Federal Reserve’s Interest Rates Revision Could Make Mutual Funds Riskier To Invest

Mutual funds have always been a rather dependable financial instrument. However, the latest revision of interest rates could mean trouble for the investors.

The largest buyers of the U.S. corporate bonds may not continue investing their money in these financial instruments when the Federal Reserve eventually raises interest rates. Mutual funds bought about half of the company bonds that have been added to the U.S. market since 2008, and they are certainly concerned about any reduction in profits.

If this isn’t alarming enough, the current assets are valued at $ 1.5 trillion, says Morgan Stanley. The company was the fifth–largest underwriter of the debt across the world last year and is acutely aware of the impending crises once the interest rates are raised, making mutual funds a much less lucrative and stable option for large buyers. Thus, it doesn’t come as a surprise that Morgan Stanley’s share of the debt expanded to 16 percent from 13 percent, in direct contrast to buyers who have a vested interest in pension funds and life insurers. Typically these companies hold on to such long–term, low–risk securities for a much longer duration, reported Bloomberg.

The Federal Reserve’s easy–money policies like shorter-term notes due in one to five years and demand for mutual funds has now significantly put the market at risk due to the interest rate revision, which will be perceived as one that is arresting profit margins.

Raising interest rates has traditionally been intended for two totally opposite reasons. The Federal Reserve has kept the interest rates in check to allow positive economic activity. It has done so by holding down borrowing costs. On the other hand, if the rates were held back despite economy doing well, corporate bonds buyers have shown a willingness to invest in equities or riskier asset classes.

The transition phase is almost upon the US investment companies, cautioned Morgan Stanley’s Mahadevan.

“We’re potentially at a transition point now where, if we are going to move into a world of higher yields, the pension fund or the insurance company will be motivated to do more investment in fixed income and credit”

In short, “Dollars that would normally be parked in money-market funds have been funneled into short duration funds to earn at least a little bit of yield. That reveals significant interest-rate risk in short duration, with the clear threat of outflows from mutual funds, exchange-traded funds and other investment vehicles” said Hans Mikkelsen, the head of U.S. investment-grade credit strategy at Bank of America Corp. in New York.

Mutual Funds in the US are now at a tipping point of being used an instrument to gain short term profit. This, coupled with an increase in interest rates, could erode the perception of dependability.

[Image Credit | Chugh Securities]