Fund Managers' Risk Aversion Reaches New High

by Phillip Morton, Investors Offshore.com

18 February 2008

Institutional investors are more risk averse now than they have been in seven years, Merrill Lynch's Survey of Fund Managers for February has revealed.

According to the bank's survey, conducted with the help of market research company Taylor Nelson Sofres (TNS), about 30% of the panel say that they have hedged against further falls in equities over the next three months.

Merrill explained that fears over the economy and corporate profitability have stimulated a rise in portfolio cash levels to an average of 4.7%, up from 3.9% in January. A net 41% of fund managers are overweight in cash, the highest since September 2001's terrorist attacks on the United States, while investors have a shorter-term focus than at any time since March 2003.

The bank's survey found that risk appetite has plunged to new lows, with a net 40% taking a lower level of risk than normal. The FMS Composite Indicator for liquidity and risk has fallen to 31, its lowest level since the survey first tracked risk appetite in April 2001.

"Risk aversion is so extreme and cash levels are so high, that the challenge is now to identify the catalyst that prompts money to return to the stock market," noted David Bowers, independent consultant to Merrill Lynch. "While it's not clear what that catalyst will be, there's no doubt that the ability to draw a line under the credit crunch will be an important step."

The survey found that equities bias remains embedded, and that investors remain predisposed toward equities. Holding them back is concern over the credit crunch's impact on corporate and economic health. A net 25% of respondents believe that equities are undervalued — three months ago that figure was a net 5%. A net 48% of respondents view bonds as overvalued.

The number of respondents who forecast a deterioration in corporate profits over the coming 12 months has risen to a net 68%, up from 57% in January. The percentage of managers who believe the global economy is in recession has doubled for the second month running to 16%, while the number who think a global recession is "likely" in the next 12 months rose to 28%, up from 19% in January.

Asset allocators are now unwinding their long-running strategy of being long equities, short bonds. This month, a net 8% said they were underweight equities, the first underweight reading since March 2003. Overweight positions in emerging market equities are starting to be pruned back.

Meanwhile, the bank concluded that investors' four-year love affair with continental European stocks has ended. Only 7% of asset allocators are overweight eurozone equities compared with 23% in January.

Sentiment within the eurozone itself is weakening, with a net 87% of respondents to the Regional FMS expecting growth in earnings per share to fall, while a net 25% believes inflation will fall.

"Eurozone investors are asking for rate cuts, worried not by inflation, but by a potential collapse in growth," explained Karen Olney, chief European equities strategist at Merrill Lynch. "Investors are sending a clear signal that they expect a raft of downgrades to consensus earnings forecasts — 96% of respondents say these forecasts are too high."

Eurozone investors believe that the European Central Bank's focus on inflation is overdone. A net 49% say that the bank's monetary policy is too restrictive.

Merrill Lynch, however, believes that while market turmoil might dampen consumer confidence in the short term, the eurozone's economic fundamentals are strong, with forecasts for GDP growth of 1.9% in 2008 and 2.1% in 2009. Furthermore, inflation should remain a concern for the ECB. Merrill Lynch forecasts inflation to rise to 2.7% in 2008, above the ECB's target (less than, but close to 2%) before falling to 2.0% in 2009.

“The market is pricing in 75 basis points of interest rate cuts, but given the inflationary outlook we simply do not believe that the ECB has room to manoeuvre and deliver these cuts,” observed Guillaume Menuet, European economist at Merrill Lynch.

A total of 190 fund managers participated in the global survey from 1st February to 7th February, managing a total of USD587 billion. A total of 171 managers participated in the regional surveys, managing USD393 billion.

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