Institutional investors on the lookout as interest rates climb

A 5% hike in federal funds rate sees institutions seeking protection in fixed income strategies

Institutional investors on the lookout as interest rates climb

As interest rates continue to increase, worries of a liquidity crisis have institutional investors on high alert.

According to a recent study by the U.K.-based market research firm CoreData Research of institutional investors in the U.S., 50% of respondents were worried that rising interest rates might result in significant withdrawals of funds, depleting cash or other highly liquid assets. The poll found that 49% of investors were concerned that rising interest rates may expose undiscovered flaws in the American financial markets.

The U.S. interest rates have risen to their highest level in more than ten years, causing investors to worry about an impending liquidity crisis. The fed funds rate goal was raised by the US Federal Reserve this month to a range of 4.5% to 4.75%, the highest level since 2007.

Based on 2022 research by academics at the University of Bath, financial institutions may experience a liquidity shortage as investors turn to safer assets like cash and marketable securities if the central bank keeps tightening the economy.

Nabeel Abdoula, deputy chief investment officer at the $6 billion Fulcrum Asset Management, believes that investors are rushing for cash during increased market volatility because it may be a useful portfolio diversifier. “When the policymakers are trying to [create] an environment of high interest rates to slow the economy down, the role of cash in portfolios is something that is worth reflecting on in terms of giving you the option of earning assets,” he said.

According to CoreData, 27% of institutional investors polled predicted that the economy will experience stagflation, a severe recession, and a decline of 10% to 20% in equity markets by 2023.

In terms of macroeconomic expectations, the largest funds—those with assets of $10 billion or more—are the least optimistic, with just 4% anticipating a bull market and 29% predicting a bear market. Thirty percent of those surveyed have optimistic outlooks for 2023 for funds with assets under $1 billion.

In the face of rising rates and market turbulence, investors are searching for safety in fixed income. CoreData reports that if the federal funds rate rises to 5%, 55% of investors polled stated they intend to increase their allocation to fixed income securities. Investment-grade and government bonds are the most often used debt strategies, indicating that they have chosen a risk-averse stance.

“On the one hand, institutional investors harbor deep concerns about higher interest rates triggering an economic tsunami whose waves will reverberate through the U.S. financial system. But on the other hand, higher interest rates now offer better income opportunities after a prolonged and frustrating search for yield in the post-financial crisis low-rate environment,” said Andrew Inwood, founder and principal of CoreData. “The income has finally returned to fixed income.”

The finding is based on a January poll of 120 institutional investors in the United States, including endowments, public pensions, and private defined benefit plans.