What strategy should fund managers employ when anticipating an increase in interest rates?

When fund managers anticipate an increase in interest rates, the appropriate strategy is to sell bonds and keep funds in cash. As interest rates rise, bond prices typically fall. This inverse relationship means that if a fund manager holds bonds during a period of rising interest rates, the value of those bonds will likely decline, resulting in potential losses for the fund and its investors.

By selling bonds before an increase in interest rates, managers can avoid these losses and preserve capital. Keeping funds in cash enables them to maintain liquidity and flexibility, allowing for potential reinvestment in higher-yielding assets once the market conditions become more favorable. This strategy maximizes the potential for returns while minimizing the risks associated with holding depreciating bond assets.

Investing heavily in stocks might be seen as a good strategy when anticipating overall market growth, but it does not directly address the risk posed by falling bond prices in the current interest rate environment. Increasing bond purchases would likely lead to losses if rates rise, as the new bonds purchased would also decline in value. Holding onto all bonds, especially if they were bought at lower interest rates, guarantees losses as their market value decreases with rising interest rates. Therefore, selling bonds to preserve capital and holding cash is a more prudent approach in such a scenario