markets continue to evolve. For many, that reassessment could lead them toward a broader set of durable, income-producing assets, of which private asset-backed finance is potentially one.

The goal is not to replace the anchor; it is to make it hold.