U.S. taxable investment-grade bonds advanced 1.10% in the fourth quarter of 2025, as measured by the Bloomberg U.S. Aggregate Bond Index. This result capped a year of elevated volatility, yet one in which the bond market posted gains in all four quarters. For the full year, the Aggregate index rose 7.30%, its best annual result since 2020.

Quarterly performance was fueled by a combination of elevated starting yields and price appreciation, as bond prices rose amid falling interest rates and investor demand, supported by stable fundamentals. The U.S. Federal Reserve, after resuming the monetary easing program it had paused from January until September of this year, followed through with additional policy rate reductions in October and December. The three rate cuts in 2025's second half, each of a quarter percentage point (25 basis points), brought the federal funds rate down to a target range of 3.5% to 3.75%, from a peak range of 5.25% to 5.5%, which the central bank maintained from July 2023 to September 2024.

The reductions drove short-term bond yields lower and contributed to gains for the investment-grade bond market in October and November (both +0.62%). Following its December meeting, though, Fed officials signaled they might hold steady for now. With progress on inflation stalled – monthly metrics continued to show U.S. consumer inflation moving within a tight range around 3%, above the Fed's 2% target – and labor-market statistics softening but remaining relatively resilient, Fed Chair Jerome Powell indicated a wait-and-see stance and said, "We're well-positioned to see how the economy evolves from here."

This announcement shifted the market's expectation for additional rate cuts deeper into 2026, and the Aggregate index took a small step back in December (-0.15%). For the three months, short-term bond yields fell in step with the benchmark interest rate, but long-term yields rose marginally, a function of the Fed's policy signals as well as heavy issuance of long-term Treasurys to fund U.S. government spending.

Due to this steepening of the yield curve, short- and intermediate-term issues fared best in Q4. Bonds with maturities of 7 to 10 years posted the strongest advance at 1.52%, while 1- to 3-year bonds rose 1.18%, 3- to 5-year maturities were up 1.32%, and 5- to 7-year bonds climbed 1.36%. Conversely, long-term securities of 10+ years were weakest (-0.00%). By credit rating, higher-quality bonds rated AAA and AA outperformed investment-grade debt rated A and BAA (the Bloomberg equivalent to BBB).

At the sector level, U.S. Treasurys (+0.90%) slightly outperformed investment-grade corporate bonds (+0.84%), which were constrained by historically tight credit spreads. (Notably, for the full year, corporates advanced 7.77%, comfortably besting the 6.38% gain for Treasurys). Other yield-advantaged, credit-sensitive sectors – including agency mortgage-backed securities (+1.71%), commercial mortgage-backed securities (+1.34%) and asset-backed securities (+1.25%) – exhibited relative strength in Q4, while government-related bonds (+1.12%) finished roughly in line with the broader market.

Outside the Aggregate index, returns varied widely. U.S. Treasury Inflation-Protected Securities gained just 0.13%, per Bloomberg. But investor interest in higher-yielding assets drove strong results for higher-income categories. U.S. high-yield corporate bonds (+1.31%) outperformed investment-grade corporates, while high-yield emerging-markets debt (4.85%) delivered the bond market's best return. For the year, investment-grade and high-yield emerging-markets bonds led all categories, gaining 9.45% and 13.93%, respectively, aided by improving fundamentals and a weaker U.S. dollar. ■

At the end of 2025, the global and U.S. business cycles remained constructive, with U.S. monetary and fiscal easing likely to continue in 2026. U.S. trends included strong corporate fundamentals and earnings momentum, softening labor markets, and to date a resilient consumer sector.

Nominal 10-year U.S. Treasury yields ended Q4 effectively unchanged from the previous quarter at roughly 4.2%, after beginning the year around 4.6%. The Fed eased monetary policy in the second half of 2025, cutting its short-term policy rate by 75 basis points and ending quantitative tightening (after reducing its balance sheet by $2.5 trillion since 2022).

The market currently anticipates two more Fed rate reductions in 2026, based on expectations for weakening employment trends and near-term inflation, though those cuts may not come until mid-year or later. The yield curve steepened in 2025 amid concerns over fiscal deficits, persistent inflation and Fed independence, all of which pressured long-term yields.

Versus the Aggregate index, the ETF was overweight risk assets at year-end, with a tilt toward short- and intermediate-term investment-grade corporate credit, high-yield securities, leveraged loans and international credit. It also was overweight U.S. Treasurys, including nominal securities and futures, as well as asset-backed securities and commercial mortgage-backed securities. The fund had below-index exposure to government agency mortgage-backed securities and long-dated investment-grade credit. By credit rating, the fund was underweight bonds rated AA and A, and overweight securities rated AAA, BBB and lower. Overall, the portfolio was bulleted around the intermediate portion of the yield curve and, at period end, maintained a duration slightly longer than that of the index.

In a dynamic environment, we continue to find pockets of value within the fixed-income market, based on our view of pricing and fundamentals. Our goal remains to work with our investment teams to try to find attractively priced bonds for the portfolio while maintaining a disciplined approach to risk management.

It is important to reiterate that the portfolio is constructed with a careful emphasis on security selection, especially with consideration to liquidity and financial resiliency. Investing is a long-term endeavor, and we're focused on generating strong risk-adjusted performance over a full market cycle. Given this focus, our long-term performance remains compelling. ■