Investors more risk-averse amid geopolitcal unrest – BofA Merrill Lynch

Global investors are moving toward a “risk off” stance, taking on greater protection as the prospect of geopolitical instability grows, according to the BofA Merrill Lynch Fund Manager Survey for March.

Responding at a point of growing tension in Ukraine, 81 percent of investors said they see geopolitical risk posing a threat to financial markets stability – more than four times the reading one month ago. Twenty-seven percent of investors say that a geopolitical crisis is the biggest tail risk – up from 12 percent in February. At the same time, investors continue to express concern about the prospects for emerging markets – with sentiment towards China’s economy falling further.

Investors have reacted by showing reduced optimism about the prospect for corporate profits globally and by reining in risk. They have increased cash allocations, reduced equity holdings and taken on greater protection.

“With neither inflation nor recession posing a threat, we believe the equity bull market is far from over and investors should be putting excess cash into risk assets,” said Michael Hartnett, chief investment strategist at BofA Merrill Lynch Global Research.

“We see signs that recent exuberance in sentiment and positioning in Europe is waning. While Europe’s recovery remains in play, markets likely need to consolidate further before resuming their upward trend,” said John Bilton, European investment strategist.

Corporate optimism off highs

Investors have scaled back their belief in a vibrant recovery in corporate profit growth – but remain positive. A net 40%t of global investors believe that global profits will improve in the coming 12 months, down from a net 45% in February. A net 12% say that it’s unlikely corporate profits will rise by 10% or more in the year ahead, up from 4% of the panel taking that view in February.

At the same time, investor demand for companies to borrow and invest has eased. A net 34% of respondents say that corporate balance sheets are underleveraged, down from a net 40% last month. A net 63% believe that companies are underinvesting, down from last month’s high of a net 67%.

Sectoral allocations this month reinforce a defensive mindset with a sharp fall in allocations towards banks and a rise in allocations to energy companies and utilities.

Hedge funds take risk-off stance

Hedge fund managers provide an illustration of the risk-off mentality taking shape in this month’s survey, having reduced both leverage and exposure to equities. The weighted average ratio of gross assets to capital has fallen to 1.34 times from 1.49 times, the lowest in 20 months. Thirty-one percent of hedge funds have a leverage ratio of less than one time – compared with 19% in January.

Weighted net exposure to equities has fallen to 29%, down three percentage points month-on-month from 38 percent in January and the lowest since June 2012.

Emerging market sentiment close to lows?

The investor panel has indicated that sentiment towards global emerging markets is close to reaching a low and that improvement is in sight. While the view towards China has deteriorated further, investors see scope to return to the region.

A net 47% of regional fund managers in Japan, Asia Pacific and global emerging markets expect China’s economy to weaken in the coming year, up from a net 41% a month ago. The proportion of global asset allocators underweight emerging market equities has risen two percentage points month-on-month to a net 31% – a new record low.

On the brighter side, investors have indicated that they see value in the region. A record net 49% of the global panel believes that emerging markets is the most undervalued of the regions, compared with a net 36 percent in January. Furthermore, the proportion saying that emerging markets is the region they would most like to underweight in the coming year has fallen three percentage points month-on-month to a net 21%.

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