Investors, Betting on Elevated Interest Rates Into ’24, Are Favoring Fixed Income

Institutional investors expect elevated interest rates and inflation in 2024, increasing the appeal of income-generating investments, according to CoreData’s Q3 2023 Equities Sentiment Report.

Fixed income is the most preferred asset class for risk-adjusted returns in the coming year, with 50% of 100 institutional investors surveyed choosing the investment option. That was followed by cash and equities, which shared the same ranking (47%).

The prospect of higher rates has also prompted investors to adopt a more cautious approach, with 44% slowing down their investment in risk assets and 30% reducing their exposure, according to CoreData. Moreover, 43% of institutional investors have adjusted their strategic allocations to government bonds and cash-like investments, while 39% have grown their tactical exposure to these assets.

“These results show that 5% risk-free yields have completely changed the calculus for institutional investors,” said Michael Morley, U.S. research director at CoreData, in a statement.

Some of the flight to safety is due to the growing concern of a tech bubble forming in the stock market. Seven in 10—71%—said the technology sector is overvalued, up from 55% in Q2, according to the report.

Still Elevated

On November 1, the Federal Reserve held the key federal funds rate between 5.25% and 5.5%; this was the second meeting in which the Fed held rates, after a string of 11 rate hikes. However, inflation remained well above the Fed’s 2% target, the agency noted and said it remains “strongly committed” to bringing prices down.

CoreData’s Q3 survey found that 77% of respondents anticipate that interest rates and inflation will remain elevated over the next 12 months, a notable increase from the 65% figure reported in the Q2 survey, held in June.

Additionally, due to the higher interest rates, 39% of investors have raised their hurdle rate for risk assets, increasing the pressure on asset managers, according to the data providers. This has led to some investors parting ways with managers unable to meet their return expectations, with 38% of organizations reporting offboarding active strategies that have underperformed over recent years.

Still Active

Despite these challenges, 54% of investors maintained confidence in actively managed equity strategies, expecting them to deliver strong outperformance in the next year, the report found. This confidence comes from anticipated subdued market returns, it goes on to say. Yet, just 35% are bullish about U.S. equities in the next three months compared with the 45% who are bearish.

“The trend of de-risking portfolios and consolidating active investments with high-conviction managers is likely to accelerate, putting a painful squeeze on the industry, which is already faced with a low-beta environment,” Morley said.