Risk Appetite Plunges to Lowest Levels Since Early 2009

Fifty-five percent of European fund managers now see the region suffering two quarters of negative real GDP growth over the next year, according to the BofA Merill Lynch Survey of Fund Managers completed between September 1 and September 8. This compares with only 14 percent expecting the same fate as recently as July.


Europe's sovereign and banking challenges dominate risks identified by global asset allocators.


Sixty-eight percent of survey respondents now view the eurozone debt crisis as the largest of these risks, up from 43 percent in June and 60 percent in August. Sentiment towards European banks is at its lowest since the survey began asking about it in January 2003.


These negative views of Europe are reflected in investors' stance on eurozone equities. While the weaker growth outlook is reflected in global fund managers' first net underweight (5 percent) on equities in over two years, a net 38 percent are now underweight European stocks - up from a net 15 percent last month.


While other regions also suffered, sentiment towards the U.S. improved somewhat. Only a net 9 percent of U.S. fund managers now expect the economy to weaken in the next year. Global investors also restored an overweight position in U.S. equities.


"The survey shows that sentiment on Europe is now so negative that contagion risk to the rest of the world has risen significantly," says Gary Baker, head of European Equities strategy at BofA Merrill Lynch Global Research.


"The current very extreme levels of risk aversion indicate that it is time to look for contrarian trades," adds Michael Hartnett, chief Global Equity strategist at BofA Merrill Lynch Global Research.


Risk Aversion Soars

As measured by the ML Risk & Liquidity Composite Indicator, investors' aversion to risk has soared to levels last seen in March 2009 in the wake of the global financial crisis. A net 45 percent of investors are taking lower risk than normal relative to their benchmarks, up nearly 20 percentage points from August.


Cash holdings remain notably high at an average 4.9 percent of portfolios, with more than one-third of investors overweight cash.


Reduced risk appetite is also evident in hedge funds' exposures. The sector has cut its net long position to 19 percent, down from 33 percent a month earlier. Investors' assessment of market liquidity has also turned to a net negative.


Sentiment towards bonds has improved as investors have turned negative on equities. Global asset allocators have halved their underweight in the asset class in just two months - from a net 45 percent in July to a net 21 percent now. Other asset classes also benefited from a shift out of equities. Most notably, the global underweight in real estate halved month-on-month, to a net 7 percent.


The growth slowdown has altered investors' view of oil. A net 14 percent of respondents view the commodity as overvalued, up from a net zero percent in August.


Within equities, the story is not one of a simple rotation into defensive sectors. While consumer staples, pharmaceuticals and utilities all benefited from the exodus from banks - to a net 47 percent underweight - so did industrial and technology shares.


Japan, China Take Eurozone Knock-On

As Europe's outlook has weakened, investors have lost confidence in other regions too. Views of the Japanese economy have soured significantly, for example.


A net 42 percent of Japanese fund managers expect it to strengthen in the next year, down from a net 75 percent a month earlier. A net zero percent expects Japanese corporate earnings to improve in the period, compared to a net 58 percent in August.


Similarly, a net 30 percent of regional fund managers expect the Chinese economy to weaken over the next 12 months. August's figure was a net 11 percent.


This is reflected in a sharp decline in asset allocators' enthusiasm for Chinese equities. Having ranked as their net most preferred BRIC stock market for the previous three months, China plunged almost 30 percentage points on this measure in September. It now has the same net 18 percent reading as Russia.


Fiscal Policy Finds Focus

With inflation fears having largely receded, investors have turned their focus to fiscal policy. A net 23 percent view it as too restrictive for the current phase of the business cycle, compared to the net 19 percent who viewed it as too stimulative just two months earlier.



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