According to State Street (STBK) Global Markets, the State Street Institutional Investor Risk Appetite Index declined from 0.36 in August to -0.18 in September, marking its lowest level since the outbreak of conflict in the Middle East in March and signaling the end of a five-month streak of risk-on positioning by institutional investors.

Equity allocation remains at a historically elevated level of 56.6%, though it pulled back by 0.8 percentage points in September.

Flows moved into fixed income assets rather than cash. The bond allocation, excluding short-term Treasury bills, rose by nearly 1 percentage point, while the cash allocation fell by 0.18 percentage points. This represents the largest single-month increase in fixed income allocation in more than five years.

Although fixed income holdings remain at historically low levels, the notable increase in September indicates that institutional investors are finally being drawn in by higher sovereign bond yields, even as the macroeconomic outlook remains under pressure.

Michael Metcalfe, Head of Macro Strategy at State Street Global Markets, commented that it is not surprising that the risk appetite recovery tracked by the index failed to extend into a sixth month. Investors were already significantly overweight equities, and rising oil prices alongside tighter monetary conditions provided ample justification for pausing further additions to risk assets.

What was more unexpected was where the safe-haven flows went. Sometimes, what investors do not do speaks louder than what they do: despite weakness in both equity and bond markets, the cash allocation edged lower and remained below its long-term average. Instead, the capital released by an 80 basis point reduction in equity holdings and a 20 basis point decline in cash allocation flowed into fixed income assets, producing the largest single-month increase in over five years.

Asset managers' fixed income holdings are near a 20-year low, so a certain degree of portfolio rebalancing was inevitable. However, this asset allocation shift occurred during a period of sharply rising yields.

This sends a preliminary signal that, despite concerns over inflation, fiscal and political outlooks, long-term yield levels are finally attractive enough to draw institutional investors back into the market.